When it comes to transacting money or anything of value, people and businesses have relied heavily on intermediaries such as banks and governments to guarantee trust and certainty when dealing with their money. Mediators perform a range of critical tasks that help to ensure a high level of trust in transactional processes like authentication & record keeping.
However, Blockchain eliminates the middleman and continues to guarantee the safety and security that comes with traditional money management. But if there is no middleman checking the authentication and keeping records, who or what is enabling such a high level of security that is found in Blockchain technology? Well, the fact is that the traditional methods of security have just been digitised, there is still a ledger and there is still a sure fire way to gain verification.
Simply put, Blockchain is a type of distributed ledger or decentralised database that keeps continuously updated digital records of who owns/spends what. Okay, reading that back it doesn’t sound so simple but it is, I promise.
A distributed ledger has a series of replicated databases, which have been synchronized via the internet and visible to anyone within that network. Blockchain networks can be private with restricted membership similar to an intranet, or they can also be public like the Internet, which is accessible to anyone in the world. The most widely used application of Blockchain technology at the moment is Bitcoin, a digital currency. Many other digital currencies have also adopted this technology, but we will go into that more another time.
So back the basics, each computer in the system represents a “node” in the blockchain network and each “node” has a copy of the ledger file. This node will help to verify the transaction that will take place during the currency exchange with a cryptocurrency such as Bitcoins.
But what actually happens during a transaction? Well, say if Bob wants to send bitcoins to Charlotte, he will transmit a message to the network that states the amount of bitcoin in his account should be decreased by which in this case is 10 BTC, and the amount in Charlotte’s account should increase by the exact same quantity. Each node in the network receives the message and applies the requested transaction to its copy of the ledger, updating the account balances.
So how do the nodes know it’s you? Well, if a message is encrypted with a specific public key, only the owner of the paired private key can decrypt and read the message. And the reverse is also true: If you encrypt a message with your private key, only the paired public key can decrypt it. The wallet containing your bitcoin is encrypted with a private key and this key is only known by the owner so only he/she can spend the coins within the wallet.
When you encrypt a transaction request with your wallet’s private key, you are generating a digital signature that is used by blockchain computers to verify the source and authenticity of the transaction. The digital signature is a string of text resulting from your transaction request and your private key and therefore it cannot be used for other transactions.
There is a “balance” verification that is performed based on links to previous transactions. So, how can the system trust that input transactions are legitimate? It checks all the previous transactions correlated to the wallet you use to send the cryptocurrency via the input references.
But why would you choose Blockchain over banks? Well for one, Blockchain is almost impossible to hack which means your currency is extremely safe. There is no risk of Bankruptcy with this new digital technology which is a risk with traditional banks. Transferring money via Blockchain can take seconds whereas other methods could take days or even weeks to arrive, the time depends on each cryptocurrency. Financial intermediaries or ‘middlemen’ also charge a sum of money to carry out these services and are at high risk of fraudulent activity. Blockchain will increase the velocity of money, which will increase cash flow and capital investments. It’s a win-win all around.
That’s the extreme basics of how Blockchain technology works, and why it could be an alternate solution to banking. So in summary, computers called ‘nodes’ use the ledger and the previous transactions to verify your digital money. You can also mine Cryptocurrency but again, we will cover that in another blog post.
“Blockchain is to Bitcoin, what the internet is to email. A big electronic system, on top of which you can build applications. Currency is just one.” — Sally Davies, FT Technology Reporter
Do you trust Blockchain technology? and will it make banks obsolete? Tell us what you think.