Blockchain Is Not Magic
Post by Douglas Antin
Wait…What’s Blockchain Again?
Ok, so maybe you or someone you know could use a brief explanation on what blockchain is again. Blockchain enables peer to peer (P2P) transactions using complex math with a lot of computing power (cryptographic functions) to remove the need for a middleman to enforce the transaction. Removing the middleman addresses counter-party risk associated with a third-party intermediary and this can potentially reduce transaction costs.
The blockchain consists of a network of people using computing power to verify that “blocks” of information shared between the network are true, i.e.: verifying that the data is consistent and has not been altered. This process creates what is called a decentralized ledger or a public account of transactions that have taken place on the blockchain. The ledger is “distributed” because there is no one person or institution in control of verifying the information that was added to the network. Instead, verifying information on the blockchain can be considered somewhat of a democratic process because, in this case, many people combine their computing power collectively to authenticate transactions. If a transaction is authenticated by a majority of the computing power on the network, it is verified meaning majority rule is the form of governance.
Each block on the chain is a grouping of information based events chained to a set of past and verifiable events. The entirety of the blockchain, therefore, contains all the transactions that have taken place on this public ledger. The chain of democratically reviewed and public history of transacted information is what makes the blockchain a “trustless” technology. In other words, you don’t need to trust an individual middleman to process or verify the transaction. You can think of blockchain like a very large and intricate game of telephone but in this version, all participants can look back and verify the messages that are sent are true.
So how is blockchain actually used? Bitcoin, the original application of blockchain, was created as a digital cash and payment system using the distributed P2P network concept. The primary purpose of Bitcoin was for individuals who did not want to rely on financial institutions to make a transaction. Following the original Bitcoin blockchain, other experiments with public and decentralized ledgers have taken place. One blockchain technology concept worth noting was the development of the smart contract.
A smart contract is an event based agreement between two or more parties that stipulates if certain conditions are met then specific consequences will result. Smart contracts are the software coded version of the agreement and the code provides an automatic and self-enforcing program, for example, you agree to the terms, write the code and then either you meet the terms and get the desired outcome or you do not meet the terms and get what the agreement stipulates. These contracts have the potential to reduce costs associated with the middlemen (third parties) of business exchanges. Removal of the middlemen creates an opportunity to eliminate bank fees, escrow accounts (and their fees), check processing and all the communication and paperwork involved in complex transactions. Ultimately, reducing the costs of business creates the possibility of a more inclusive environment for disenfranchised communities left on the sidelines due to the cost of business and lack of access to strong financial institutions.
What’s Happening Now?
With Bitcoin’s adoption and subsequent growing use, a new type of blockchain was created that could be used to facilitate more than peer to peer payments. Using smart contracts, Ethereum aims to become a new type of global and decentralized computer network. This open-source blockchain provides networked computing power to run a wide variety of applications beyond P2P payments, powered by smart contracts. Areas of exploration include distributed file sharing, futures markets, asset exchanges, loans, and crowdfunding.
Many developers began creating innovative applications on the Ethereum blockchain but needed an innovative way to fund their development efforts. Enter the ICO or Initial Coin Offering. Much like an IPO, Ethereum based companies would perform a crowdfunding sale of tokens or coins instead of shares to raise capital. A company would issue tokens to supporters that contribute funds and when the campaign ends, smart contracts facilitate the distribution of tokens to funders. This was all made possible by the underlying smart contracts that managed the ICO processes.
There are many varieties of ICO’s because the coin/token issued can have a multitude of purposes depending on the company issuing them. BUT, there is a catch because it’s not entirely clear whether or not these tokens are considered securities and subject to SEC regulation. Should the SEC and other global regulatory bodies start to take action against the ICO process, it could have significant implications for the short-term adoption of smart contracts.
Challenges with Blockchain
How can we trust who is on the other side of a digital transaction? Is a person who they really say they are? We are currently in an age of catfishing and trolling by people who withhold their identities. Additionally, there are still regulatory complexities such as Know Your Customer laws (KYC) and Anti Money Laundering laws (AML) that require identity verification to take place. Without a legitimate identity verification process to surpass regulatory hurdles and facilitate confidence in peer to peer transactions, it may be difficult to build a strong foundation for the future business processes smart contracts could enable.
Ethics & Overcoming Breakdowns
Although the concept of smart contracts has been around since the early ’90s, it’s still a topic in relative infancy. There are not many good examples of breakdowns at this point beyond failed ICO’s but what will happen when there are? As an example, what happens in a peer to peer transaction when the contract executes in an unintended way? How will arbitration take place? What will be the implications to the broader smart contract ecosystem?
So here is the bottom line: blockchain is a relatively new and potentially useful technology. It’s not magic but it does use some very sophisticated concepts that many people don’t yet understand. As more experimentation is conducted with blockchain, new use cases will create unique business opportunities that have the potential to significantly disrupt many industries. Experimentation and industry disruption will create yet to be conceptualized 2nd and 3rd order consequences. Although blockchain is extremely complicated, it’s important not to ignore the development of this technology.
Douglas Antin is an MBA candidate at F. W. Olin Graduate School of Business and Co-Founder at HeadGear Safety Systems Inc. He wrote this article as part of the graduate course Thought Leadership in Technology. You can learn more about the course here.
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