Bitcoin and Blockchain
When bitcoin broke into public consciousness in 2013, it couldn’t have been sexier: a digital currency being used to buy everything from drugs to cupcakes. Then the excitement shifted to an aspect of bitcoin that is a bit less sexy: public online ledgers. Blockchain — the technology used for verifying and recording transactions that’s at the heart of bitcoin — is seen as having the potential to reshape the global financial system and possibly other industries. Both bitcoin and its blockchain are gaining imitators as well as adherents, along with plenty of critics, including Jamie Dimon, the chief executive officer of JPMorgan Chase & Co. This year’s wild price surge has given ammunition to both.
The price of bitcoin rocketed in 2017 as the debate raged on whether the cryptocurrency — whose total value neared $300 billion in early December — should be considered a legitimate financial asset. It got a huge boost when Cboe Global Markets Inc., started futures trading tied to the digital currency and CME Group Inc. and Nasdaq Inc., said they would follow suit. Futures trading will push bitcoin closer to the mainstream by making it easier to trade without the hassles of owning bitcoin directly. Bitcoin began to look almost traditional compared with the new cryptocurrencies whose explosive growth has drawn warnings from regulators around the globe. More than $3.5 billion was raised through initial coin offerings through mid-November. The bitcoin community came together (mostly) in November to reject a proposed software change that had threatened a split. Meanwhile, more than 100 banks are working within the R3 consortium, created to find ways to use blockchain as a decentralized ledger to track money transfers and other transactions. Australia’s stock exchange plans to start using blockchain to process equity transactions. Blockchain is also being tested by retailers like Wal-Mart Stores Inc. for ensuring food safety, as industries explore what advantages the technology might hold over traditional databases.
Virtual currencies aren’t new — online fantasy games have long used them — but the development of a secure digital currency without a central issuer rightly turned heads. Mysterious spikes and drops in the price of bitcoin since its birth helped build an early reputation for the currency as a tool for selling drugs and laundering money. Its history also featured arrests for Ponzi schemes. The person or people who created the bitcoin system under the pseudonym Satoshi Nakamoto solved a problem central to any currency —preventing counterfeiting — and did it without relying on a government’s authority. The software also solved one specific hurdle for digital money — how to stop users from spending the same unit of currency twice. The breakthrough idea was blockchain, a publicly visible, anonymous online ledger that records every single bitcoin transaction. It’s maintained by a network of bitcoin “miners” whose computers perform the calculations that validate each transaction, preventing double-spending. The miners earn a reward of newly issued bitcoin. The pace of creation is limited, and no more than 21 million will ever be issued.
Since bitcoin first boomed, there’s been no shortage of critics to call its rise a bubble and to argue that the currency has no intrinsic value. In September, Dimon called bitcoin a “fraud.” But a month later his chief financial officer followed rivals at Goldman Sachs Group Inc. and Citigroup Inc. in expressing openness to working with cryptocurrencies. Entrepreneurs in the field say that focusing on the price of bitcoin is missing the point — its value is as proof of concept for a new kind of payment system not reliant on third parties like governments, big banks or credit-card companies. Others say blockchain advocates are hyping what amounts to no more than a new kind of database. Proponents of ether, the second most commonly used digital currency, respond that the etherium blockchain does far more than let bitcoin users send value from one person to another. Its advocates think it could be a universally accessible machine for running businesses, as the technology allows people to do more complex actions in a shared and decentralized manner.
The Reference Shelf
- A Bloomberg Businessweek article looking at how interest in blockchain is surpassing that in bitcoin.
- Bloomberg Markets traced the interest of Silicon Valley investors in bitcoin.
- CoinDesk has a Bitcoin price index; Bitcoincharts.com has a range of data.
- Two explainers, one aimed at kindergarteners and the other a you-too-can-mine-bitcoin project, plus an exploration of the double-spending problem.
- The New Yorker looks at Dark Wallet, a project meant to speed the spread of bitcoin, from the law student who invented the printable gun.
The difference between Bitcoin and blockchain for business
Are Bitcoin and blockchain the same thing? No, they aren’t. However, they are closely related. When Bitcoin was released as open source code, blockchain was wrapped up together with it in the same solution. And since Bitcoin was the first application of blockchain, people often inadvertently used “Bitcoin” to mean blockchain. That’s how the misunderstanding started. Blockchain technology has since been extrapolated for use in other industries, but there is still some lingering confusion.
How are Bitcoin and blockchain different?
Bitcoin is a type of unregulated digital currency that was first created by Satoshi Nakamoto in 2008. Also known as a “cryptocurrency,” it was launched with the intention to bypass government currency controls and simplify online transactions by getting rid of third-party payment processing intermediaries. Of course, accomplishing this required more than just the money itself. There had to be a secure way to make transactions with the cryptocurrency.
Bitcoin transactions are stored and transferred using a distributed ledger on a peer-to-peer network that is open, public and anonymous. Blockchain is the underpinning technology that maintains the Bitcoin transaction ledger. Learn more here and watch the video below for an overview:
LEARN MORE ABOUT BLOCKCHAIN FOR FINANCIAL SERVICES
How does the Bitcoin blockchain work?
The Bitcoin blockchain in its simplest form is a database or ledger comprised of Bitcoin transaction records. However, because this database is distributed across a peer-to-peer network and is without a central authority, network participants must agree on the validity of transactions before they can be recorded. This agreement, which is known as “consensus,” is achieved through a process called “mining.”
After someone uses Bitcoins, miners engage in complex, resource-intense computational equations to verify the legitimacy of the transaction. Through mining, a “proof of work” that meets certain requirements is created. The proof of work is a piece of data that is costly and time-consuming to produce but can easily be verified by others. To be considered a valid transaction on the blockchain, an individual record must have a proof of work to show that consensus was achieved. By this design, transaction records cannot be tampered with or changed after they have been added to the blockchain.
How is blockchain for business different?
The blockchain that supports Bitcoin was developed specifically for the cryptocurrency. That’s one of the reasons it took a while for people to realize the technology could be adapted for use in other areas. The technology also had to be modified quite a bit to meet the rigorous standards that businesses require. There are three main characteristics that separate the Bitcoin blockchain from a blockchain designed for business.
Assets over cryptocurrency
There is an ongoing discussion about whether there is value in a token-free shared ledger, which is essentially a blockchain without cryptocurrency. I won’t weigh in on this debate, but I will say this: blockchain can be used for a much broader range of assets than just cryptocurrency. Tangible assets such as cars, real estate and food products, as well as intangible assets such as bonds, private equity and securities are all fair game. In one business use case, Everledger is using blockchain to track the provenance of luxury goods to minimize fraud, document tampering and double financing. Now, over one million diamonds are secured on blockchain.
Identity over anonymity
Bitcoin thrives due to anonymity. Anyone can look at the Bitcoin ledger and see every transaction that happened, but the account information is a meaningless sequence of numbers. On the other hand, businesses have KYC (know your customer) and AML (anti-money laundering) compliance requirements that require them to know exactly who they are dealing with. Participants in business networks require the polar opposite of anonymity: privacy. For example, in an asset custody system like the one being developed by Postal Savings Bank of China, multiple parties, including financial institutions, clients, asset custodians, asset managers, investment advisors and auditors are involved. They need to know who they are dealing with but one client or advisor doesn’t necessarily need to be able to see all transactions that have ever occurred (especially when those transactions relate to different clients).
Selective endorsement over proof of work
Consensus in a blockchain for business is not achieved through mining but through a process called “selective endorsement.” It is about being able to control exactly who verifies transactions, much in the same way that business happens today. If I transfer money to a third party, then my bank, the recipient’s bank and possibly a payments provider would verify the transaction. This is different from Bitcoin, where the whole network has to work to verify transactions.
Why will blockchain transform the global economy?
Similar to how the internet changed the world by providing greater access to information, blockchain is poised to change how people do business by offering trust. By design, anything recorded on a blockchain cannot be altered, and there are records of where each asset has been. So, while participants in a business network might not be able to trust each other, they can trust the blockchain. The benefits of blockchain for business are numerous, including reduced time (for finding information, settling disputes and verifying transactions), decreased costs (for overhead and intermediaries) and alleviated risk (of collusion, tampering and fraud).