Blockchain Explained

Blockchain technology has undoubtedly been the buzzword of the past 12 months. Companies have been scrambling to understand and utilize the technology. Long Island Ice tea Corp was a struggling soft drinks business but in 2017 changed its name to Long Blockchain Corp. Its new strategy became partnership and investment in Blockchain technology. The share price of the company rose by a staggering 289% within a day. Despite the hype, the exact definition and workings of Blockchain still elude most. This article will explore what Blockchain is, how it works and how it is currently being utilized.

Background

Blockchain is a peer to peer decentralised distributed ledger. In simple terms, it is a spreadsheet of transactions that is duplicated across every computer on the network. It was invented in 2008 as the network for Bitcoin, allowing for transactions between parties without the need for an intermediary. This was the beginning of what has been called one of the most revolutionary technological advancements since the internet. On a Blockchain, transactions are verified and completed on the network without a “middle-man”. Blockchains are decentralised and there is no single entity that has full control of a Blockchain network. Therefore, there is no single point of weakness, making it nearly impossible to hack and/or manipulate. In order for someone to fabricate or alter a transaction on a Blockchain, they would have to replicate the fabricated transaction on every computer on the network. In Bitcoin’s case, this amounts to millions of computer worldwide. Once a transaction is confirmed on the Blockchain ledger, it is visible to everyone on the network and cannot be altered.

How it works

The basic premise for how Blockchain works is relatively straightforward. A party on the network puts in a request to execute a transaction between themselves and another party. Miners then verify the transaction. Once verified, the transaction becomes permanently written into the ledger, available for everyone on the network to see.

Each computer on the network seeking to make a transaction is a “node”. Once a node wants to execute a transaction, this request is sent to the network, visible to everyone. This transaction is grouped with other transactions into blocks. “Miners” are responsible for verifying blocks. Miners use powerful computers to solve complex algorithms to verify the validity of the transactions within the block. Once a sufficient number of miners confirm the validity, the transaction is confirmed. Once confirmed, the Blockchain ledger is updated with the new block across the whole network on every computer. Miners attach their logic for verification and receive rewards for solving the algorithms (i.e. Bitcoins). This is called the “proof of work” method of verification.

Another method for verifying transactions is the proof of stake method. Proof of stake validation requires miners to solve algorithms but they put their “stake” in the Cryptocurrency on the line when they validate transactions. If their work in solving the algorithms is erroneous they will lose that stake. Like proof of work however, there must be a consensus amongst a number of miners.  There is no direct reward for solving the algorithms although miners receive the transaction fees. All of the currency in circulation is created at the beginning so miners aren’t creating currency from their mining as in Proof of Work. This is why proof of stake miners are called “forgers”.

The diagram below illustrates the process for completing transactions on the Blockchain network.

(Credit: Block geeks)

Applications of Blockchain Technology

We can expect Blockchain technology to improve efficiency to a number of socioeconomic aspects such as asset ledgers, financial transactions, public records storage, commercial supply and trade networks. The transition from current systems to Blockchain will undoubtedly be time-consuming but the potential benefits are nonetheless worth it. Blockchain technology already has existing applications in the following ways:

Banking and Finance – Blockchain technology is most famous for its use in Bitcoin. Bitcoin is a peer to peer payment system and its Blockchain was the first ever created. Blockchain in the banking sector however, reaches much further than Bitcoin. Many analysts see Blockchain distributed ledgers as a foundational technology where there is a potential for its use to revolutionise modern economic systems and provide more security for all users involved. This is distinctly different from the anarchist ‘disruptive technology’ reputation given to Bitcoin where many see it as an outsider threatening traditional financial institutions of the world. JP Morgan’s CEO Jamie Dimon, has been a stark critic of Bitcoin but conversely, was extremely positivity about the underlying Blockchain technology.

Banks such as HSBC, RBS and UBS have all been experimenting with technology (Business Insider).  There is an expectation that we will soon see the use of Blockchain in transaction settlement. Financial institutions currently pay significant settlement fees to execute transactions. It is likely that Blockchain may now replace this.  JP Morgan has already begun work on its “Quorum” solution to facilitate clearing, settlement and cross border payments. (CNBC)

Even, cryptocurrency is edging its way into the mainstream banking sector. Ripple has teamed up with MoneyGram to trial cross-border payment solutions.  Ripple’s XRP cryptocurrency can complete over 50,000 transactions per second. This is more than double VISA’s rate of 24,000 transactions per second. This will allow parties to send money instantly and massively reduce costs for all parties. Although Ripple have control over the supply of XRP and so is not truly decentralised. Therefore, calling XRP a Cryptocurrency is deemed a misnomer by many. This does however; illustrate the potential of cryptocurrencies to bring substantial change to banking.

Land Registration – Land registration is typically one of the most complex areas in property law, as the titles and types of ownerships related to a land can be plentiful and complex. In the English system, the 2002 rejuvenation of the Land Registration System was necessary so that titles over vast periods of time could be properly recorded so that relevant parties were aware of all existing relationships to property. Blockchains are transparent and resistant to alteration which means that relationships to the property can be easily understood by property lawyers, title holders and prospective buyers. Therefore it is understandable that like other nations, Georgia is piloting a property registry incorporating blockchains.

Government: Malta – The Maltese government has demonstrated recent interest in diversifying its small economy, which is heavily dependent on imports for many goods including oil. It will attempt to become an economy heavily dominated by financial services and has even created a junior minister position responsible for innovation in financial services. Malta is also expected to utilise Blockchains at the core of this diversification, where it intends to pass legislation in July which will look to regulate the technology by examining the intellectual property of each Blockchain and instating an administrator and auditor with specific and limited functions and roles.

Hospitals – Globally hospitals hold massive amounts of public data records which include content for many people at any one site. The global Electronic Health Record (HER) market is the collection of digital versions of patent medical history which are accurately updated by medical professionals. Thus there is an effective record system which allows for quick access to crucial information and thus improves efficiency and patient participation. However the EHR market struggles with the ability to effectively share this information globally to relevant members but with the safety of concealment from non-members. In order to ensure patient privacy and still allow multiple providers of the information to view and alter records, some say Blockchains are the way forward. The use of Blockchains will mean that records are permanent and secure yet when altered will have a corresponding effect on all subsequent records. It will also allow for security from outsiders yet gives all active users equal and full access to existing records. An indication of global health industries’ move to this technology is shown by the FDA’s research partnership with IBM Watson to explore methods of sharing EHR data (clinical trials, genetic sequencing) via Blockchains.

Smart Contracts – One of the most promising uses for Blockchain technology is in smart contracts. Smart contracts are self-executing and self-enforcing, removing the need for intermediaries to execute agreements. They operate similar to a vending machine. Blockchain based smart contracts are tipped to revolutionise the legal sector. Users simply write the conditions of the contract into the Blockchain network. Once the conditions have been met, the contract automatically executes. A number of law firms including Linklaters, Cooley and Womble Bond Dickinson have already began to invest in the technology. Hogan Lovells has also begun experimenting with smart contracts.

Many analysts however, do argue that smart contracts can enhance contract law but will not replace traditional contracts. For example, there is no room for deliberate ambiguity to be written into code. Check out our insight article looking at how AI and smart contracts are changing the legal sector.

Summary

Strengths

  • The decentralised nature of Blockchain. The Blockchain is distributed to every computer on the network so there is no single point of weakness. This protects the Blockchain from hacking/manipulation.
  • Blockchain technology is exceptionally secure. There has never been a successful hack on a Blockchain.
  • The Peer to peer structure of the Blockchain network removes the need for intermediaries. This can facilitate cheaper transaction costs between parties.
  • The transparency afforded to users on a Blockchain is unrivalled. All transactions that take place on the network are accessible to everyone. The financial sector has been battling to improve transparency in the industry and Blockchain provides an obvious solution.
  • The efficiency of data storage is unparalleled, as the technology allows quick input of permanent data and retracing of older versions via the blockchain links. This advantage is why the UN are looking to use Blockchains to deal with the identity challenges faced by stateless people. (Coindesk)
  • Blockchain’s possible uses are endless. We provide some of the current uses above but there are thousands of additional applications in development.

Weaknesses

  • While being unable to alter and manipulate Blockchain is the inability of parties to manipulate Blockchain data this could turn out to be a threat to its development. Child abuse images were recently found on the Bitcoin Blockchain. Users can save additional data alongside the transaction and this tends to be information relating to the transaction. Researchers found that 3 files stored on the Blockchain contains child abuse images and links to dark web services. This could mean that any person who downloads the Blockchain may be download content which is explicitly unlawful to possess. There is no legal precedence but because the data cannot be removed this creates a significant issue. (The Guardian)
  • The technology is still in its relative infancy as are the applications built upon it. Applications built on Blockchain are still highly susceptible to exploitation and fraud as regulators get to grips with the technology. South Korean officials were recently accused of insider trading in the Cryptocurrency market. Ironically, the laws of insider trading do not apply because cryptocurrencies are not regulated products. Regulators are still trying to understand Blockchain and implementing sufficient regulation will be lengthy. In the mean time, it is likely that we will see manipulation of the markets.

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