Maybe this is not the shortest ever, but surely the best we could put together to provide enough details to get a complete understanding of it.
Let’s start by breaking a myth: bitcoin is not just cool because it’s digital. Nope!
Digital assets and electronic money are not a new thing, they have been around for quite some time before Bitcoin or any other cryptocurrency was ever conceived. Our online accounts are collections of records in a database that don’t need to have a corresponding physical asset in the bank’s basement vault. They are a pure form of electronic money which can only become physical when we materialize it in hard cash, at the ATM. Which I am frankly doing less and less often, as electronic payments are displacing notes.
Cash represents just a tiny percentage of broad money. In UK it’s only 5% and, despite some pundits would like to eliminate it completely, this would be problematic at large until considerable groups of people are digitally illiterate, have no access to banking services or have nearly to no access to the internet.
So Bitcoin’s innovation is not certainly in it being digital. It is instead in it being issued, recorded and transferred in new and better ways than the financial services industry had ever done with any forms of value (not just money) before.
Bitcoin’s payments and transfers can be executed and confirmed without the need of trusted or legally accountable certifiers. Anyone can be a validator, anonymously. The legitimacy of their work is granted by the concurrence of different factors:
- the large amount of resources required to validate a block of transactions,
- the necessity for the network to verify each of these blocks of validated transactions,
- an economic incentive received by validators only when the network confirms the block.
Confirmed transactions are added to a public ledger, which is fully distributed across the network and is called Blockchain. Blockchain stores the complete history of each single transaction ever happened, including time, participants and amounts transferred. As the nodes in the network continuously agree on the state of the ledger, its integrity is granted “as long as a majority of CPU power is controlled by nodes that are not cooperating to attack the network” (cit.: Satoshi Nakamoto’s whitepaper). In reality this is not accurate, the threshold can be lower than 50%, but we’ll eventually come back to that in a follow up post. Let’s keep it short and say that integrity is granted as long as a very high percentage of the network doesn’t cooperate against it.
Such a network would work perfectly even if we removed trusted intermediaries: notaries, bookkeepers, banks, accountants, auditors, supervisors, etc. It would function if we removed Central Banks’ too, with their monetary policies.
In fact the creation of new Bitcoins is controlled by a set of fixed rules: the reward to validators is (mainly) constituted of new Bitcoins. If such rewards were not in place, there would be no incentives for any node to engage in the resource-intensive job of validating transactions. (This is the main reason for Bitcoin-ers are vivaciously skeptical of the possibility of a Blockchain without the incentives provided by its cryptocurrency).
Bitcoin’s powerful idea to remove the need for any trusted third parties, among them banks, and to have a public ledger accessible to anyone, is certainly a few steps too far for the financial industry as we know it. On the other hand, in the financial services there are several processes which require an enormous set of different counterparties and layers to interact in burdensome ways. For example, in the markets all of these layers – custodians, brokers, exchanges, etc. – have to keep separate records of the same transactions, generally as a regulatory requirement. Their ledgers risk to get out of sync, hence need to be reconciled occasionally.
The whole process could be simplified using some of the principles of the Blockchain technology, allowing counterparties in a private network to access a single shared ledger which is sufficiently secure and gives enough control to each party that they don’t need to maintain their own separate records.
Thus some of the intermediate layers could be eliminated and record-keeping would be much less burdensome and more resilient.
According to a joint report from Oliver Wyman, Santander Innoventures and Anthemis, “distributed ledgers technology could reduce banks’ infrastructure costs attributable to cross-border payments, securities trading and regulatory compliance by between $15-20 billion per annum by 2022.”
Sounds like a pretty good reason to keep an eye on the technology, and get involved and invest in the creation of Proof of Concepts.
If you want to discover more about Blockchain, how it can help you and your company, or if you want to start developing solutions based on distributed ledger technologies, ping us at: firstname.lastname@example.org