Letter #15: Blockchain - A Worldwide Revolution in Data and Value Transfer
Read now to learn what blockchain is and how it’s driving value for humanity with its revolutionary technology.
Bitcoin, Ethereum, and other cryptocurrencies can be found everywhere these days. Your friends are investing in them, your store wants to trade its goods to you in exchange for them, and your bank wants to make a profit off of them. Cryptocurrencies have a variety of use cases, but what enables cryptocurrencies to actually work and what makes them so secure? The answer is a revolutionary new technology called Blockchain.
The ABCs of Blockchain
At its core, a blockchain is simply a ledger, or record, of every transaction that has ever occurred on the blockchain’s network. Any network participant can broadcast a transaction to the network, like a transfer of Bitcoin to an artist in exchange for a digital piece of art (aka an NFT or “Non-Fungible Token”), and have it confirmed and added to the blockchain by the nodes or validators that support the network. Transactions that are broadcast to the network around the same time are grouped together into “blocks”, time stamped to help order the block correctly on the blockchain, and then connected to the preceding block to form the complete chain of all transactions.
The purpose of a blockchain is to store information, and in that regard it can seem similar to databases that support your favorite apps like Twitter or YouTube. However, there are a variety of features inherent to blockchain that set it apart from other types of databases:
Decentralization is the most commonly cited feature of many blockchains, and for good reason. The vast majority of databases are controlled by a single entity, typically a corporation or a government. For example, Twitter exerts complete control over all of the data shared on its platform and the U.S. Internal Revenue Service manages access to complete records of citizens’ tax information. Any user is completely reliant on the controlling entity to protect the information and to grant access to it. And if that entity doesn’t want to share the information with you, even if it's your own information, then you won’t have access.
Blockchains on the other hand are typically decentralized, which in essence means that they are not controlled by any one person or group. The Bitcoin network for example has nearly 15,000 nodes, most of which are run by many different people, companies, and groups around the world.
So why is decentralization important? A decentralized network doesn’t rely on any one entity to provide it with security or legitimacy. It relies on every one of the participants securing it to validate all transactions. And because those participants are globally distributed and have competing priorities, there is no single point of failure and no risk of one group co-opting the network to benefit themselves.
Anonymous or Pseudonymous
The IRS knows who you are. So do Twitter, your bank, your Uber driver, and everyone else at the ever expanding number of corporations and government agencies that we interact with on a daily basis. In order to gain access to their systems, we are required to provide a host of identifying information, such as our names, birthdays, gender, email address, and more. Don’t want to share it? Your options are to do it or to not use their system.
Blockchains, however, are typically permissionless. Anyone at all can use them: good or bad, rich or poor, no matter where you live or who you are. This feature of blockchain is enabled by the fact that users are either anonymous or pseudonymous. Who you are on a blockchain can be a simple chain of letters and numbers. And for certain blockchains, the alphanumeric entry that represents your participation in the network isn’t publicly visible unless you choose to make it so. The power of the blockchain is in the hands of its users. All of them.
We discussed above that a blockchain is a string of blocks of transactions connected sequentially thanks to the use of time stamps. However, each block also contains a specific reference to the block that preceded it. Such is the case for every block in the blockchain, meaning that every block is interconnected with every other block. If anyone were to try to change a block in the blockchain, the fake block would have no interconnectivity with the rest of the chain and would be easily identifiable to the rest of the network as fraudulent.
Immutability matters because participants can trust that once their transaction is confirmed on the blockchain, it will be nearly impossible for anyone to reverse or change it. Value and information can be exchanged freely on the blockchain without having to rely on a third party to validate that the transaction is correct. And users trust the immutability of blockchain. As of writing, users have currently entrusted several trillion dollars’ worth of value to cryptocurrency blockchains and protocols.
The programmability of blockchains is finally having its day in the sun. DeFi, NFTs, and more rely wholly on the ability for blockchains to be programmed to perform a certain function if specific conditions are met. Because there are no third parties controlling the network, a blockchain is governed by the rule of code, rather than the rule of law or corporate rules, both of which are subject to the whims of whatever person or group happens to be in charge.
Blockchain programmability is often used synonymously with the term smart contract, which is a “self-executing contract with the terms of the agreement between buyer and seller being written directly into code”. A number of blockchains, such as Ethereum, Bitcoin, and the Binance Smart Chain allow for programmable smart contracts. And, for better or for worse, tens of thousands of people around the world are entrusting their information and their wealth to decentralized platforms built on top of smart contracts.
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Man vs. Machine: Proof of Stake & Proof of Work
Not all blockchains are created equal and not all blockchains operate in the same way to reach consensus about which transactions are valid and should be included on the blockchain. There are a variety of different blockchain types, but the two most common are Proof of Stake and Proof of Work:
Proof of Stake
The Proof of Stake (PoS) consensus algorithm determines the amount of power that any entity has to validate transactions on the network based on the amount of the network’s token that the entity holds compared to the total amount of available tokens. Tokens on a public blockchain can typically be acquired by anyone. The fewer tokens you have, the less mining or validating power you have, and vice versa when you have more tokens.
Proof of Work
The Proof of Work (PoW) consensus algorithm relies purely on the brute processing power of machines on the network to confirm transactions. PoW requires that machines randomly guess hundreds of millions of answers in order to correctly solve an arbitrary mathematical puzzle. This seemingly random methodology ensures that no one is able to game the system for their own benefit. The only way to have a better chance at solving the puzzle is to pay for stronger computers, and more of them.
Can I Use Your Blockchain?
Throughout most of this article, we’ve talked about blockchain in the context of being “permissionless”, or open to all people and not controlled by any one entity. Permissionless blockchains are the most well-known and those that you are most likely to encounter in the news or in daily life.
However, there is a subset of blockchains that eschew accessibility and decentralization in order to meet a specific entity’s goals for the blockchain. For example, perhaps the creator of the blockchain wants to reduce the reliance on any one participant in a network (i.e., eliminate the single point of failure), but for one reason or another doesn’t want to allow just anyone to access the network and associated information. Blockchains of this type are referred to as “permissioned”.
There are a variety of permissioned blockchains out there, but because they're not open to anyone, you’re much less likely to hear about them. Hyperledger Fabric is an example of a permissioned blockchain that is typically used in enterprise contexts, such as when competitors in the same industry want to participate in a blockchain together without necessarily handing over the keys of the kingdom and trusting each other completely. JPM Coin, from the bank J.P. Morgan, is another example of a permissioned blockchain that allows “participating clients to transfer US Dollars held on deposit with J.P. Morgan” and helps “solve common hurdles of traditional cross-border payments”.
Blockchain Does It Better
The most common use case for blockchain these days is securing and transferring cryptocurrencies and crypto-assets from one participant to another. However, that is far from the only way that blockchains can be used. After all, blockchains can facilitate the transfer of a variety of different types of information, and all such transfers benefit from the features of blockchain discussed above. We’ll touch upon a handful of alternative use cases here:
The retention and transfer of health care information is one of the most regulated industries in the world today. It is an industry that is ripe for disruption as a vast number of patient files are retained on aging systems that are often poorly secured. Health care records can benefit from the pseudonymity and immutability offered by blockchain to ensure that health care data stays more private while also being protected from unauthorized change.
The country of Estonia gives an example of an effective rollout of blockchain technology in the context of health care, having used blockchain since 2016 to secure the sensitive health information of its 1.3 million citizens. The main architect of the foundation that implemented the project described the benefits of blockchain in the following way:
We are using blockchain as an additional layer of security to help us ensure the integrity of health records. Privacy and integrity of healthcare information are a top priority for the government and we are happy to work with innovative technologies like the Blockchain to make sure our records are kept safe.
Proof of ownership within the real estate industry is one of the most costly transactions that most of us will encounter during our lifetimes. If you’ve ever purchased or sold a house, then you know you have to pay significant fees to escrow companies, title companies, governments, and the like to ensure that your purchase or sale goes through.
Blockchain offers the ability to transfer real estate from one party to the next while significantly reducing the reliance on “trusted” third parties to make the transaction work. Additionally, blockchain offers the ability to tokenize real estate, or digitally represent ownership of the asset on a blockchain. Through real estate tokenization, ownership of the asset can easily be subdivided into small portions, opening up real estate investing to millions of small time investors who are often excluded from such transactions.
Supply chain is another area that is ripe for disruption through blockchain. Supply chain is the management of a good from the raw materials being pulled out of the ground all the way to the finished product being put on the shelf for consumption. Along the way, the goods and their components can flow through a host of different locations and be handled by dozens or more different companies. Tracking a good through the supply chain can understandably be a nightmare, especially in the context of modern companies’ ESG (environmental, social, governance) initiatives.
The ease and low cost of securely transferring unchangeable data through the blockchain can greatly simplify the process of tracking goods through the blockchain. A decentralized blockchain can be accessed by anyone around the world, meaning there’s no need to trust a third party or any one member of the supply chain to certify the goods’ provenance. That information from start to finish can be uploaded to the blockchain. And because blockchains are immutable, no one along the way can falsify data to cover their tracks.
In today’s world, it’s common to live a good portion of one’s life online. Want to talk to friends? Video chat them through FaceTime. Want to buy a movie? Stream it on your smart TV. Want to order dinner? Get it through the Grubhub app.
However, for some reason the process of voting in an election is still largely non-digital. We have devices in hand that we trust for almost every part of our lives and yet we are still expected to go in person to a polling station and fill out a ballot with pencil and paper.
The promise of blockchain is that voting information can be transferred securely, pseudonymously, and immutably by anyone anywhere with a smartphone and an internet connection. Gone are petty arguments about where to put a polling station.
One of the main drawbacks of today’s internet is the identity verification process. If you use one hundred different websites and apps, each will recommend that you use a unique username and password. But who can honestly remember one hundred different usernames and passwords?
Third-party password managing software is not an adequate solution. It suffers from relying on a single point of failure. If the software company gets hacked, the hackers can access your login to any site or app for which you use the password manager.
Imagine, however, that your online identity is tied to a representation on the blockchain. A public blockchain can be viewed by each of the websites and apps that you want to use. And they could restrict access to the content they maintain that’s tied to you unless your private key is used to authenticate you upon login. No longer would you need to protect dozens of different passwords or rely on a third-party to do it for you. All you need is to protect the private key backing your online identity.
The Promise of Blockchain
Blockchain promises to revolutionize the way we transfer value and information throughout the world. Our current system is flawed. It relies heavily on biased third parties to act as security enforcers and arbiters of truth. Next to the unbiased, mathematical sovereignty provided by today’s blockchain, what third party system can ever truly compete?
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This is not financial advice. This newsletter and related content are for informational purposes only. Cryptocurrencies and digital assets can be risky. Always do your own research before making any sort of investment.
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