Imagine how it would be if:
- You always had a notary on hand to irrefutably endorse the validity of your identity and the documents you sign, and
- You had an auditor to instantly provide verification that your transactions were recorded correctly.
If you had these two “trusted parties” always involved, then approval of transactions would happen instantly, assuming the notary and auditor agreed that the transaction was valid. As a result, since your identity was instantly verifiable by anyone you chose to share it with, it would be like having priority status everywhere you go. No more waiting for verification of your paperwork.
Does this sound like a utopian dream? Does it sound expensive? Would developing a system to accomplish this take forever, or never happen?
In fact, this is a good analogy for how blockchain technology works. And right now, there is a growing legion of innovators and entrepreneurs across the globe who are aggressively re-imagining the most fundamental business interactions and inventing new styles of digital interactions.
Digital Currency Using Blockchain Technology
Blockchain technology is one of the most significant developments in decades. It represents fundamental architectural improvements for how we record, store, and transmit data over the Internet. In this article, I’ll provide a brief technical overview of what a Blockchain is and why you should care.
To understand what blockchain technology is, and what problems it attempts to solve, consider digital currency. This is just one application of blockchain technology, but there are many other uses beyond currency that I’ll address later in this article.
By now most everyone has heard of Bitcoin. It is a “digital currency” that uses blockchain technology to transmit secure payments between parties using the Internet, digital wallets, and a distributed database that runs on thousands of private computers all over the world. For now, hold your doubts about how “private computers” can possibly provide a more secure methodology for transmitting something as important as monetary transactions. I propose this methodology is in fact more secure than anything you’ve ever heard of when it comes to global payments.
The bitcoin “network” consists of a large network of computers, owned by disinterested parties (called miners) all over the world. Each of these computers (called nodes) contains a dedicated hardware and software environment that runs open source software to operate copies of the blockchain database. This blockchain database is maintained by each miner, and all of the nodes are responsible for safeguarding the security and validity of every record in the database.
Transactions are added to the blockchain database only after mathematical proof confirms that the transaction is valid. Consider this example, which describes what happens when Alice wants to pay Bob some bitcoin.
When Alice initiates the transaction, an encrypted “proposed” transaction is simultaneously broadcast to all of the miners on the blockchain. This proposed transaction contains Alice’s unique ID that proves she is who she says she is and that she owns the digital currency she intends to transmit. It also contains Bob’s public ID.
Immediately and simultaneously, all of the mining nodes in the network go to work on solving a complex mathematical algorithm to decrypt and validate that Alice actually has the authority to transmit this currency to Bob. These computers actually run a “race” to be the first one to solve the mathematical equations, and on average it takes about 10 minutes. These transactions are grouped into “blocks” and added to the database as they are validated by a consensus of the nodes in the blockchain.
You might wonder why people would allow their computers to be used as mining machines and how we can know that someone won’t hack into the whole thing and control everything.
The answer is miner incentives that are built into the system to compensate miners when they are first to verify transactions. The diagram below shows what happens when Alice wants to send 2 bitcoins to Bob. She initially has 10 bitcoins, but after the transaction completes, she will have just 7.999 bitcoins remaining. Bob receives the full 2 bitcoins, but the miner who “wins the race” is rewarded with .001 bitcoins as payment for their validation services.
These incentives are one of the most important concepts in blockchain technology. Essentially it gamifies the whole system by rewarding the fastest miner. The revenue stream from validating transactions funds the miners’ operations for maintaining and securing their copy of the blockchain database. The distribution of revenue across all the mining nodes enhances the security of the entire blockchain because each node participates as an equal partner in the system.
The onramp to trading using Bitcoins is to find a dealer who will sell you some bitcoins. In order for you to purchase Bitcoins, you need a “bitcoin wallet.” You can create a wallet and purchase bitcoins from a bitcoin dealer on the Internet. You’ll purchase bitcoins with US Dollars, Euros, or whatever currency you have, and most dealers will accept credit cards or your bank transfer.
Once you have bitcoins, you can use them to purchase items from a growing number of merchants across the globe.
There is much more to blockchain technology, but this Bitcoin example shows the basic idea.
- The blockchain is an Internet-based, distributed, public database where transactions can only be added once they are validated through complex mathematics that prove authenticity of the data.
- The blockchain is a public ledger of all transactions that have ever been executed.
- It is constantly growing as blocks are added. The blocks are added to the blockchain in a linear, chronological order. Each node maintains an exact copy of the blockchain. The blockchain has a complete ledger containing all transactions ever generated.
- The new block can only be added after multiple miners solve the same math problem and after they confirm the answer given by the first miner to solve the problem.
- New blocks can only be added in the precise order in which they were proposed to the network. Timestamps on all proposals are used to ensure the order of transactions in the chain. Furthermore, every new block contains a “pointer” to the block that immediately precedes it in the chain. This pointer essentially describes the fingerprint of the preceding node.
With this basic understanding of Bitcoin and blockchain technology, consider the impact it could have on accounting. Today, with the global network of connected computers (i.e., the Internet), we can realistically consider a global public ledger of accounts that contains all transactions between all parties across the globe.
Do we want a global public ledger? It may sound scary, but what if we could completely erase the white board and develop a new system of accounting?
If we embrace this we would no longer need to record bookkeeping entries on each side of every transaction, duplicating each other’s work and introducing errors along the way. We would have a world in which my debit is your credit and it would be a transparent, ledger of truth that all would “trust” as the books of record.
Such a global, decentralized, public, secure ledger would mean
- Transactions would be viewable by anyone.
- Fraud would be much harder to commit.
- Costs of “keeping the books” would dramatically decrease.
- Humans could focus on the analytics of good data, and dramatically reduce the creation of Big Bad Data. [link to big bad data article]
I suppose it gets somewhat political to think about these issues, but blockchain tech has the capability to deliver on all of these goals.
Delegation of security to mathematical formulas as opposed to human validation is a leap many won’t trust. But this delegation of security is at the core of why this is so compelling. Whenever we entrust data to humans it is exposed to fraud and corruption, but mathematics cannot be corrupted.