The Bank of England’s recent report on Payment Technologies and Digital Currencies considered the blockchain technology that enables digital currencies to be a “true technological innovation” that could have far-reaching implications for the financial industry.
So what is the blockchain and why are you guys so excited?
The blockchain is a decentralized online public ledger of all digital transactions that have taken place. It is the digital currency’s equivalent of a high street bank’s ledger, which records transactions between two parties.
Just as our modern banking system could not function without the means to record fiat currency exchanges between individuals, neither could a digital network function without the trust that comes from being able to accurately record sell ethereum in Nigeria digital currency exchanges between parties.
It is decentralized in the sense that unlike a traditional bank, which is the sole holder of an electronic ledger of their account holder’s savings, the blockchain ledger is shared by all members of the network and is not subject to the terms and conditions of any particular financial institution or country .
So what? Why is this preferable to our current banking system?
A decentralized currency network ensures that by being outside of the increasingly interconnected current financial infrastructure, one can mitigate the risks of being a part of it when things go wrong. The 3 main risks of a centralized currency system highlighted as a result of the 2008 financial crisis are credit, liquidity and business failure. In the US alone, 504 banks have failed through bankruptcy since 2008, up from 157 in 2010 alone. Typically, such a bankruptcy does not jeopardize the account holder’s savings due to federal/national assistance and insurance for the first few hundred thousand dollars/pounds, since bank assets normally absorbed by another financial institution, but the impact of the collapse can cause uncertainty and short-termism. Term issues in accessing funds. Because a decentralized system like the Bitcoin network does not depend on a bank to facilitate the transfer of funds between two parties, but rather relies on its tens of thousands of users to authorize transactions, it is more resilient to such failures since there are so many Backups as has members of the network exist to ensure transactions continue to be authorized in the event a member of the network “breaks down” (see below).
A bank need not fail to impact savers, however, operational IT outages such as those that recently prevented RBS and Lloyds customers from accessing their accounts for weeks can impact a 30-40 year old’s ability to Withdraw Savings Legacy IT infrastructure groaning under the strain of keeping up with growth in customer spending and a general lack of investment. A decentralized system does not rely on this type of infrastructure but relies on the combined computing power of its tens of thousands of users ensuring the ability to scale as needed, where a failure in any part of the system will not cause the network to grind to a halt.
Liquidity is a last real risk of centralized systems, in 2001 Argentinian banks froze accounts and introduced capital controls due to their debt crisis, Spanish banks changed their fine print in 2012 to block withdrawals above a certain amount and Cypriot banks briefly froze customer accounts and used up to 10% of individuals’ savings to help pay down the national debt.
As Jacob Kirkegaard, an economist at the Peterson Institute for International Economics, told the New York Times about the Cypriot example: “The deal reflects that being an unsecured or even secured depositor in banks in the euro area is no longer as safe as it is earlier.” In a decentralized system, payment is made without a bank facilitating and authorizing the transaction, with payments only being validated by the network when there are sufficient funds, there is no third party to stop a transaction, abuse it, or devalue the amount you hold.
OK. You make a point. So how does the blockchain work?
When a person makes a digital transaction and pays another user 1 bitcoin, for example, a message is created that consists of 3 components; a reference to a previous record containing information proving that the buyer has the means to make the payment, the address of the recipient’s digital wallet into which the payment will be made, and the amount to be paid. Finally, any terms for the transaction that the buyer can specify are added, and the message is “stamped” with the buyer’s digital signature. The digital signature consists of a public and private “key” or code, the message is automatically encrypted with the private “key” and then sent out onto the network for verification, whereby only the buyer’s public key can decrypt the message.
This review process is designed to ensure that the destabilizing effect of “double spending” that poses a risk on digital currency networks does not occur. Double Spend means John gives George £1 and then gives Ringo the same £1 (Paul has had to borrow £1 for a few years). This may seem inconsistent with our current banking system and in fact the physical act of a fiat currency exchange keeps John from giving away the same £1 twice but when it comes to digital currencies which are just data and have the ability to be copied or edited Relatively easy to obtain information, the risk of 1 unit of digital currency being cloned and used for multiple 1 bitcoin payments is real. The ability to do so would destroy all trust in the network and render it worthless.
“What the deal reflects is that being an unsecured or even secured depositor with banks in the euro area is not as safe as it used to be.”
To ensure the system isn’t abused, the network takes every message automatically generated by a buyer and combines several of them into a “block” and presents them to network volunteers, or “miners,” for review. Miners compete to be the first to validate a block’s authenticity, special software on home computers automatically attempts to verify digital signatures and ensure that the components of a transaction message flow logically from the previous one used in its creation, and it in turn mirrors the one preceding it block used in its creation, and so on and so on. If the sum of the preceding components of a block does not equal the whole, an unintended change has probably been made to a block and authorization can be stopped. A typical block takes 10 minutes to validate and therefore go through a transaction, although this can be sped up by the buyer adding a small “tip” to encourage miners to validate their request more quickly, with the miner processing the block -Puzzle solves rewarded with 25 bitcoins plus any “tips” so new currency is circulated, this incentive ensures volunteers continue to maintain the integrity of the network.
By allowing anyone to compare and validate a proposed change against the ledger, blockchain eliminates the need for a central authority like a bank to administer it. By removing this middleman from the equation, numerous savings in terms of mandatory transaction fees, processing times, and restrictions on how much a transaction can be made and to whom can be negated.
Sounds too good to be true.
has its own particular risks , a decentralized one is no different. The main threat to Bitcoin’s decentralized network is the “51% threat”, where 51% refers to the number of total miners on the network working together in a mining “pool” to validate transactions. As it becomes more costly for a person in terms of time and computing power to successfully validate a transaction as the network grows larger and more mature, individual miners are now joining “pools” where they combine their computing power to ensure a smaller one but more regular and consistent returns. Should a pool grow large enough to include 51% or more of all network users, it could theoretically validate massive double-spend transactions or refuse to validate authentic transactions en masse, effectively destroying trust in the network. Although there are more incentives built into the system to legitimately mine Bitcoin than destroying it through fraud, the 51 percent threat poses a risk for such a decentralized system. To date, mining pools are handling this issue responsibly and becoming voluntary Steps taken to limit the formation of monopolies as it is in everyone’s interest to maintain a stable system that can be trusted.
So… despite that risk, the Bank of England likes the thing that sounds like it could put them out of business?
Specifically, the BoE looks beyond bitcoin and digital currency payments and envisions ways in which blockchain can make existing financial products and platforms more efficient and add value to them. One only has to look at existing financial assets such as stocks, loans or derivatives, already digitized but sitting on centralized networks, to appreciate the possibilities that exist for the individual by removing the middleman…
… and become your own stockbroker. Colored Coins is a project that aims to allow anyone to convert their assets or property into something they can trade. Think of The Antiques Roadshow. I love this show, especially when a little old sweetheart finds out she used a £200,000 14th-century Ming dish to store fruit on her dresser. Colored coins would allow the court owner (or his car or house) to have one or more of his bitcoins represent some or all of the value of his wealth so that they could be exchanged for other goods and services, a individual Bitcoin worth a total of £200,000 or they issue 200 coins, each worth £1,000.
Similarly, a company could issue stocks represented by digital currency directly to the public, which in turn could then be traded without the need for an expensive IPO or traditional exchange, and shareholders could vote through a secure system similar to how transactional news is currently used to be created. Patrick Byrne, CEO of one of the largest buy or sell ethereum US retailers, which became the first major online merchant to accept international bitcoin payments, is currently exploring plans to create such an exchange powered by the blockchain, which he hopes will have current inherent features Issues such as “abusive naked short selling,” which allows traders to sell stocks they don’t own, is driving stock prices down and allegedly helped bring down Lehman Brothers.
The digitization of assets could also revolutionize the crowdfunding industry. Kickstarter is an example of a platform that facilitates product funding through micropayments from interested members, often in return for small memorabilia after the project is complete, such as a gift card. B. signed goods or a copy of one of the first products produced. For example, with the ability to easily digitize an asset and spend shares of it and any future profits, investors might be more inclined to invest more.
The potential of blockchain to improve the way we communicate, bank, manage our wealth, etc. is huge and will only be realized by the imagination of people like Vitalik Buterin and the Ethereum community and the willingness of current institutions to change limited.