Blog. Bitcoin is overhyped, but blockchain has great potential
In 2008 Bitcoin was introduced. Issuance and control of this new electronic currency are not regulated by a central bank but by a network of computers. You can send Bitcoins to another person without going through an intermediary, such as a bank, that authenticates and settles the payment. Bitcoin is controversial because it has been associated with illegal trade, for example through the website Silk Road which was shut down by the FBI. Other alternative currencies are not really taking off either because the user benefit is too small. There are already 400 so-called cryptocurrencies that have failed.
Nevertheless, Bitcoin is important. Worldwide over $1 billion has been invested in Bitcoin related startups. The focus is shifting from digital currencies to other uses of blockchain, which is the technology behind Bitcoin. Blockchain technology can be used for any type of structured information and can process transactions between two or more parties faster, cheaper and safer than is possible with traditional and centralized transaction systems.
Now that not only startups, but also incumbents are investing in blockchain technology, the tipping point for this technology is approaching.
Shifting power from central authorities to users
Blockchain is new technology and the related terminology is still in development. For most people concepts such as distributed ledger or peer-to-peer transaction system are meaningless without wider context. In short, Bitcoin is an application of blockchain technology which uses a distributed database. And a database you may also call a ledger. Now let’s go over this step by step.
Companies and institutions keep all kinds of records. They maintain a ledger to record transactions and ownership of assets. Previously this was done on paper, nowadays it happens with the help of automated transaction systems. All data is stored in databases. When a transaction takes place between two organizations both parties update their records.
Ledgers that record asset ownerships of third-parties and transactions between them are more complicated. Banks manage the checking accounts, savings accounts, stocks and mortgages of their clients. The Office of the Land Registry records ownership of properties. Another government agency keeps track of the cars on the road. With every transfer of ownership what is added on one side needs to be subtracted on the other. Trust is essential for this system to function and these organizations pay great attention to securing their systems.
New to blockchain is that the database is not maintained by a central organization such as a bank or government agency. All users in the network have a copy of the database and all have real-time access to the same information. The verification of the transactions is embedded in the network through a consensus mechanism. It is only after more than half of the databases have verified and approved a transaction that it is accepted and added to the blockchain. Transactions can’t be removed, so the transactions are always traceable. Reliability is further enhanced by data encryption and access controls.
The reliability of this system is not dependent on a single party. In other words, there is no single point of failure. You can only trade with other people that you do not know personally if you have trust in the system. Blockchain offers that trust without an intermediary that validates the transactions and can intervene and censor.
Applications of blockchain beyond alternative currencies
The use of blockchain is not limited to currencies. All types of information and ownership can be recorded and transactions facilitated, for example to support the Internet of Things. If you have a washing machine that is connected to the internet it can automatically order detergent. The blockchain registers who the owner of the machine is and where the detergent must be ordered from. The payment is made automatically and the owner is kept informed via smartphone notifications.
Many databases that record who owns which assets or who has certain rights to these assets may be suitable for blockchain. These include physical property such as real estate, cars and diamonds, as well as intellectual property such as art and science. You can, for example, combat fraud or theft in this way.
Electronic voting can also be managed with blockchain. The blockchain records who has voting rights, who has already voted and what (or who) has been voted on. Other applications include games, gambling and betting. New markets are created in several areas.
Public and private blockchains
Bitcoin is an example of a public blockchain, also referred to as a ‘permissionless’ blockchain. Anyone can take part in it.
The biggest growth is currently taking place in the private blockchains. Only pre-approved computers may participate. Hence this is also called a ‘permissioned’ blockchain. Many commercial organizations do not want to give up control over their data. This is not only driven by concerns about security but also by laws and regulations.
Regulators, especially in the financial sector, play a major role here. They are accustomed to appeal to financial institutions regarding the reliability of their systems. This is not possible in a public blockchain. Banks must also comply with Anti Money Laundering (AML) and Know Your Customer (KYC) regulations.
This effectively means that regulators insist on private and permissioned blockchains. In order to stop certain transactions or to provide guarantees the role of the financial institution as intermediary in this process remains critical.
Consortiums set standards, promote applications and keep control
Candidates for blockchain applications in the financial sector are the relatively labor-intensive and complex administrations of international currency trading, bonds and options. It is possible to log these contracts in a shared ledger, while the individual users remain anonymous. Supervisors may follow the activities on the market, but they do not see who made certain transactions.
Several financial institutions have now joined forces in a consortium which aims to further develop blockchain technology. ING is participating in R3, a consortium of more than 40 major banks. ABN AMRO is part of the Hyper Ledger project which is a more diverse group of financial institutions, consultants and IT companies.
For many blockchain startups it will be very difficult to compete with these consortiums and they may well choose to cooperate with larger firms instead of trying to beat them. That way they will become co-creators rather than disruptors. Blockchain brings efficiency, but it is not the end of financial institutions as some market watchers have predicted.
In addition, we also see the emergence of blockchain platforms like Ethereum which offer blockchain technology as a service. Here you can build your own applications without having to develop blockchain technology by yourself.
Ethereum provides a global infrastructure for smart contracts that let you register your property and trade it. All the conditions are saved in the blockchain and are executed automatically (self-executing). The assumption is that because no one is in control everyone can rely on it.
Consider exponential growth
While Bitcoin and other alternative currencies are overhyped the underlying blockchain technology has serious potential. Benefits such as reducing transaction costs and reducing fraud warrant further research and more experiments.
Blockchain is a typical example of an exponential technology. The first stage of development is slow and remains below the radar. We have so far seen no successful large-scale applications of blockchain. However, early indications are telling us that the investments in blockchain are increasing and that blockchain is also being embraced by large, existing organizations. As a result, between 2020 and 2025 we could reach the tipping point where blockchain technology gets preference over the old (legacy) transaction systems.