The Fundamentals and Future of Blockchain and Bitcoin: Part 1 of 4

If you’ve heard anything about blockchain, or Bitcoin, or the nearly 2000 crypto coins offered so far, you’ll likely have also heard some pretty wild and far-reaching prognostication about the many ways in which it will alter the very fabric of society, government, and power relationships. We are told that this revolution in tech, this Internet 3.0, this 6th wave of digital technology [Bill Tai] will first revolutionize payments; then obviate governments’ role as monetary mint; then revolutionize everything from identity management, to supply chain management, to energy markets, and even our corporate model of value creation.

In fact, the applications of blockchain as a platform may very well be profound and impactful. But the hype tends to gloss over the fundamentals of what blockchain is, and why it has provoked the imaginations of its proponents. This blog series is an attempt to clearly, and more importantly, dispassionately explain the utility of the technology, as well as why and how it works at a technical level, while remaining approachable for non-developers and those uninitiated to its core innovations.

Proof of Ownership

Vinay Gupta has termed blockchain, in a nod to the Internet of Things (IoT), the Internet of Agreements (IoA). That may be an appropriate, durable, and complete evocation to capture the utility of blockchain. However, for this blog, I’d like to break it down one step further as a way of explaining blockchain starting from an essential problem/need/value proposition, and from there, explain how blockchain works to provide a promising technical solution. Blockchain, as a ledger, concerns proof of ownership.

What do we mean when we say we own something? If we steal it, do we own it? What if we find it? What if it’s an idea, and we think we’re the first to think of it? In these 3 cases, and many others, our claim to ownership can rightly be challenged by someone else who likewise may claim to own it. How does the one party or the other prove ownership? I think most of us would agree that if someone can prove that they made or invented it, or had ownership transferred to them, say as a sale, gift, or trade, then they are the rightful owner. Though, in the case of some assets, it’s not unusual for us to enquire further to understand the provenance and complete chain of ownership (e.g., a title search during a real estate purchase). Depending on the nature of an asset, the burden of proof of ownership and provenance may require an assertion, typically in the form of a document from a trusted authority. Examples of trusted authorities include: in the case of currency, a bank; in the case of a patent or real estate, a government agency; in the case of a Gucci handbag, Saks 5th Avenue; and in the case of lobster, Legal Seafood. We trust, and sometimes verify, that these authorities maintain a truthful and complete record of the provenance and/or transfer of ownership, typically in the form, one way or another, of a ledger.

But there are problems with our use of trusted authorities to authenticate ownership. First of all, it often adds significant cost. If you’ve bought a house, you may have noticed that one of the many transaction—or closing—costs was the title search. In this case, you payed a service to search the archives of government agencies to certify that the title had no other claims of ownership than those disclosed and accounted for in the transfer agreement. Likewise, if you have ever been a seller in a credit card transaction, you will have noticed that the bank takes a significant portion of the purchase price as a fee for asserting that the purchaser owns the debt obligation. In addition, in both these cases there is the chance of fraud, which results in additional cost. For real estate, we buy title insurance in case a claim is made against ownership that was not discovered during the search. In the case of credit cards, not only does the fee kept by the bank include insurance to protect the bank should the buyer not pay back the debt, but the seller runs the risk that the buyer may dispute the purchase and use the bank to reverse the payment.

In other words, there is both cost and risk associated with employing 3rd parties to serve as trusted authorities. We have come to accept the risks and costs of our existing proofs of ownership, but in fact, they are messy, expensive, and ultimately a burden on economic activity. What if there was a way, without a 3rd party, to examine and update a publicly available ledger of asset provenance and transfer?

Starting from the problem set of proving ownership without a 3rd party, we can approach the value proposition of blockchain from the ground up. For a ledger to be of any value, we have to trust that it was not edited by unknown or untrusted parties. That is to say, that the entries were accurate, and if any changes were made, they were made in a manner that did not undermine the veracity of the record of ownership. One way to accomplish this is to ensure that the ledger is immutable (unchangeable) such that any changes or corrections to the record of ownership is additive. Prior records, even if inaccurate, should be preserved just as they were entered, with a timestamp that also cannot be changed. Likewise, the ledger must be durable. Colloquially, we may refer to such a record as “etched in stone,” and indeed, at some time in history, this was a pretty good way to create an immutable and durable record. Since then we’ve invented paper, and digital storage, and relational databases. The immutability and durability of all of these methods of record keeping, though, is in no way guaranteed. Despite our best efforts at security and disaster recovery, it is possible, and all too common, for data to be compromised or even destroyed.

Check back here for the next part where I will begin to describe specifically how blockchain works to create an immutable ledger.