Cryptocurrencies made headlines last year, particularly the original and best-known, Bitcoin, as investors rode a meteoric rise and fall in their value.
But, for many of us, Bitcoin, Ripple, Neo and the other cryptocurrencies are shrouded in technological mystery. It can be hard to understand how they work, and whether we can trust them.
Introduced to the world in 2008 by a person or group of people who go by the pseudonym Satoshi Nakamoto, Bitcoin relies on blockchain technology as a way of moving and storing digital money, and many other cryptocurrencies have followed suit by using it.
If you want to wrap your head around this new way of spending, getting to grips with blockchain is a good place to start.
We talked to some of our leading experts at the University of Melbourne, to help us unpick the technical jargon around the technology quietly revolutionising the way the world does business.
What is blockchain?
Blockchain is a system of processing and recording transactions openly and transparently. It’s a public record of all transactions ever made, for example, recording a particular cryptocurrency transaction – its best-known application. It is a way of verifying who owns what, and how much of it.
“The reason cryptocurrencies became so popular is because the blockchain technology that underpins them allows users to basically cut out the middle man in managing the ledger that records who owns which bitcoin,” says Senior Lecturer in finance at the University of Melbourne, Dr Vincent Grégoire.
Traditionally, when we buy or sell something, we rely on a third party to make a transaction, like a bank. But blockchain cuts this step out. Instead, when a transaction is sent, a decentralised network of computers validates it. Once finished, the completed transaction is added to a public ledger for all users to see.
Blockchain gets its name from the way the transactions are processed and recorded. Dr Grégoire says the network will process a group of transactions, known as a ‘block’, and these blocks are permanently linked together to create a ‘chain’.
“There’s no way to reverse any bit of that history without modifying every following block,” he says.
“Every time you’re adding some new information, you’re at the same time validating the previous information.”
How safe are blockchains?
An algorithm called Proof of Work is used to keep transactions safe. The idea is that it takes a lot of computing power to generate a valid proof for a new block, and so a malicious party can’t fake a proof of some alternative history and persuade everyone else to accept it.
But as Dr Vanessa Teague, Senior Lecturer in the Department of Computer and Information Systems at the University of Melbourne, explains, modifying the block history may not be as hard as it seems. For one thing, you may not need more computational power than everyone else. For another, the computational power of the blockchain is concentrated in very few hands.
“There is some evidence that even the Bitcoin blockchain, which is very large and well-established, isn’t as diverse or widely distributed as we would like it to be.
“There’s a concern that some entities actually control a very large fraction of the computation, which means that if a couple of them got together, they could possibly cheat.
“There’s also a common misconception that blockchain technologies are privacy-preserving, which they’re not; conversely, the whole point is to write everything on a public ledger. For example, ransomware payments have been successfully tracked across the Bitcoin blockchain to identify the criminals.”
Blockchain has been popularised by Bitcoin, but its applications stretch well beyond cryptocurrencies.
Ethereum is a blockchain technology that enables smart contracts. A smart contract is a set of rules, written in code, that predefine how certain transaction will play out. When the conditions are met, the agreement is self-executing and the ledger is updated accordingly.
For example, a company may set up a smart contract that will automatically assign ownership of a product when a customer transfers a certain amount of money. That product may then be automatically marked for shipping.
Dr Grégoire says smart contracts could lead to substantial cost savings.
“Smart contracts can be self-executing and self-enforcing because they’re computer code. You can have a lot of this execution happening automatically without human intervention.”
Blockchain also has the potential to transform supply chain management, by allowing users to track transactions securely and transparently. Last year Australian start-up AgriDigital and the nation’s biggest grains exporter CBH Group trialled the technology in the grain industry.
“It reduces inefficiency and it’s also good in terms of traceability, because every shipment from the farm is tracked through blockchain, which all stakeholders along the supply chain can read and access,” Dr Grégoire says.
Hype or hope
Late last year, iced tea company Long Island Iced Tea changed its name to Long Blockchain, and overnight its stock price almost tripled.
As investors scramble to capitalise on the blockchain craze, Dr Grégoire warns this hype could undervalue the technology.
“We see companies jumping on the bandwagon without having good ideas, just saying ‘we’re going to do blockchain’. That’s problematic in the sense that it’s not adding any value, it’s not creating anything.
“If you think about the tech bubble in the early 2000s,at the time it burst, every company related to technology suffered a stock market fall, even the good ones.
“That’s a concern for sure. In the long run it might hurt good companies who are truly innovating.”
But Dr Grégoire is confident the technology has a strong future.
“There’s so much investment being made by well-managed corporations in blockchain because the technology itself is promising. I think it’s going to survive the hype.”
Dr Teague sees a future for the technology of any application not concerned with privacy.
“It’s not for preserving privacy, it’s just for making sure that everybody agrees on the history of the transactions. This has great value, as long as it really is as secure and decentralised as it is assumed to be.”
Banner image: Shutterstock