Extremely simplified, Blockchain is an indelible, anonymous, public ledger of every transaction you make.

 Source: Xische Reports 2017

Source: Xische Reports 2017

How Blockchain works

The mining and exchange of a cryptocoin works like this: 

Step 1: Mining. 

Assuming you don’t have access to a faucet, or USD 4,000 to buy a bitcoin today, your participation in the exchange starts with ‘mining’ bitcoin, as if you were mining for gold to take with you on a shopping trip. 

Bitcoin is mined today exactly as Wei Dai envisioned the process in 1998. Once your computer is connected to the Bitcoin network through a bitcoin wallet, you can start mining. Mining happens any time a bitcoin transaction is requested on your network. In order to complete the transaction, a unique hash needs to be assigned to each request. To create that hash, every computer connected to the network races to solve a short math problem. The first computer to solve the problem — which generates the unique hash — receives an amount of bitcoin proportional to the complexity of the problem. The harder the problem is to solve, the more bitcoin you earn. 

Step 2: Setting up your wallet.

Now that you have some bitcoin, you probably want to spend it on something. First, you need to set up your wallet. Your wallet is a unique ledger assigned to you and protected through a public key infrastructure to keep your identity anonymous. The ledger tracks how many bitcoins you — and everyone else on your network — have to spend by recording every transaction ever made. Functionally, it is similar to the ledger of a traditional cheque book, except that it is readable by everyone on the network. 

Step 3: Requesting a transaction.

With your wallet full of bitcoin, now you’re ready to spend. 

Every exchange of bitcoin begins with a transaction request. When you request a transaction, a new ‘block’ is created (like a new row in your cheque book) that contains all of the details of the transaction. Your block is assigned a new hash that is mathematically verifiable as unique. 

Step 4: Verifying a transaction.

Once your block is created, each participant in the network verifies that all of the details for the transaction are correct. This is done by comparing the hashes of all of the previous transactions on the ledger (for example, when you first deposited money in your wallet). 

This is the step that ensures you have enough bitcoin to complete the transaction, and that the party you are transferring funds to is able to receive them. 

Step 5: Performing the transaction.

Once every computer in the network verifies the transaction, it is cleared to proceed. The funds change accounts, and the public ledger is updated accordingly. 

Step 6: Storing the transaction data.

When you began your transaction request, you created a new block that stored all of the details of the transaction. As soon as your transaction is completed, that block gets added to the public ledger. That ledger is viewable by everyone in the network, and it is made up of all of the blocks of every transaction that has ever taken place on the network.  

Because each block is linked to a unique hash, the ledger cannot be altered: if someone were to go in an try to change the details of a past transaction, the hash would change (because the data changes), and as a result, that block and all following blocks would become invalid. 

In this way, the exchange network is not only anonymous (using public key infrastructure) and decentralised (each participant in the network verifies each transaction), it is also tamper-proof. 

This public ledger of connected blocks bearing the complete and indelible transaction history of the network is called ‘the Blockchain’, and it is the undergirding technology on which the Bitcoin system operates. 

 

Beyond Bitcoin

When the banks finally lifted the hood on Bitcoin, they discovered a powerful new protocol that could fundamentally transform how their institutions utilised the internet for transactions. 

Blockchain adds an extra layer of security for all participants in an ecosystem. Rather than rely on one centralised repository, Blockchain’s decentralised model distributes decision-making power across a wide network of connected machines. To launch an attack, a malicious actor would need to divide his attention to overwhelm 51% of the network’s distributed nodes, rather than focusing his efforts on a single main gate. 

Blockchain’s distributed ledger also enhances trust among participants on the network, which could include other banking institutions or customers themselves. Blockchain’s hash protocol ensures that no record that has been stored on its ledger can be altered. Changing any data on the ledger would result in a new hash being created, which would invalidate the entire chain after the record in question. With an unalterable ledger, all participants in the network can be sure that the each transaction has proceeded exactly and only as recorded. 

Because the Blockchain ledger stores all historical transaction data on a distributed network, the requirements to complete a transaction can be verified near-instantly. If Bill previously gave $5 to Sue, and now Sue wants to give $3 to Evan, Evan’s and Sue’s banks don’t need to independently go and check if Sue has $3 to give: as soon as Sue begins the transfer request, all of the parties on the network verify that Sue is able to send the money (and that Evan is able to receive it), by checking the Blockchain ledger. As soon as the request is verified, the value changes hands. 

Using Blockchain, banks could cut trade processing times from three days to three minutes or less. Once they understood what the Blockchain could do, the banking world rolled up their sleeves. 

In March 2015, Nasdaq OSX, which oversees the Nasdaq stock exchanges, announced that it would begin testing a system using Bitcoin’s Blockchain to oversee stock trades on the Nasdaq Private Market, a separate market for private companies. By managing pre-IPO trades on the Blockchain, CEOs would be able to instantly see who is buying and trading their stock. Before Nasdaq’s pilot, pre-IPO companies were tracking this kind of data on Excel spreadsheets.[20]

Nasdaq’s move highlighted a growing interest in Blockchain from the banking and technology sector. By the end of the year, over a half dozen financial and tech industry heavyweights — IBM, Cisco, the London Stock Exchange and JP Morgan among them — were experimenting with building their own Blockchains.[20]

“Bitcoin is like MySpace… it is paving the way for the Facebook or Twitter of Blockchain.” — James Angel [20]

Bitcoin’s Blockchain is revolutionary, but it is also imperfect. James Angel, a professor of finance at Georgetown University, compares Bitcoin to MySpace. While bitcoin as a currency is deeply flawed, according to Angel, its underlying technology can be adapted to fundamentally change the financial sector. Bitcoin’s Blockchain set the ball in motion, but it is more likely that another platform will emerge as the true heavyweight. 

Inspired by the Bitcoin Blockchain, IBM and Digital Asset Holders (DAH), a start-up founded by a former JP Morgan executive, began work on their own Blockchain as part of the Open Ledger Project, supported by Linux. They dubbed their blockchain ‘Hyperledger’.[21]

In keeping with the Linux ethos, Hyperledger is open source: although IBM has contributed the bulk of the code for the Blockchain ledger, it is freely open and editable to others. Still more important for the future of Blockchain, Hyperledger is also a distributed ledger, and machines from many different organisations can participate in the network. As Marley Gray of Microsoft puts it, “Blockchain is essentially worthless within a single organisation. You have to have parties that are not yourself”.[21]

“Blockchain is essentially worthless within a single organisation.” — Marley Gray, Microsoft

By the close of 2015, with Blockchain being embraced by governments, banks, and the technology industry, it became clear that Bitcoin was only the beginning; the first use case of a technology that held the potential to radically transform the Internet.

 

Smart Contract Breakthrough

As interest in Blockchain grew, developers began exploring the system’s potential beyond financial transactions. 

Although initially designed for monetary exchanges, early advocates recognised that the technology could be used to oversee the exchange of any contract of record. The title deed of a new home, the sale of a used car, the execution of a will, a driver’s licence — even a ballot vote. 

Not only can a Blockchain record the exchange of these contracts on an indelible ledger, it can, through a decentralised network, automatically execute contracts and eliminate the need for a middleman.

Take for example the purchase of a new home:

In most jurisdictions, finding your dream home, though you might search for months, only gets you to the starting line. Most buyers will take out a mortgage, which means you will need to have your mortgage loan pre-approved from the bank before making an offer, and your bank will require a credit score from a third party credit-rating firm. You will likely be closing with a real estate broker, not the current home owner. So once an offer is made, the validation process will proceed in duplicate with the brokers and bankers on each side of the transaction filing forms and reports. And there are any number of inspections that you, as the new owner, have the right to request. These inspections will need to be approved, conducted, and recorded. When you finally reach the settlement stage, your local government will step in to record transition of ownership. Then begins the lengthy process of registering for various utilities, phone lines, internet, cable, updating your address with the postal service, updating your voting address, and updating your address for food delivery apps.

A real estate application on Blockchain, utilising self-executing smart contracts, can condense this process to just a handful of steps, with banks, brokers, and the local government participating on a decentralised Blockchain network with a distributed ledger.

 

Ethereum and the World Computer

Smart Contracts are open-ended: almost anything that can be transacted can be represented by a Smart Contract. The closest parallel to a Smart Contract is a website. Websites are used for the exchange of information, and all website developers follow a certain protocol when programming their sites. But the actual information on the site is infinitely variable. 

Whereas Bitcoin restricted itself to one type of Smart Contract, for the purpose of the exchange of bitcoins, the team behind Ethereum saw an opportunity to develop a Blockchain that would support any potential transaction on a peer network. The language on which Ethereum is built is Turing-complete — meaning Ethereum is capable of doing just about anything that can be expressed in a computer programme. And because Ethereum rests on a Blockchain, the history of every transaction is stored on an enormous, distributed computer: the Ethereum Virtual Machine (EVM).[22] [23]

“Ethereum is literally a computer that spans the entire world.” — Haseeb Qureshi [24]

Ethereum has ignited a surge of interest in Smart Contracts and the supporting ecosystem of tools required to build Smart Contracts on the EVM. Ethereum’s value has skyrocketed over the last six months.[24]

 

The Internet of Transactions

Blockchain is not a ‘new’ internet, nor is it trying to replace the internet. By deploying a decentralised, hash-based protocol with an indelible ledger, Blockchain is offering a powerful alternative to the internet processes that have become routine since the widespread adoption of the World Wide Web. 

By connecting centralised servers capable of storing massive amounts of data to a graphical user interface that allowed humans to easily read and interact with that data, the World Wide Web ushered in an internet of information that fundamentally changed the way we access and store information.

Blockchain has the potential to effect the same revolution, but for transactions. If its potential is realised correctly, we could trade stocks, buy homes, and play fantasy football on the Blockchain with the same security and ease with which we watch cat videos on YouTube.