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Ensuring bitcoin fungibility in 2017 and beyond
Few people understand what it is, but Wall Street banks, IT organizations, and consultants are buzzing about blockchain technology. See how venture firms, corporates, regulators, and builders are shaping the future of blockchain technology.
This explainer will offer simple definitions and analogies for blockchain technology. It will also define Bitcoin, Ethereum, blockchain broadly, and initial coin offerings, and highlight promising use cases for the technology. For a deep dive into how Ethereum works, you can read our What Is Ethereum explainer.
Lastly, this report will make clear the distinctions between distributed ledger technology and blockchain, and highlight where these technologies have an application — and where they do not. The financial crisis caused a lot of people to lose trust in banks as trusted third parties.
Many questioned whether banks were the best guardians of the global financial system. Bad investment decisions by major banks had proved catastrophic, with rippling consequences. Bitcoin is a decentralized, public ledger. There is no trusted third party controlling the ledger.
Anyone with bitcoin can participate in the network, send and receive bitcoin, and even hold a copy of this ledger if they want to. The Bitcoin ledger tracks a single asset: The ledger has rules encoded into it, one of which states that there will only ever be 21M bitcoin produced. Because of this cap on the number of bitcoins in circulation, which will eventually be reached, bitcoin is inherently resistant to inflation.
Bitcoin is politically decentralized — no single entity runs bitcoin — but centralized from a data standpoint — all participants nodes agree on the state of the ledger and its rules. Alice hands Bob a physical arcade token. Bob now has one token, and Alice has zero. The transaction is complete. Alice and Bob do not need an intermediary to verify the transaction. But what if the same transaction were digital?
Alice sends Bob a digital arcade token — via email, for example. Bob should have the digital token, and Alice should not. What if Alice put the same digital token online for all to download? After all, a digital token is a string of ones and zeros. This ledger will track a single asset: When Alice gives Bob the digital token, the ledger records the transaction. Bob has the token, and Alice does not.
By default, Dave — who is not involved in the transaction at all, will have to control the ledger. What if Dave decides to charge a fee that neither Alice or Bob want to pay? Or, what if Alice bribes Dave to erase her transaction?
Maybe Dave wants the digital token for himself, and adds a false transaction to the ledger in order to embezzle it, saying that Bob gave him the token? Think back to the first physical transaction between Alice and Bob. Is there a way to make digital transactions look more like that? Alice and Bob could distribute the ledger to all their trusted friends, not just Dave, and decentralize trust. Because the ledger is digital, all copies of the ledger could sync together.
If a simple majority of participants agree that the transaction is valid e. When a lot of people have a copy of the same ledger, it becomes more difficult to cheat. If Alice or Bob wanted to falsify a transaction, they would have to compromise the majority of participants, which is much harder than compromising a single participant.
And even if Alice bribes Dave to change his copy of the ledger, Dave only holds a single copy of the ledger; the majority opinion would show the digital token was sent. In sum, this distributed ledger works because everyone is holding a copy of the same digital ledger.
The more trusted people that hold the ledger, the stronger it becomes. Such a ledger allows Alice to send a digital token to Bob without going through Dave. In a sense she is transforming her digital transaction into something that looks more like a physical one in the real world, where ownership and scarcity of an asset is tangible and obvious.
You may have noticed a key difference between the above example and Bitcoin. In contrast, Bitcoin is entirely public, and anyone can participate. How can we avoid bad actors corrupting the ledger? A public ledger would allow for many more participants.
The more participants, the stronger the ledger becomes. Because Bitcoin expands beyond trusted participants and gives anyone access, it runs a higher risk of bad actors and false transactions. However, Bitcoin is free and open to anyone, trusted or not, like a Google document that anyone can read and write to. Bitcoin offers a solution: In simple terms, certain Bitcoin participants are incentivized to do the dirty work and maintain the network.
For doing this work, these miners are rewarded with bitcoin. When miners devote computational power, they also use a tremendous amount of electricity. Further, if the Bitcoin community became aware of the hack, it would likely cause the price of bitcoin to drop steeply.
This makes such an attack economically self-defeating. Many of them seek to improve on Bitcoin or expand its capabilities. Other cryptocurrencies use different rules and engage with other economic models. A single bitcoin is not just a string of ones and zeros, but the first successful at least so far censor-proof, portable, easily transactable, durable, and secure digital asset.
Hashes, public-private key encryption, segregated witness, sidechains, forks, and block size, among other elements, fall outside of the scope of this piece.
To ensure its public, decentralized ledger remains secure, Bitcoin uses a blockchain. Blockchain technology offers a way for untrusted parties to reach agreement consensus on a common digital history.
Blockchain technology solves this problem without using a trusted intermediary. Effectively, Bitcoin uses a blockchain to decentralize payments. Where else could we use this unique database architecture to get rid of the middleman? Land title is one. It could be quite useful for everyone to have access to a decentralized source of record saying who owns a given parcel of land.
Once a land distribution is agreed upon, it can be recorded in a distributed ledger and no longer be subject to ongoing debate. A number of companies are working on this, including velox.
In the same vein, a blockchain could be used to establish ownership over any number of physical assets — cars, art, musical instruments, and so on.
A blockchain means there is no single entity controlling the ledger. Therefore, recording physical assets on a blockchain is a prime example of where the technology might come in handy to track ownership with a tamper-proof, neutral, and resilient system. Identity might also be low-hanging fruit.
The recent Equifax hack exposed the social security numbers of M Americans. Blockchain technology might present a better means of establishing identity.
Instead of a state or government issuing it, identity could be verified on an open, global blockchain — controlled by nobody and trusted by everybody. Thus, users could control their own identity. A number of companies are working in this arena, including ID and Civic. The hype around Bitcoin, blockchain, and cryptocurrencies has contributed to renewed interest in distributed ledger technology.
Bitcoin uses distributed ledger technology and adds a consensus layer on top — the blockchain. Instead, a trusted third party could be used to lightly administer a distributed ledger. This means anyone can access them. On the other hand, if all parties are known and trusted, distributed ledger technology could provide sufficient security.
For Bitcoin, a public, permissionless blockchain is the only possible solution. In many other instances, a blockchain would be a terrible idea. Another major issue is scaling blockchains. For a blockchain to work, lots of participants need to hold up-to-date copies. This means that the same database is held by thousands of nodes. This is fairly inefficient.
If we were to look at how technology has developed over the past fifteen years, blockchain runs counter to the logic behind cloud computing. Cloud computing trends toward a single database that multiple nodes can access.
Further, nodes holding copies of the blockchain receive constant updates. These nodes are distributed around the world. Because of this, blockchains have high latency latency is the amount of time it takes for data to move through the network.
As a result, blockchains face scaling issues. Bitcoin can process about transactions per second. Ethereum maxes out at about 20 transactions per second.
Visa can process over 1, transactions per second.