Last year, Ripple Labs, creator of the virtual currency XRP, was fined
$0.7 million (~£540,000) by the US Financial Crimes Enforcement Network
for violating regulations concerning money laundering.
Some observers cite this as the moment cryptocurrencies shaved off
their startup hipster beards, put on a tie, and went mainstream. Being
fined by a regulator means that you’re part of the financial services
industry at last.
Given that the first and most famous cryptocurrency, Bitcoin, was
launched back in 2009, it has taken the wider industry a relatively long
time to warm to it. But now suddenly everyone is talking about
bitcoin’s underlying blockchain technology as a disruptor of potentially
massive proportions: Sweden is trialling a new land registry that uses
blockchain , dozens of startups spanning numerous sectors are poking
around at possible uses, and importantly policy makers such as the
European Parliament have voted in favour of a more hands-off approach
towards blockchain tech regulation .
So, what’s the connection between Bitcoin and blockchain? And why the renewed interest in the latter?
It's kinda like a database
Blockchain is a ledger of records arranged in data batches called blocks
that use cryptographic validation to link themselves together. Put
simply, each block references and identifies the previous block by a
hashing function, forming an unbroken chain, hence the name.
Put like this, blockchain just sounds like a kind of database with
built-in validation—which it is. However, the clever bit is that the
ledger is not stored in a master location or managed by any particular
body. Instead, it is said to be distributed , existing on multiple computers at the same time in such a way that anybody with an interest can maintain a copy of it.
Better still, the block validation system ensures that nobody can
tamper with the records. Rather, old transactions are preserved forever
and new transactions are added to the ledger irreversibly. Anyone on the
network can check the ledger and see the same transaction history as
everyone else.
Effectively blockchain is a kind of independent, transparent, and
permanent database coexisting in multiple locations and shared by a
community. This is why it’s sometimes referred to as a mutual
distributed ledger (MDL).
There’s nothing new about MDLs, their origins traceable to the
seminal 1976 Diffie–Hellman research paper New Directions In
Cryptography . But for a long time they were regarded as complicated and
not altogether safe.
It took the simpler implementation of blockchain within Bitcoin to
turn things around. The permanence, security, and distributed nature of
Bitcoin ensured it was a currency maintained by a growing community but
controlled by absolutely nobody and unable to be manipulated.
Following the launch of Bitcoin, dozens of vigorous tech startups have
vied with each other to produce the Next Big Thing in blockchain-based
cryptocurrency, from the relatively-well-regarded Ethereum to the
frankly ludicrous Coinye West.
A notable drawback of blockchains is that their distributed nature
demands constant computational power in many multiple locations, and all
the on-going accumulated (electrical) power that entails.
Enlarge / A satellite image of Ireland, for those not familiar with the shape of the country.
“You may have heard a myth that bitcoin consumes the energy
consumption of Ireland,” says Michael Mainelli, executive chairman of
financial tech think tank Z/Yen. “That’s absolutely wrong. It’s only
half the energy consumption of Ireland.”
So when one large bank recently announced that it planned to bring out
400 different kinds of virtual currency, they risk consuming 200
Irelands’ worth of power just to keep them running.
In fact, the renewed interest in blockchain has less to do with
inventing yet more currencies to spend at hipster cafes than with
realising the benefits of an MDL in cutting costs and reducing the power
of monopolies elsewhere in the financial services industry.
“Financial services are based on mistrust,” explains Mainelli. “So
what do we do? We set up a registry and get someone to handle the
transactions. If I register my sailing boat and then sell it, the
transaction is safeguarded. If something then goes wrong with the boat,
we can go back to the registry and look at the records.”
This in turn produces a monopoly of third-party services to manage
exchange and settlement in the financial industry, which can be
expensive and is not without risk of manipulation—the Libor scandal
being just one recent example.
Blockchain: For when everyone distrusts each other
But if the registry was not owned by a central third party but sitting
on multiple machines and everybody had copies, it would have resilience
and looking up transactions would be quick. And with the data being
immutable once entered in the ledger, it would provide a permanent
record that financial regulators and auditors could quickly fall in love
with.
In principle, MDLs have a much wider potential beyond financial
services. Solving the issue of trust and ensuring non-malleable
permanence of the data could make it invaluable for managing the
provenance of assets, date-stamping events, geo-stamping those events in
a specific location, establishing identity, and so on.
In other words, it’s a souped-up audit trail for anything you like,
not just a cryptocurrency. It’s not just one system. Indeed, the
situation can be compared of the database revolution of the 1970s: there
wasn’t just one type or structure for a database, you created the
specific database you wanted for your own purposes.
The current resurgence in interest in blockchain , therefore, could be a
welcome sign that sanity is breaking out in the financial technology
(fintech) investment arena, as those working in financial services and
other sectors begin to recognise the practical benefits beyond the
Bitcoin hype. Indeed, one day we may look back on this time as a
transitional period when everything changed. Blockchain could become the
norm for data records sooner than we think. Mainelli offers an example:
“Imagine I showed you an app on my phone that showed all the ski
resorts around the world. You wouldn’t say ‘Wow, does that use a
database?’ Well, duh, what else?
“In about three or four years, you’re going to be looking at an
identity app and perhaps you’ll be saying ‘Wow, does that use a
distributed ledger?’"
Alistair Dabbs is a London-based freelance technology journalist,
author and columnist, most commonly specialising in digital imaging and
responsive publishing despite his print industry roots.