Blockchain, often synonymous with the term Bitcoin, has perfused into our quotidian economy since its 2008 inception by an anonymous person or group known as Satoshi Nakamoto. Walmart is using it to track Chinese pork, BP is experimenting with it to streamline oil and gas trading. Blockchain’s expansion past its original purpose as a platform for cryptocurrencies illustrates the potential this programme holds to be the next great innovation since the emergence of the World Wide Web.
What is blockchain?
Blockchain technology describes a distributed ledger which, process and stores information without a central authority. They can be compared to distributed databases, except that blockchains are politically decentralised. Jointly maintained through a peer-to-peer network of computers, they utilise advanced cryptographic algorithms to maintain an immutable record of data – thus agree on a single truth. Since such consensus is obtained by design and does not require trusted intermediaries, blockchains are also referred to as trust-less systems, in the sense that trust is inherent to the system.
What is cryptocurrency?
As one application of blockchain technology, a cryptocurrency is a digital asset intended to function as a medium of exchange utilising cryptography to secure transactions, control supply of additional units, avoid double spending of digital assets and to verify the transfer of assets. The main attraction of cryptocurrency is its independence from governments and central banks. This is achieved through a blockchain network that acts as a secure online ledger; any time there is an exchange of a cryptocurrency, the trade is logged and several hundred of these exchanges make up a block. No entity controls these blocks, as blockchains are decentralised across every wallet for the particular cryptocurrency, thus allowing for bureaucratic sovereignty.
How does it work? The principles of crypto-economics.
Taking the example of a blockchain-based cryptocurrency, all transactions are recorded and authorised in a process referred to as ‘mining’, in which individual ‘miners’ actively solve ever more complicated encryptions. The solution to these encryptions is nearly impossible to predict. This means there is no better strategy than guesswork, leading the miners to use their CPU to guess until they get the Hash value below the target Hash and are subsequently rewarded. Each block is created chronologically and includes the Hash of the previous block, thereby providing evidence the block came afterward. While finding the Hash function is hard, the verification thereof is significantly easier, which ensures a truly decentralised ledger by being continuously audited from many different mining entities. This verification process is effective at ensuring no one entity is able to alter the blockchain as it would take an immense amount of computing power to provide 51% of all the computing power required to control the ledger.
In this case, the dominant strategy of all miners is directed towards the reward for a successfully validated block, hence the continuation of verified blocks. This is one way that game theory ensures consensus and security on a blockchain. Blockchains, combining cryptographic computation with a strategic use of incentives, are fundamentally rooted in economic theory and thereby popularising the term ‘crypto-economics’.
In its current state, however, the technology is still immature, prone to failure and not equipped for scale. There is even substantial reason to believe that we are in the midst of a ‘crypto bubble’, with Bitcoin’s valuation skyrocketing to unseen highs from 12 USD in November 2012 to over 7,000 USD only five years later. Furthermore, in many recent cases, blockchain companies managed to raise – and still raise – millions of US-dollars in cryptocurrency through initial coin offerings (i.e. going public on blockchain instead of on stock exchanges), while having delivered nothing but a mere idea. Rejected from reputable investors, certain blockchain companies approached the masses instead through obscure endorsements, from model Paris Hilton, boxer Floyd Mayweather, and musician DJ Khaled. With all due respect to these individuals, receiving investment advice from non-specialist celebrities may be just another indicator the existence of a bubble.
According to Amara’s law, ‘we tend to overestimate the effect of a technology in the short-run and underestimate the effect in the long run’. In light of these previously mentioned recent developments, it should not come as a surprise if blockchain technology sooner or later falls short of its inflated expectations.
Trust by design, nevertheless, is an unprecedented paradigm change across disciplines. Once widely adopted, the implications of blockchain could well reach far beyond the discipline of computer science and affect economic, political and social systems alike.