Why Blockchain Could Kill Your Bank

11 / July 2017,

Why Blockchain Could Kill Your Bank

Bitcoin has exploded in popularity. Its value has doubled every year since its inception in 2009 and now one coin is worth somewhere between $2500 and $3000 depending on what time of day it is.

Blockchain and cryptocurrency sound complicated and unless you have an advanced degree in computer engineering they are. That doesn’t mean the underlying principles behind them can’t be understood, it just means that source code for Ethereum might be out of reach.

If you’re reading this you’re probably wondering why an SEO company is writing about Blockchain and for that I can’t give you a legitimate answer, other than I listened to a very interesting podcast on the topic, ran out of blog ideas and cryptocurrencies and the concepts supporting them have the potential to fundamentally change the way people do business. From contracts to banking to day-to-day commerce, this will disrupt major industries.

Like all disruptive forms of technology people are calling it fad and a bubble. Digital currencies could very well be in a bubble, in fact they probably are, they are highly speculative and extremely volatile, investors will probably lose money but the technology that supports them isn’t going away-the multiple applications are just too valuable.

I don’t want to sound like the harbinger of revolution here but it’s 1993 or maybe even 98 and this is the internet.

In 1995, Newsweek ran an article stating that, “no online database would ever replace your daily newspaper.”

As much as it pains me to write this, we’ve all witnessed the slow and steady death null of the American newspaper. Looking back now with the hindsight of 25 years it seems obvious that the internet would disrupt and eventually destroy the print newspaper business but at the time-if you’re old enough to remember-lots of very prominent voices who wouldn’t admit to it now were calling the internet a fad.

I’m not sure I’ll feel the same nostalgia I do about newspapers if Blockchain technology wipes out banks and credit card companies but who knows maybe in thirty years when robots have taken our jobs, millennials are complaining about the next generation of 20 somethings, my universal basic income doesn’t cover 1/3 of the cost of a CrossFit Gym membership and we discover that reality is just a simulation being carried out by an advanced society for reasons we are incapable of understanding I’ll feel differently.

Don’t worry about the banks though. The people responsible for the financial crisis of 2008 have already landed on their feet and are doing astronomically better than they were before the housing crisis. In fact, investment banks have been quietly dumping obscene amounts of capital into Blockchain based technologies for several months, they see Blockchain as a path to automation and as a way to produce more derivative financial products that are guaranteed to melt investors faces off. So, as it usually goes the people that will get screwed are all going to be low level; the tellers, the sales people, the middle management and if you doubt that for a second, look what happened at Wells Fargo. But I digress, this blog is about what Blockchain is, not some semi-political rant against the banking industry.

Blockchain is the technology that allows digital currencies to exist securely, preventing double spending, duplication and other types of shady business. While the idea of cryptocurrency has been around since the early nineties it wasn’t until Satoshi Nakamoto (most likely not a real person but a group of people) released the white paper on Bitcoin in 2008 that a system was developed to support it effectively.

Banking isn’t the only industry that will be significantly affected. Currency is just one of the many applications of Blockchain, it could be applied to contract law, intellectual property, financial markets or any transaction that requires third party verification. It will allow peer-to-peer transactions to take place of on a scale we’ve never seen before, all that’s needed is a phone with an internet connection. Of course, Quantum computing could come along and change everything but that’s a completely different topic.

But in order to gain an understanding of how it works we need to understand what money actually is.

What is Money?

MoneyUnderstanding cryptocurrency requires a fundamental understanding of what money is. Noah Yuval Harari the author of Sapiens: A Brief History of Humankind, believes that what distinguishes humans from other apes and humanoid species is the ability tell stories, translate those stories into a system of shared beliefs and then cooperate in large groups because of that belief system. On an evolutionary scale humans were definitely not the strongest and maybe not even the most intelligent but what allowed us to eradicate predators and other species of humans like Neanderthals, was the ability to cooperate on a large scale through the use of shared fictions.

Money is one of these stories we humans tell ourselves. Money is a system of accounting, a store of value, a medium of exchange. But in reality, whether the money we’re talking about is a Fiat currency (paper money not backed by something like gold) a precious metal like gold, silver, a clam shell or a piece of shiny black obsidian, it has no intrinsic value, you can’t eat it or drink it, it is a shared fiction, a system of mutual trust, a unit of cooperation.

It is the one belief system that all humans can agree on.

What is Cryptocurrency?

There are literally hundreds of cryptocurrencies but the most popular/valuable by far are Bitcoin and Ether which have a combined market capitalization of 76 Billion dollars. To quote the character Erlich Bachman from the HBO series Silicon Valley: “It’s the frothiest thing in the valley right now.”

CryptocurrencyDistilled to the most basic explanation, cryptocurrency is currency protected by cryptography. Cryptography is secret code/math that prevents third parties from reading a message. Secret codes have been around as long as humans have used languages to communicate but modern cryptographic algorithms are extremely complex and require lots of time and computational power to crack, making brute force style attacks next to impossible. Cryptocurrencies are pseudo-anonymous, meaning they can be traced easily but typically a name isn’t associated with the transaction. Coins are “carried” in a digital wallet, in reality all that’s actually needed is a one way private key, theoretically if you memorized that key you could go anywhere with millions of dollars only in your mind. The concept of public and private keys is simple: a public key can be seen by everyone and encrypts to you, while a private keys decrypts and is known only to you. This seems like a lot to keep straight but just wait until I try to explain deep learning.

For some people, words like cryptocurrency or Bitcoin bring to mind buying heroin on the internet, pirates, murder for hire on the Dark Web or what you have to pay the Russian hacker to unlock your laptop after its been infected with ransomware and while there is a dark side to digital currencies, they also eliminate or reduce many of the negative aspects of paper money. They are secure, impossible to counterfeit, easily verifiable, simple to transfer, transport and most importantly remove trusted third parties.

Now let me be clear this should in no way be misconstrued as investment advice. I am not qualified to make any market predictions and the fact I bought Ether (the crypto currency supported by the Ethereum Blockchain) last week when it was at $325 and then over the weekend it plummeted in value to almost $200 should be evidence enough of this fact.

Like I said above, these currencies are highly speculative, within the space of a week Ether flash crashed temporarily dropping its value to around 15 cents before skyrocketing back up to over $300, it then proceeded to lose one third of its value when a fake news story surfaced claiming the 22-year-old coder Vitalik Buterin, who created the currency had died (he is not dead). This is not something you want to dump your entire 401K into.

Every currency has highly specific individual features. So, it would be wise to do a fair amount of research before you jump into the market.

Despite the insanity and wild fluctuations in price, it’s important to keep in mind the implications of the technology behind cryptocurrency.

What is a Blockchain?

A Blockchain is like a giant ledger. Bitcoin is the largest Blockchain. Nick Szabo, a lawyer and computer scientist, who writes the blog Unremunerated uses the metaphor of a fly trapped in the amber. It is a permanent, time stamped, practically unalterable record of every transaction that has ever taken place for a particular digital currency, distributed throughout a network of computers.

Each transaction requires that data undergo transformation into a hash value (a string of alphanumeric characters that represent the piece of data, each hash is then verified by a network of computers. Each hash informs the next hash creating the chain. These calculations that produce hashes require time and computational power called proof of work. You may have heard the term mining. Miners compete to verify each transaction by solving complex coded problems (hashing) using extremely fast GPU’s or graphics cards. The first miner to solve the problem is paid in cryptocurrency like bitcoin and the transaction is then placed on the ledger which is distributed across the entire network. This is the Blockchain. The faster a computers hash rate the more money it earns.

Within each of these steps, there are ultimately several sub steps but this is just a general overview, I could easily turn this into 10,000 words trying to explain Merkel trees and Byzantine Fault Tolerance but the average person doesn’t need to go that deep to gain an appreciation of Blockchains capabilities.

The fact that Blockchain makes these transactions permanent and unalterable makes it perfect for agreements or contracts between two parties, like a trust fund or a settlement. The Blockchain could be programmed in such a way that funds are released on a certain date or when the terms of the agreement are met all without paying an intermediary institution to carry it out for you. It can be difficult to wrap your mind around the implications this has for numerous industries. This is the type of thing that keeps powerful people awake at night.

Limitations and Other Issues

Limitations and Other Issues

There are some security limitations specifically with Bitcoin, notably the possibility of a 51% attack. The idea behind this is that if one entity controls 51% of the networks computing power or hash rate, then that entity could theoretically control which transactions take place or reverse transactions that have happened for the time period. It could also give them the ability to double spend coins during the time they control the network. This is just a possibility and for that matter a fairly slim one; for several reasons; (1) if something like this did take place there is a very high likelihood that the value of the currency would tank, making the attack pointless (2) the amount of difficulty involved makes it unlikely even for very large entities like governments.

There are also other issues, like the idea of a “hard fork” which would really be a reprograming of the Blockchain that Bitcoin is supported by. Ethereum underwent a hard fork after a security breech that allowed hackers to steal millions of dollars and the code update was necessary to prevent further security issues.

In the Bitcoin community, the idea of a hard fork is highly controversial. It is also an idea that I don’t fully understand, there are lots of people more qualified to speak on this matter, so I’ll leave it to them.

Blockchain

What This All Means

Blockchain technology and the idea of distributed internet storage are revolutionary ideas but like all revolutionary ideas many of their future applications remain unknown. Just like artificial intelligence and all of its subfields, Blockchain has the potential for good and bad. And undoubtedly there are negative outcomes associated with it we have yet to even consider.

Smart contracts and pure peer-to-peer transactions could potentially remove deeply entrenched operators from numerous industries. What these trusted third parties stand to lose is monetarily and politically enormous.

It’s very possible that what waits on the other side of this technological development could ultimately be worse than what exists at the present moment. Will rapidly advancing technology widen the income gap between rich and poor exponentially? Or will it finally put people in developing countries on a more level playing field? I don’t know. That question is way above my pay grade.

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