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What is Blockchain Technology?

"The practical consequence [...is...] for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate."

- Marc Andreessen

From a cruising altitude, a blockchain might not look that different from things you're familiar with, say Wikipedia.

With a blockchain, many people can write entries into a record of information, and a community of users can control how the record of information is amended and updated. Likewise, Wikipedia entries are not the product of a single publisher. No one person controls the information.

Descending to ground level, however, the differences that make blockchain technology unique become more clear. While both run on distributed networks (the internet), Wikipedia is built into the World Wide Web (WWW) using a client-server network model.

A user (client) with permissions associated with its account is able to change Wikipedia entries stored on a centralized server.

Whenever a user accesses the Wikipedia page, they will get the updated version of the 'master copy' of the Wikipedia entry. Control of the database remains with Wikipedia administrators allowing for access and permissions to be maintained by a central authority.

Wikipedia's digital backbone is similar to the highly protected and centralized databases that governments or banks or insurance companies keep today. Control of centralized databases rests with their owners, including the management of updates, access and protecting against cyber-threats.

The distributed database created by blockchain technology has a fundamentally different digital backbone. This is also the most distinct and important feature of blockchain technology.

Wikipedia's 'master copy' is edited on a server and all users see the new version. In the case of a blockchain, every node in the network is coming to the same conclusion, each updating the record independently, with the most popular record becoming the de-facto official record in lieu of there being a master copy.

Transactions are broadcast, and every node is creating their own updated version of events.

It is this difference that makes blockchain technology so useful - It represents an innovation in information registration and distribution that eliminates the need for a trusted party to facilitate digital relationships.

Yet, blockchain technology, for all its merits, is not a new technology.

Rather, it is a combination of proven technologies applied in a new way. It was the particular orchestration of three technologies (the Internet, private key cryptography and a protocol governing incentivization) that made bitcoin creator Satoshi Nakamoto's idea so useful.

The result is a system for digital interactions that does not need a trusted third party. The work of securing digital relationships is implicit -- supplied by the elegant, simple, yet robust network architecture of blockchain technology itself.

Defining digital trust

Trust is a risk judgement between different parties, and in the digital world, determining trust often boils down to proving identity (authentication) and proving permissions (authorization). 

Put more simply, we want to know, 'Are you who you say you are?' and 'Should you be able to do what you are trying to do?'

In the case of blockchain technology, private key cryptography provides a powerful ownership tool that fulfills authentication requirements. Possession of a private key is ownership. It also spares a person from having to share more personal information than they would need to for an exchange, leaving them exposed to hackers.

Authentication is not enough. Authorization - having enough money, broadcasting the correct transaction type, etc - needs a distributed, peer-to-peer network as a starting point. A distributed network reduces the risk of centralized corruption or failure.

This distributed network must also be committed to the transaction network's recordkeeping and security. Authorizing transactions is a result of the entire network applying the rules upon which it was designed (the blockchain's protocol). 

Authentication and authorization supplied in this way allow for interactions in the digital world without relying on (expensive) trust. Today, entrepreneurs in industries around the world have woken up to the implications of this development - unimagined, new and powerful digital relationshionships are possible. Blockchain technology is often described as the backbone for a transaction layer for the Internet, the foundation of the Internet of Value. 

In fact, the idea that cryptographic keys and shared ledgers can incentivize users to secure and formalize digital relationships has imaginations running wild. Everyone from governments to IT firms to banks is seeking to build this transaction layer.

Authentication and authorization, vital to digital transactions, are established as a result of the configuration of blockchain technology.

The idea can be applied to any need for a trustworthy system of record.

Authored by Nolan Bauerle; images by Maria Kuznetsov

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How Does Blockchain Technology Work?

As stated in our guide "What is Blockchain Technology?", there are three principal technologies that combine to create a blockchain. None of them are new. Rather, it is their orchestration and application that is new.

These technologies are: 1) private key cryptography, 2) a distributed network with a shared ledger and 3) an incentive to service the network's transactions, record-keeping and security.

The following is an explanation of how these technologies work together to secure digital relationships.

Cryptographic keys

Two people wish to transact over the internet.

Each of them holds a private key and a public key.

The main purpose of this component of blockchain technology is to create a secure digital identity reference. Identity is based on possession of a combination of private and public cryptographic keys.

The combination of these keys can be seen as a dexterous form of consent, creating an extremely useful digital signature.

In turn, this digital signature provides strong control of ownership.

Identity

But strong control of ownership is not enough to secure digital relationships. While authentication is solved, it must be combined with a means of approving transactions and permissions (authorisation).

For blockchains, this begins with a distributed network.

A Distributed Network

The benefit and need for a distributed network can be understood by the 'if a tree falls in the forest' thought experiment.

If a tree falls in a forest, with cameras to record its fall, we can be pretty certain that the tree fell. We have visual evidence, even if the particulars (why or how) may be unclear.

Much of the value of the bitcoin blockchain is that it is a large network where validators, like the cameras in the analogy, reach a consensus that they witnessed the same thing at the same time. Instead of cameras, they use mathematical verification.

In short, the size of the network is important to secure the network.

That is one of the bitcoin blockchain's most attractive qualities -- it is so large and has amassed so much computing power. At time of writing, bitcoin is secured by 3,500,000 TH/s, more than the 10,000 largest banks in the world combined. Ethereum, which is still more immature, is secured by about 12.5 TH/s, more than Google and it is only two years old and still basically in test mode.

System of record

When cryptographic keys are combined with this network, a super useful form of digital interactions emerges. The process begins with A taking their private key, making an announcement of some sort -- in the case of bitcoin, that you are sending a sum of the cryptocurrency -- and attach it to B's public key.

Protocol

A block - containing a digital signature, timestamp and relevant information - is then broadcast to all nodes in the network.

Network servicing protocol

A realist might challenge the tree falling in the forest thought experiment with the following question: Why would there be a million computers with cameras waiting to record whether a tree fell? In other words, how do you attract computing power to service the network to make it secure?

For open, public blockchains, this involves mining. Mining is built off a unique approach to an ancient question of economics -- the tragedy of the commons.

With blockchains, by offering your computer processing power to service the network, there is a reward available for one of the computers. A person's self-interest is being used to help service the public need.

With bitcoin, the goal of the protocol is to eliminate the possibility that the same bitcoin is used in separate transactions at the same time, in such a way that this would be difficult to detect.

This is how bitcoin seeks to act as gold, as property. Bitcoins and their base units (satoshis) must be unique to be owned and have value. To achieve this, the nodes serving the network create and maintain a history of transactions for each bitcoin by working to solve proof-of-work mathematical problems.

They basically vote with their CPU power, expressing their agreement about new blocks or rejecting invalid blocks. When a majority of the miners arrive at the same solution, they add a new block to the chain. This block is timestamped, and can also contain data or messages.

Here's a chain of blocks:

The type, amount and verification can be different for each blockchain. It is a matter of the blockchain's protocol - or rules for what is and is not a valid transaction, or a valid creation of a new block. The process of verification can be tailored for each blockchain. Any needed rules and incentives can be created when enough nodes arrive at a consensus on how transactions ought to be verified.

It's a taster's choice situation, and people are only starting to experiment.

We are currently in a period of blockchain development where many such experiments are being run. The only conclusions drawn so far are that we are yet to fully understand the dexterity of blockchain protocols.

More on this point in our guides "What are Applications and Use Cases for Blockchain Technology?"and "What is the Difference Between Open and Permissioned Blockchains?"

Authored by Nolan Bauerle; images by Maria Kuznetsov

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What Can a Blockchain Do?

Financial institutions have financed the disruption of countless industries over the last 30 years; they have an idea of what a revolutionary technology can do to static incumbents.

So, to stay ahead of change, banks have been proactive in setting up R&D labs, building test centers and establishing partnerships with blockchain developers to fully understand the revolutionary potential of the technology.

Financial institutions were the first to dip their feet in, but academia, governments and consulting firms have also studied the technology.

All of this work is, of course, in addition to what the entrepreneurs and developers are doing, either by finding new ways to use the bitcoin or ethereum blockchains, or else creating entirely new blockchains.

This has been going on for over three years now, and the results are starting to come in.

While some of the waters are still murky, this is what we know a blockchain can do:

Establish digital identity

As discussed in our guide "How Does Blockchain Technology Work?", the identity component of blockchain technology is fulfilled through the use of cryptographic keys. Combining a public and private key creates a strong digital identity reference based on possession.

A public key is how you are identified in the crowd (like an email address), a private key is how you express consent to digital interactions. Cryptography is an important force behind the blockchain revolution.

Serve as a system of record

As stated in our guide "What is a Distributed Ledger?"blockchains are an innovation in information registration and distribution. They are good for recording both static data (a registry) or dynamic data (transactions), making it an evolution in systems of record.

In the case of a registry, data can be stored on blockchains in any combination of three ways:

  • Unencrypted data - can be read by every blockchain participant in the blockchain and is fully transparent.
  • Encrypted data - can be read by participants with a decryption key. The key provides access to the data on the blockchain and can prove who added the data and when it was added.
  • Hashed data - can be presented alongside the function that created it to show the data wasn't tampered with.

Blockchain hashes are generally done in combination with the original data stored off-chain. Digital 'fingerprints', for example, are often hashed into the blockchain, while the main body of information can be stored offline.

Such a shared system of record can change the way disparate organizations work together.

Currently, with data siloed in private servers, there is an enormous cost for inter-company transactions involving processes, procedures and cross-checking of records.

Read more on this in our guide "What are the Applications and Use Cases of Blockchains?".

Prove immutability

A feature of a blockchain database is that is has a history of itself. Because of this, they are often called immutable. In other words, it would be a huge effort to change an entry in the database, because it would require changing all of the data that comes afterwards, on every single node. In this way, it is more a system of record than a database.

Read more on this in our guide "What is the Difference Between a Blockchain and a Database?".

Serve as a platform

Cryptocurrencies were the first platform developed using blockchain technology. Now, people have moved from the idea of a platform to exchange cryptocurrencies to a platform for smart contracts.

The term 'smart contracts' has become somewhat of a catch-all phrase, but the idea can actually be divided into several categories:

There are the 'vending machine' smart contracts coined in the 1990s by Nick Szabo. This is where machines engage after receiving an external input (a cryptocurrency), or else send a signal that triggers a blockchain activity.

There are also smart legal contracts, or Ricardian contracts. Much of this application is based on the idea that a contract is a meeting of the minds, and that it is the result of whatever the consenting parties to the contract agree to. So, a contract can be a mix of a verbal agreement, a written agreement, and now also some of the useful aspects of blockchains like timestamps, tokens, auditing, document coordination or business logic.

Finally, there are the ethereum smart contracts. These are programs which control blockchain assets, executed over interactions on the ethereum blockchain. Ethereum itself is a platform for smart contract code.

Blockchains are not built from a new technology. They are built from a unique orchestration of three existing technologies.

Read more on this in our guide "What are the Applications and Use Cases of Blockchain Technology?".

Authored by Nolan Bauerle; images by Maria Kuznetsov

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What is a Distributed Ledger? 68

Ledgers, the foundation of accounting, are as ancient as writing and money.

Their medium has been clay, wooden tally sticks (that were a fire hazard), stone, papyrus and paper. Once computers became normalized in the 1980s and '90s, paper records were digitized, often by manual data entry.

These early digital ledgers mimicked the cataloguing and accounting of the paper-based world, and it could be said that digitization has been applied more to the logistics of paper documents rather than their creation. Paper-based institutions remain the backbone of our society: money, seals, written signatures, bills, certificates and the use of double-entry bookkeeping.

Computing power and breakthroughs in cryptography, along with the discovery and use of some new and interesting algorithms, have allowed the creation of distributed ledgers.

In its simplest form, a distributed ledger is a database held and updated independently by each participant (or node) in a large network. The distribution is unique: records are not communicated to various nodes by a central authority, but are instead independently constructed and held by every node. That is, every single node on the network processes every transaction, coming to its own conclusions and then voting on those conclusions to make certain the majority agree with the conclusions.

Once there is this consensus, the distributed ledger has been updated, and all nodes maintain their own identical copy of the ledger. This architecture allows for a new dexterity as a system of record that goes beyond being a simple database.

Distributed Ledgers are a dynamic form of media and have properties and capabilities that go far beyond static paper-based ledgers. For more on this, please read our guide "What Can a Blockchain Do?" For now, the short version is they enable us to formalize and secure new kinds of relationships in the digital world.

The gist of these new kinds of relationships is that the cost of trust (heretofore provided by notaries, lawyers, banks, regulatory compliance officers, governments, etc...) is avoided by the architecture and qualities of distributed ledgers.

Our Wikipedia analogy in our guide "What is Blockchain Technology?" hints at the power of these new kinds of relationships.

The invention of distributed ledgers represents a revolution in how information is gathered and communicated. It applies to both static data (a registry), and dynamic data (transactions). Distributed ledgers allow users to move beyond the simple custodianship of a database and divert energy to how we use, manipulate and extract value from databases -- less about maintaining a database, more about managing a system of record.

Authored by Nolan Bauerle; images by Maria Kuznetsov

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What is the Difference Between Public and Permissioned Blockchains?

In our guide "How Does Blockchain Technology Work?", we introduced a description of the three technologies that make up blockchain technology: cryptographic keys, a distributed network and a network servicing protocol.

Bitcoin is the most ambitious kind of blockchain. Anyone can use bitcoin's cryptographic keys, anyone can be a node and join the network, and anyone can become a miner to service the network and seek a reward. Miners can walk away from being a node, return if and when they feel like it, and get a full account of all network activity since they left.

Basically, anyone can read the chain, anyone can make legitimate changes and anyone can write a new block into the chain (as long as they follow the rules). Bitcoin is totally decentralized. It is also described as a 'censor-proof' blockchain.

For these reasons, it's known by its widest description, a public blockchain. But, this is not the only way to build a blockchain.

Blockchains can be built that require permission to read the information on the blockchain, that limit the parties who can transact on the blockchain and that set who can serve the network by writing new blocks into the chain.

For example, Ripple runs a permissioned blockchain. The startup determines who may act as transaction validator on their network, and it has included CGI, MIT and Microsoft as transaction validators, while also building its own nodes in different locations around the world.

A blockchain developer may choose to make the system of record available for everyone to read, but they may not wish to allow anyone to be a node, serving the network's security, transaction verification or mining. It's a mix-and-match situation that is reflected in the various ways entrepreneurs are experimenting with the technology.

With permissioned blockchains, this may or may not involve 'proof of work' or some other system requirement from the nodes. There is some politics around this, as there are those who consider private blockchains that do not use any proof of work (that is, blockchains with no mining) to not be blockchains at all, but simply shared ledgers.

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What is the Difference Between a Blockchain and a Database?

As stated in our guide "What is Blockchain Technology?", the difference between a traditional database and a blockchain begins with architecture, or how the technologies are orchestrated.

A database running on the World Wide Web is most often using a client-server network architecture.

A user (client) with permissions associated with their account can change entries that are stored on a centralized server. By changing the 'master copy', whenever a user accesses a database using their computer, they will get the updated version of the database entry. Control of the database remains with administrators, allowing for access and permissions to be maintained be a central authority.

This is not at all the same as with a blockchain.

For a blockchain database, each participant maintains, calculates and updates new entries into the database. All nodes work together to ensure they are all coming to the same conclusions, providing in-built security for the network.

The consequences of this difference is that blockchains are well-suited as a system of record for certain functions, while a centralized database is entirely appropriate for other functions.

Decentralized control

Blockchains allow different parties that do not trust each other to share information without requiring a central administrator. Transactions are processed by a network of users acting as a consensus mechanism so that everyone is creating the same shared system of record simultaneously.

The value of decentralized control is that it eliminates the risks of centralized control. With a centralized database, anybody with sufficient access to that system can destroy or corrupt the data within. This makes users dependent on the administrators.

Some administrators have earned the trust put in them, for the most part. People's money is not stolen by banks that record the money they hold in private databases, for example. And, there is a logical reason why you would want centralized control. Centralized control can be a speciality, a reason for being.

But, that also means those with control, such as a bank, need to spend billions of dollars keeping these centrally held databases from being altered by hackers or anyone else who might wish to profit from another's loss. If the central administrators we're trusting to keep our information secret fail in this regard, then we lose.

History of itself

Most centralized databases keep information that is up-to-date at a particular moment. They more or less are a snapshot of a moment in time.

Blockchain databases are able to keep information that is relevant now, but also all the information that has come before. Blockchain technology can create databases that have histories of themselves. They grow like ever-expanding archives of their own history while also providing a real-time portrait.

It is the expense required to compromise or change these databases that has led people to call a blockchain database immutable. It is also where we can start to see of the evolution of the database into a system of record.

Performance

While blockchains can be used systems of record and are ideal as transaction platforms, they are considered slow as databases when compared to what is possible for digital transaction technology that we see today with Visa and PayPal.

While there will certainly be improvements to this performance, the nature of blockchain technology requires that some speed be sacrificed. The way distributed networks are employed in blockchain technology means they do not share and compound processing power, they each independently service the network, then compare the results of their work with the rest of the network until there is a consensus that something happened.

Centralized databases, on the other hand, have been around for decades, and have seen their performance increase in lock-step with a formula that has come to define innovation in the digital era: Moore's Law.

Confidentiality

Bitcoin is a write-uncontrolled, read-uncontrolled database. That means anyone can write a new block into the chain, and anyone can read a block in the chain.

A permissioned blockchain, like a centralized database, can be write-controlled and read-controlled. That means the network or the protocol can be set up so only permissioned participants can write into the database or read the database.

But, if confidentiality is the only goal, and trust is not an issue, blockchain databases pose no advantage over a centralized database.

Hiding information on a blockchain requires lots of cryptography and a related computational burden for the nodes in the network. There is no way to do this that is more effective than simply hiding the data completely in a private database that does not even require network connectivity.

Think of all the databases Ethan Hunt has broken into in the "Mission: Impossible" series and you can get a sense of the type of confidentiality possible in the private databases.

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What Are the Applications and Use Cases of Blockchains?

Blockchain technology is a revolution in systems of record.

Bitcoin is history's first permanent, decentralized, global, trustless ledger of records. Since its invention, entrepreneurs in industries around the world have come to understand the implications of this development.

The nature of blockchain technology has got imaginations running wild, because the idea can now be applied to any need for a trustworthy record. It is also putting the full power of cryptography in the hands of individuals, stopping digital relationships from requiring a transaction authority for what are considered 'pull transactions'.

For sure, there is also a lot of hype. This hype is perhaps the result of how easy it is to dream up a high-level use case for the application of blockchain technology. It has been described as 'magic beans' by several of the industry's brightest minds.

There is more on how to test whether blockchain technology is appropriate for a use case or not in our guide "Why Use a Blockchain?". For now, we turn to a discussion of the development of blockchain technology for how it could be useful.

As a system of record

Digital identity

Cryptographic keys in the hands of individuals allow for new ownership rights and a basis to form interesting digital relationships. As we've discussed in our guides "What is Blockchain Technology?""How Does Blockchain Technology Work?" and "What Can a Blockchain Do?", blockchains provide an opportunity to establish a strong system for digital identity.

Because it is not based on accounts and permissions associated with accounts, because it is a push transaction, and because ownership of private keys is ownership of the digital asset, this places a new and secure way to manage identity in the digital world that avoids exposing users to sharing too much vulnerable personal information.

Tokenization

For the purposes of authenticating a unique physical item, the items are paired with a corresponding digital token. This essentially means tokens are used as to bind the physical and digital worlds. These digital tokens are useful for supply chain management, intellectual property, and anti-counterfeiting and fraud detection.

Inter-organizational data management

As stated in our guide "What is a Distributed Ledger?", blockchain technology represents a revolution in how information is gathered and collected. It is less about maintaining a database, more about managing a system of record.

For governments:

Governments have an interest in all three aspects components of blockchain technology.

Firstly, there's the ownership rights surrounding cryptographic key possession, revocation, generation, replacement, or loss.

They also have an interest in who can act as part of a blockchain network.

And they have an interest in blockchain protocols as they authorize transactions, as governments often regulate transaction authorization through compliance regimes (eg stock market regulators authorize the format of market exchange trades).

For this reason, regulatory compliance is seen as a business opportunity by many blockchain developers.

For financial institutions:

Read more on this in our guides "How Could Blockchain Technology Change Finance?" and "What Can a Blockchain Do?".

For audit trails:

Using the client-server infrastructure, banks and other large institutions that help individuals form digital relationships over the internet are forced to secure the account information they hold on users against hackers.

While banks can spend the billions of dollars to keep information secure, the system is currently asking businesses to do the same. We are sharing the same information with these businesses as we are with the banks, after all. Yet, businesses are under attack and have been hacked, resulting sometimes in the exposure of customers' intimate financial details.

Blockchain technology offers a means to automatically create a record of who has accessed information or records, and to set controls on permissions required to see information.

This also has important implications for health records.

As a platform

For smart contracting

Blockchains are where digital relationships are being formed and secured.

A consortium of the largest banks in the world, as well as several insurance companies, led by a startup, is seeking to build a platform to establish new digital relationships between banks themselves. Their approach to securing these new digital relationships is a combination of Ricardian contracts and coded business logic.

In short, this version of smart contracts seeks to use information and documents stored in blockchains to support complex legal agreements.

Other startups are working on sidechains - bespoke blockchains plugged into larger public blockchains. These 'federated blockchains' are able to overcome problems like the block size debate plaguing bitcoin. It is thought these groups will be able to create blockchains that authorize super-specific types of transactions.

Ethereum takes the platform idea further. A new type of smart contracting was first introduced in Vitalik Buterin's white paper, "A Next Generation Smart Contract and Decentralized Application Platform". This vision is about applying business logic on a blockchain, so that transactions of any complexity can be coded, then authorized (or denied) by the network running the code.

As such, ethereum's primary purpose is to be a platform for smart contract code, comprising of programs controlling blockchain assets, executed by a blockchain protocol, and in this case running on the ethereum network.

For automated governance

Bitcoin itself is an example of automated governance, or a DAO (decentralized autonomous organization). It, and other projects, remain experiments in governance, and much research is missing on this subject.

Read more about this under 'Politics' in our guide "What are Blockchain's Issues and Limitations".

For markets

Another way to think of cryptocurrency is as a digital bearer bond.

This simply means establishing a digitally unique identity for keys to control code that can express particular ownership rights (eg it can be owned or can own other things). These tokens mean that ownership of code can come to represent a stock, a physical item or any other asset.

Rules on how these instruments can be transacted can be coded by a blockchain protocol.

For streamlining of clearing and settlement

In the world of stock trading, we often hear the term 'T+3'. This means, a trade (T) is followed by three days before the trade is accepted (settled). There are non-blockchain ways to get this number down, but not without compromising security and risk.

With blockchain technology, however, trade is settlement, and we have a T+0 equation.

Read more on this in our guide "How Could Blockchain Technology Change Finance?".

For automating regulatory compliance

Beyond just being a trusted repository of information, blockchain technology could enable regulatory compliance in code form - in other words, how blocks are made valid could be a translation of government legal prose into digital code.

In the case of banks, for example, this could mean improving efficiency in anti-money laundering (AML) compliance. Blockchain technology can be calibrated to do different things - permit transactions or report transactions of a certain type according to exact rules.

This means that banks could automate regulatory reporting or transaction authorization.

In short

All of this work is allowing people to secure digital relationships that were impossible before. Data is being disclosed differently, secured differently and recorded differently.

This is changing digital relationships, creating the ability for them to be automated in code via 'smart contracts'.

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How Could Blockchain Technology Change Finance?

This question has been asked by every futurist research lab in many of the largest banks, central banks, financial institutions, think tanks, consulting firms and government committees around the world.

R3CEV, a consortium effort financed by some of the world's largest banks, is busy trying to answer this question. Goldman Sachs, McKinsey Consulting and Consumers' Research have all written excellent reports on this question. The UK Government, the Senates of the US, Canada, Australia and the EU have all made inquiries along these lines.

Many startups also produce white papers concerning their particular innovation or use of blockchain technology, and often include the larger social question: "How this will change things?"

Much of this research underlines four major areas of change:

Infrastructure for cross-border transactions

The digital revolution has totally transformed media, as we all know. It's had an effect in the finance industry as well. Of course, financial institutions use computers. They used them for databases in the 1970s and 1980s, they made web pages in the 1990s and they migrated to mobile apps in the new millennium.

But the digital revolution has not yet revolutionized cross-border transactions. Western Union remains a big name, running much the same business they always have. Banks continue to use a complex infrastructure for simple transactions, like sending money abroad.

The following infographic, prepared by Richard Gendal Brown, shows the infrastructure and intermediaries in cross-border banking that have been in place since the '70s.

This architecture is the result of the finance industry using highly secured private databases. Digitization has meant we merely sort information into private databases much faster.

Blockchain technology allows for financial institutions to create direct links between each other, avoiding correspondent banking. R3's principal product to date, Corda, aims at correspondent banking. Corda is a play on words incorporating 'accord' (agreement) and 'cord' (the straightest line between two points in a circle).

In Corda's case, the circle is made up of banks who would use a shared ledger for transactions, contracts and important documents.

Brown used to work on IBM's blockchain products, but has since moved over to work at R3CEV.

Competing financial institutions could use this common database to keep track of the execution, clearing and settlement of transactions without the need to involve any central database or management system. In short, the banks will be able to formalize and secure digital relationships between themselves in ways they could not before.

In the above representation, that means correspondent banking agreements and the RTGS could both be shortcutted.

Transactions can occur directly between two parties on a frictionless P2P basis. Ripple, a permissioned blockchain, is built to solve many of these problems.  

Digital assets as a class

Bitcoin created something unique: digital property.

Before bitcoin, 'digital' was not synonymous with scarcity. Anything digital could be copied with the click of a button. A quick look at the music industry and album sales tells this story convincingly.

But bitcoin did something new: it created uncopyable digital code.

So, for the first time since bits and bytes were invented, there was a way to own something digital that couldn't be copied. This gave the digital code value. To this day, bitcoin's value is based on the capacity of its blockchain to prevent double-spending and the creation of counterfeit coins.

With this in mind, bitcoin developers have pioneered coloured coins that can act as stock in a company. The 'color' of the coin represents information about what ownership rights the private cryptographic key provides.

After receiving SEC permission, online retail giant Overstock announced it would issue public shares of company stock on its tØ blockchain platform. We've also seen the advent of 'initial coin offerings' (ICOs) and 'appcoins' (cryptocurrencies native to an app that help fund development of the project).

These examples are only part of the story for blockchains in digital assets. They can be the asset, but blockchains can also be used to run the market itself.

Basically, these efforts are treating digital assets as a bearer instrument, which is a wide and dexterous application.

Governance and markets

This ability, however, extends beyond just recording transactions. Nasdaq, for example, was one of the first to build a platform enabling private companies to issue and trade shares using a blockchain. 

Other developers are coding financial instruments that can be pre-programed to carry out corporate actions and business logic.

In 2016, a blockchain project called The DAO, running on the ethereum blockchain, was launched with the aim of emulating a crowdfunding market. Your percentage of contribution to the fund represented the percentage vote in how the total fund would be spent.

Regulatory reporting and compliance

Blockchains can serve as a fully transparent and accessible system of record for regulators. The can also be coded to authorize transactions which comply with regulatory reporting.

For example, banks have severe reporting obligations to agencies such as FinCEN. Every single time they authorize a transaction of more than $10,000, they must report the information to FinCEN, who stores it for use as an anti-money laundering database.

Clearing and Settlement

With paper-world trading, the time frame for clearing and settlement of a transaction is generally referred to as 'T+3' - that is, three days after the trade (T), the transaction is settled. 

With blockchain technology, the entire lifecycle of a trade - execution, clearing and settlement - occurs at the trade stage. With a digital asset, trade is settlement, and the cryptographic keys and digital ownership they control can lower post-trade latency and counterparty risk.

Accounting and auditing

Whereas most databases are snapshots of a moment in time, blockchain databases are built from their own transaction history. They are a database with context, a history of itself, a self-contained system of record.

The implications for auditing and accounting are profound.

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What are Blockchain's Issues and Limitations?

There are treacherous passes in any technological revolution.

Some people in the blockchain industry have pointed out that blockchain has become overhyped, when, in reality, the technology has limitations and is inappropriate for many digital interactions.

But through research and development, success and failure, and trial and error, we've learned the current issues and limitations of blockchains.

Complexity

Blockchain technology involves an entirely new vocabulary.

It has made cryptography more mainstream, but the highly specialized industry is chock-full of jargon. Thankfully, there are several efforts at providing glossaries and indexes that are thorough and easy to understand.

Network size

Blockchains (like all distributed systems) are not so much resistant to bad actors as they are 'antifragile' - that is, they respond to attacks and grow stronger.

This requires a large network of users, however. If a blockchain is not a robust network with a widely distributed grid of nodes, it becomes more difficult to reap the full benefit.

There is some discussion and debate about whether this a fatal flaw for some permissioned blockchain projects.

Transaction costs, network speed

Bitcoin currently has notable transaction costs after being touted as 'near free' for the first few years of its existence.

As of late 2016, it can only process about seven transactions per second, and each transaction costs about $0.20 and can only store 80 bytes of data.

There's also the politically charged aspect of using the bitcoin blockchain, not for transactions, but as a store of information. This is the question of ''bloating' and is often frowned upon because it forces miners to perpetually reprocess and rerecord the information.

Human error

If a blockchain is used as a database, the information going into the database needs to be of high quality. The data stored on a blockchain is not inherently trustworthy, so events need to be recorded accurately in the first place.

The phrase 'garbage in, garbage out' holds true in a blockchain system of record, just as with a centralized database.

Unavoidable security flaw

There is one notable security flaw in bitcoin and other blockchains: if more than half of the computers working as nodes to service the network tell a lie, the lie will become the truth. This is called a '51% attack' and was highlighted by Satoshi Nakamoto when he launched bitcoin.

For this reason, bitcoin mining pools are monitored closely by the community, ensuring no one unknowingly gains such network influence.

Politics

Because blockchain protocols offer an opportunity to digitize governance models, and because miners are essentially forming another type of incentivized governance model, there have been ample opportunities for public disagreements between different community sectors.

These disagreements are a notable feature of the blockchain industry and are expressed most clearly around the question or event of 'forking' a blockchain, a process that involves updating the blockchain protocol when a majority of a blockchain's users have agreed to it.

These debates can be very technical, and sometimes heated, but are informative for those interested in the mixture of democracy, consensus and new opportunities for governance experimentation that blockchain technology is opening up.

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Why Use a Blockchain?


As the implications of the invention of have become understood, a certain hype has sprung up around blockchain technology.

This is, perhaps, because it is so easy to imagine high-level use cases. But, the technology has also been closely examined: millions of dollars have been spent researching blockchain technology over the past few years, and numerous tests for whether or not blockchain technology is appropriate in various scenarios have been conducted.

Blockchain technology offers new tools for authentication and authorization in the digital world that preclude the need for many centralized administrators. As a result, it enables the creation of new digital relationships.

By formalizing and securing new digital relationships, the blockchain revolution is posed to create the backbone of a layer of the internet for transactions and interactions of value (often called the 'Internet of Value', as opposed to the 'Internet of Information' which uses the client-server, accounts and master copy databases we've been using for over the past 20 years.)

But, with all the talk of building the digital backbone of a new transactional layer to the internet, sometimes blockchains, private cryptographic keys and cryptocurrencies are simply not the right way to go.

Many groups have created flowcharts to help a person or entity decide between a blockchain or master copy, client-server database. The following factors are a distillation of much of what has been previously done:

Is the data dynamic with an auditable history?

Paper can be hard to counterfeit because of the complexity of physical seals or appearances. Like etching something in stone, paper documents have certain permanence.

But, if the data is in constant flux, if it is transactions occurring regularly and frequently, then paper as a medium may not be able to keep up the system of record. Manual data entry also has human limitations.

So, if the data and its history are important to the digital relationships they are helping to establish, then blockchains offer a flexible capacity by enabling many parties to write new entries into a system of record that is also held by many custodians.

Should or can the data be controlled by a central authority?

There remain many reasons why a third party should be in charge of some authentications and authorizations. There are times when third-party control is totally appropriate and desirable. If privacy of the data is the most important consideration, there are ways to secure data by not even connecting it to a network.

But if existing IT infrastructure featuring accounts and log-ins is not sufficient for the security of digital identity, then the problem might be solved by blockchain technology.

As Satoshi Nakamoto wrote in his (or her) seminal work, "Bitcoin: A Peer-to-Peer Electronic Cash System": "Merchants must be wary of their customers, hassling them for more information than they would otherwise need. A certain percentage of fraud is accepted as unavoidable."

Private key cryptography enables push transactions, which don't require centralized systems and the elaborate accounts used to establish digital relationships. If this database requires millions of dollars to secure lightweight financial transactions, then there's a chance blockchains are the solution.

Is the speed of the transaction the most important consideration?

Does this database require high-performance millisecond transactions? (There is more on this point in our guide: "What is the Difference Between a Blockchain and a Database?").

If high performance, millisecond transactions are what is required, then it's best to stick with a traditional-model centralized system. Blockchains as databases are slow and there is a cost to storing the data - the processing (or 'mining') of every block in a chain. Centralized data systems based on the client-server model are faster and less expensive... for now.

In short, while we still don't know the full limits and possibilities of blockchains, we can at least say the use cases which have passed inspection have all been about managing and securing digital relationships as part of a system of record.

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