In 2008, the person or group using the pseudonym Satoshi Nakamoto shared a paper outlining a peer-to-peer protocol for electronic cash. The protocol he described was truly peer-to-peer without the need of a banking institution or payment processing system like Paypal.
Miners race to solve a cryptographic puzzle, which completes the next transaction (or block) on the chain, in hopes of capturing the reward of a few coins. He called his digital currency Bitcoin, now the most popular (and expensive) of cryptocurrencies one can buy.
When Nakamoto released Bitcoin, its code was open for revision and reuse. Developers flocked to take the code and fashion their own coins. The trading of fiat currencies can be complicated and involve numerous fees, and now through the power of the blockchain, could be circumvented entirely.
Cryptocurrencies completely cut out the middleman, and all of the concomitant charges, allowing users to trade units of value for services, products, and goods with incredible ease.
“The blockchain, the underlying technology, is the biggest innovation in computer science: the idea of a distributed database where trust is established through mass collaboration and clever code,” Tapscott Group CEO Dan Tapscott told Mckinsey, “rather than through a powerful institution that does the authentication and the settlement.”
Bitcoin -- and its many imitators -- exploded in popularity precisely because of its ability to function without third party institutions. With cryptocurrencies, users essentially trade encrypted keys and these trades are recorded on the Blockchain. The blockchain acts as a distributed ledger, which ensures that coins are exchanged with complete transparency and integrity without the use of a trusted third party.
“Commerce on the Internet has come to rely almost exclusively on financial institutions serving as trusted third parties to process electronic payments,” explains Nakamoto in his seminal paper describing cryptocurrency.
“The cost of mediation increases transaction costs… and there is a broader cost on the loss of ability to make non-reversible payments for non-reversible services. With the possibility of reversal, the need for trust spreads. What is needed is an electronic payment system based on cryptographic proof instead of trust.”
In theory, according to Nakamoto and proponents of cryptocurrency, Bitcoin should operate in a much more efficient fashion than our current financial system.
The problem of double-spending, a problem unique to digital currency, as digital information can easily be fraudulently reproduced or replicated, is solved by the computationally-intensive cryptographic puzzles required of each transaction, which makes falsifying a transaction incredibly difficult.
Cryptocurrencies can operate effectively only because of the powerful triple entry bookkeeping technology that is the blockchain. In fact, the technology underpinning the electronic cash may prove to be more important than the currency itself.
Financial institutions have already started to investigate the distributed ledger technology in an effort to reduce overhead and increase efficiency. IBM is pouring resources into their Hyperledger project, which aims to "advance cross-industry blockchain technologies” alongside The Linux Foundation.
Companies like Northern Trust are starting to integrate their services with the blockchain in hopes of saving money. “We decided to focus on the private equity market because the marketplace is very manual today," president of corporate and institutional services at Northern Trust, Peter Cherecwich, told Reuters. "Benefits should include a reduction in cost."
Private equity is only one of the many sectors could be affected, or even transformed, by this new technology. In a sense, this “immutable, unhackable distributed database of digital assets” as Tapscott, phrases it, could do what the Internet did for information, creating an Internet of Value, spawning innumerable applications of the blockchain outside of currency.
“If we have a global, distributed database that can record the fact that we’ve done this transaction,” posits Tapscott, “what else could it record? It could record any structured information.”
The blockchain could revolutionise how we interact with each other and how we record all sorts of transactions, not just financial ones. Blockchain could do for the Internet what double entry bookkeeping did for corporate accounting. The Internet of Things could be tracked by a immutable, distributed database, tracking transactions of everything around us -- it could, quite literally, change everything.
Article by Ellie Martin, business and marketing writer.