Being new, technical, and a potential source of enormous wealth, blockchain technology and its offshoot, cryptocurrencies, are frequently misinterpreted and misrepresented. When it comes to giving a false picture of the state of the technology, their greatest supporters are often as guilty as their fiercest critics. This makes it extremely difficult for non-specialists (and even for many experts) to tell fact from fiction, and as a result the field is rife with scams and overblown promises.
For an amateur investor interested in the possibilities of blockchain technology and cryptocurrencies, a detailed technical understanding of the programming behind one's chosen vehicle is always an asset. However, it is not a sine qua non. Even if you have never written a line of code in your life, an understanding of the abstract theory behind the blockchain concept can be a great help in spotting a scam or a high-risk proposition. Once you know what blockchain technology was designed to do and how it does it, you already have a good idea of whether or not any given blockchain-based project makes sense.
Here are a few key points to bear in mind.
- Technology can be trusted, people can't
The problem that Satoshi Nakamoto, the pseudonymous author or group of authors who wrote the paper that first set out the Bitcoin concept, set himself to solve was one that plagued financial dealings since the dawn of civilization. This problem is the high transaction costs resulting from ensuring trust in monetary transactions. Even in today's highly automated economy, business depends upon trust to a huge degree.
Companies have to trust that customers making purchases on credit will pay them; clients have to trust that their bank will not go bust; citizens have to trust that their government will not induce inflation. There are two strategies that can be employed to solve the trust problem. The first is to use signaling, verification and sanctions methods to ensure as far as possible that the people with whom one is dealing are trustworthy. It is possible to check up on their backgrounds and their assets, and to set up mechanisms to punish defections. The second is to develop a system that eliminates the need for trust altogether, by making defection impossible, which is what blockchain-based financial instruments aim to do.
The combination of blockchain technology and advanced cryptographic hashing algorithms has produced an instrument that is in theory - as unhackable as possible. If so, why is the news full of cryptocurrency hacking stories? The problem is that this instrument is being used by human beings, who are full of flaws and vulnerabilities. The best hashing algorithms in the world will not protect your altcoin holdings if you click on a link that installs a keylogger on your computer, or trade online using shady currency exchanges.
- Blockchain and Bitcoin are ideas, not corporations
A quick search on Wikipedia should put the kibosh on this assumption. Nevertheless, blockchain technology, Bitcoin and the various other altcoins available look so much like hot new internet companies that it is tempting to think of them this way. Even experts in the field frequently make judgments based on analogies drawn from the venture capital world.
In fact, as mentioned above, Nakamoto's goal in applying the blockchain concept to peer-to-peer financial transactions was merely to find a solution to an intriguing puzzle, not to launch a money-making corporate vehicle.
Nakamoto's solution to the trust problem relies upon the properties of computer networks, and more specifically, on the fact that a network with more processing power will always be able to carry out more calculations in a given time than one with less.
Any given blockchain is a register of transactions that is maintained collectively by a network of independent computers. Every time a transaction happens it is entered on the shared register. This is not particularly novel. The key innovation lies in what happens when someone tries to make a fake entry on the register. When this happens, the chain splits in two. For a while two blockchains run concurrently: the real chain and the chain containing the false entry. At this point the fake chain is being maintained and augmented by the hacker alone, while the real chain is being maintained and augmented by all the other computers in the network.
This is allowed to continue for some time before the system intervenes. The code does not make any attempt to judge which entries are fake and which are real, but merely accepts the longer of the two chains as authentic and abandons the shorter. This means that if you are a hacker trying to get a fake entry validated by the system, you have to make sure that your chain is the longest. If everyone else in the system is using their processing power to increase the length of the real chain, the only way for you to beat them is if you alone possess more than half the processing power in the network.
Bitcoin was originally created to demonstrate the viability of the solution. While it has made various people exceptionally wealthy in the intervening time, the original goal was merely to solve a puzzle. The original paper was distributed for free, and the code used to create Bitcoin was made available on open source platforms. Nakamoto owns around one million Bitcoins which makes him the 44th richest person in the world at Bitcoin's peak valuation in December 2017. Despite this, none of his Bitcoins have been used for anything other than test transactions since 2009.
- What would typically kill a corporation makes Bitcoin stronger
Perceiving Bitcoin as a theory rather than a product throws up other interesting points, notably with regard to the parameters of success and failure that can be applied.
If Blockchain PLC were a tech start-up like Facebook or Tesla, the myriad Bitcoin competitors based upon improved versions of the original code, and the frequent failure of associated enterprises would constitute red flags for all The company would seem to be headed for bankruptcy.
When an outside corporation comes up with a better version of a company's product, the original manufacturer tends to suffer. When another researcher comes up with an improved version of a theory, the theory itself grows stronger as a result. This was certainly the intention of the original developers, who made the Bitcoin code and the theoretical explanations free to access with the aim that people would tinker with the concept. Attacks and failed attempts at improvement highlight weaknesses, while successful modifications spread freely through the sharing of open-source code. Even if Bitcoin itself is eventually killed off by an improved competitor such as Ethereum or Litecoin, the blockchain concept itself will be improved by this development.
Similarly, Bitcoin's persistent links to illegal activity, would constitute a public relations disaster for any corporation and would likely result in police investigations. However, these threats have little effect on a cryptographic concept. Just as you can't blame Willoughby Smith's research into photoconductivity when your kids force you to watch The Emoji Movie, in the absence of a Bitcoin PLC, it's difficult to hold the founders responsible for the subsequent use of their ideas. On the contrary, the early adoption of Bitcoin among criminals served as a useful advertisement, being an effective demonstration of its secure qualities.
- A blockchain is a decentralised ledger
It is the independence of the various computers within any given blockchain network that is the key to its functioning. While everyone has an incentive to cheat, this is cancelled out by the equally strong incentive to prevent anyone else from cheating. Everyone is constantly checking up on everyone else. In addition to the reward inherent in keeping everyone else honest, participants also receive a small proportion of the new coins produced in return for their contribution.
This is also the reason why it is worth being extremely skeptical of claims that blockchain technology will revolutionise voting, health service records, or any other large public service. Even if it allows partners to access its networks, a government, simply by virtue of its sovereign power, always retains ultimate control; even when it does not manage all the terminals, it has the capacity to threaten those who do. For all practical purposes, a distributed transaction register in which all of the network's processing power is controlled by one organisation is not a blockchain; it's a Google Doc cosplaying as s blockchain, and any citizen invited to trust their democratic rights to such a system is right to be profoundly cynical.
However, this should not be taken to imply any endorsement of the opposing arguments that because blockchain technology is no more useful than any other cloud computing system in managing the business of governments and large corporations, this makes it essentially valueless. From the beginning, the point of the blockchain concept was to find a way of doing business that bypassed the need for large, structured institutions to reinforce trust and minimise transaction costs. Complaining that the technology does not provide these organisations with significant advantages is the equivalent of complaining that it is impossible to carve a baroque piet out of Jello; while you're technically correct, that's not what Jello was designed for.
Indeed, if you succeeded it would be a good indication that there was something seriously wrong with the Jello. Future applications for the blockchain concept will almost certainly be created by disparate groups of individuals, rather than large organisations, because this is the only way that the technology can work.
As shared in the example of government, it is legitimate to be skeptical whenever a corporation attempts to sell you on the virtues of its blockchain systems. Can the function they are carrying out be done as well or better using regular technologies? Chances are, yes.
Jennifer Dodgson is a Ph.D. Candidate at the Lee Kuan Yew School of Public Policy, National University of Singapore.