How Are Banks Using Blockchain Technology
In this current day and age, where every innovation demonstrates unprecedented potential, I still can’t help but be astonished by Blockchain technology’s incredible potential. As both a development platform and a cryptocurrency system, the possibilities are just as limited as the human spirit of innovation. Unfortunately, the knowledge we have about Blockchain technology tends to be scattered, incoherent, or just plain obsolete. I’ve written this post to help you understand the idea of Blockchain as well as fundamental protocols.
First, in Section 1, I’ll describe the background of value storage systems and outline what’s wrong with banks serving as the central authority for maintaining value transactions. In Section 2 we’ll take a look at Blockchain philosophy as a cryptocurrency system, as well as a development platform. Finally, Section 3 sheds some light on the main element principles of Blockchain technology, the working process, and the current developmental phases.
1. Background
These days, with easy access to WIFI and smartphones at our fingertips, it’s easy to consider the internet for granted. But before you understand the incredible technology of Blockchain, it’s important to grasp a few basic concepts. The internet is a network of information through which data moves from one node to a different. A node is a connection point that can receive, store, or send data, and each node reproduces and stores data infinitely.
Information on the internet spreads quickly and in a non-unique fashion. Some information shared commercially is not free, but value-driven. For example, a publisher might sell copies of the book but keep the master copy. In this example, information is transmitted through reproduction. But what happens when you’re transmitting value? When you have one hundred British pounds (£100), you cannot sell copies in the same manner as a book’s publisher, since it would be valueless. Therefore, value needs to be transported through a “move” format and not really a “copy” format to avoid duplication. For decades experts have prevented double spending by maintaining ordered ledgers of transactions.
We don’t often take the time to consider that financial transactions generally contain a date, time, sender, a receiver and an amount. Each person’s stake is determined by adding incoming amounts and subtracting outgoing amounts. Hence, both significant ways of keeping track of value transfers are cash notes (physically passing money from one hand to a different) and ledgers. However, printing notes and securing against reproduction is quite challenging and involves a relatively large amount of value. Plus, if you tear a note in half it’s suddenly worth nothing.
Which leaves us with ledgers. When carefully protected, ledgers will keep track of value in a very resilient fashion. However, they require careful attention to detail and plenty of trust. All parties mixed up in transaction need to make sure that the person updating the records is both efficient and reliable. Therefore that the security of a ledger has its own costs and risks. With the digital revolution, the days of tracking long columns of information yourself are gone. The main method of tracking value, a digitized ledger, involves the same unique transaction details (dates, amount, sender, and receiver) as a physical ledger. For instance, when you open a new bank account, you’re assigned a merchant account number. This identifies your transactions on a digital ledger. Every bank in the world maintains a distinctive, synchronous ledger so your value is tracked across exclusive storage locations.
Unfortunately, the banking system itself is inherently risky. The machine relies on a set of centralized databases that store worldwide financial transactions. Instead of trusting the folks in charge of updating physical ledgers, individuals are forced to trust the banks themselves for consistency, integrity and transactional security.
2. The Problem with Banks
Giving banks full control of global financial ledgers creates huge financial risks. As financial rule makers, banks are susceptible to toe the line and also twist reality. They often times create value out of “thin air”, counting on the fact that they’re seen as being “trustworthy”.
Let’s consider this scenario: a bank lends money to Customer A. The transaction is put into their ledger: “Amount X has been put into Customer A, and after a certain amount of time Amount X, plus Amount Y (interest) is expected from Customer A”. This seems fairly straightforward in the abstract, however in reality, Amount X may not exist before the transaction is documented. How is it possible for banks to make value from thin air? Through debt! Legally, banks can lend more income than they own, provided they’ve safeguarded their risks. Because of this, a lender pays non-payment insurance in addition to interest rates. This makes sure that rates of interest are proportional to the risks taken by banks.
The problem with this system? When people take benefit of limitless money power but are unable to repay their loans, it leads to global disaster. In the fall of 2008, the collapse of the financial sector resulted in the bankruptcy of countless organisations.
3. Blockchain Philosophy
In the fall of November 2008, an author with the pseudonym “Sakoshi Nakamoto” suggested the need for a new kind of money system - Bitcoin. Nakamoto proposed Bitcoin to create and store value in a totally different digital form - fully decentralized. Recall that in conventional banking systems, value is stored in centralized ledgers and maintained solely by banks. However in a decentralized ledger system, everyone connected to the device can initiate new transactions and Passion form a consensus to validate transactions. This advancement was the response to decades of expert research. Suddenly, the task of decentralizing value transactions on a massive scale seemed truly possible. Bitcoin successfully recreated a decentralized digital money system and inspired new ideas of other generic value mediums, including plans, certificates of ownership and many more. By creating more instances of value decentralization, the “internet of value” was born.
3.1 Blockchain Real World Applications
Though the Bitcoin platform is typically the most popular application of Blockchain technology, the potential of a Blockchain extends far beyond financial transactions. We are able to apply currency tracking concepts to other real-world applications, such as property title ownership. Let’s consider it this way: when Person A sells his/her property to Person B, Person B sends the value of the house in currency to Person A. In addition, Person A sends the ownership title or certificate to Person B. Such ownership titles can be registered with a central authority, where in fact the record of the transaction is stored in a digital ledger.
Let’s consider another example. When you operate a movie theatre, you can keep a strict record of all tickets you generate. You are able to decide the value of each movie ticket and track the creation, movement and destruction of these tickets in a ledger. In the Blockchain world, this procedure is called tokenization. It allows you to track value apart from just currency. To comprehend this further, I will describe the concept of transactions in section 3.2.
3.2 The Concept of Transactions
Transactions consist of four basic elements: origin, destination, value, and state. Consider Figure 1, which demonstrates the logic for a simple transaction. If the sender’s balance at the date of the transaction is more than the transaction value, then the sender’s balance is decreased by the transaction value, and the receiver’s balance is increased by the same amount. In other words, you can only give up to the amount you have.
On the Bitcoin platform, the essential logic is the same for all those transactions in the ledger. These programs can be customized with the addition of new variables, functions, and even more sophisticated constructs such as loops to allow the execution of varied transaction types on a Blockchain. Moreover, structures like mortgage payment plans, insurance contracts, movie tickets, lottery tickets and energy tokens can be modelled. In the world of Blockchain, they are called smart contracts.
Smart Contracts
Smart contracts are programs stored on a Blockchain. The functions of the programs are executed through transactions. Smart contracts include things of value such as copyrights for artists, contract for lawyers, laws in Congress, votes in polls, invoices for an accountant, bets in a lottery game, maintenance procedures in a factory, procedures in a supply chain, shares in an organization and so many more. The transaction sizes can vary greatly in conditions of memory and computer processing power.
4. What is a Blockchain?
A Blockchain is a digital record of valuable transactions outside the control of a central authority. It uses codes that run directly on the computing devices of most individuals mixed up in transaction. Of course, in a Blockchain free-world, a trusted party needs to take care of all the centralized transactions and maintain consistent and genuine ledgers.
There are three layers to every Blockchain concept:
1. Design goals: the properties a Blockchain software possesses such as distribution, decentralization, immutability, and peer-to-peer.
2. Implementation: A Blockchain’s developer can implement some or all these properties. Bitcoin and Ethereum are examples of Blockchain implementations.
3. Instances: different networks working on different datasets allow you to build a different version of reality. For example, the Ethereum implementation has at least four public cases of its protocol: Rinkeby, Robsten, Kovan and the primary Ethereum network. You’re also able to create private instances for development purposes using platforms such as Remix and TestRPC.
Distributed and Centralized System: In this case, all nodes in the network store “read only‟ copies of the info, but modification happens at one centralized node. Consider Napster’s peer-to-peer file sharing system. Files were distributed across networks, allowing users to download content, however the list of the files, their locations and business logic, were centralized.
Distributed and Decentralized System: When data can be distributed and decentralized concurrently, it’s impossible to corrupt or hack the network. However, the task of implementing a distributed and decentralized data system lies in maintaining consistency. Blockchain manages this consistency issue through a concept known as the consensus algorithm. Counting on leading edge research, Blockchain uses cryptoeconomics and game theory to get this to possible.
The Bitcoin Implementation
Bitcoin, Ethereum and Hyper Ledger fabric are good examples of the implementation of Blockchain. Like flavours of ice cream, they share the same base but appeal to different audiences. Bitcoin is implemented in a completely non-trusting environment. It is a specialized Blockchain because it is mainly made for one application: an electronic digital cash system. The basic element that transactions track is called unspent transaction output.
The Ethereum Implementation
Ethereum is a Blockchain implementation that depends on the same principles as Bitcoin with extra features that help it to to use in a slightly different way. For example, with Ethereum there are no unspent transaction outputs because the Blockchain has a stored state allowing it to store the balance of each account after each block. Because of the various implementation strategy of the consensus algorithm, enough time used to make new “blocks‟ in Bitcoin is 10 minutes while Ethereum is a mere 7 seconds.
Ethereum clients or nodes hook up to peers through a protocol known as DEVp2p. In DEVp2p the client performs functions such as receiving data, validating data, and writing data to the local database (LevelDB) and sends data to any requesting peers. Your client also receives transactions and propagates them to the network, which executes the smart contract functions. Decentralized applications (also called Dapps (e.g. wallets and Explorers)) hook up to the Ethereum network by way of an Ethereum node or client. A JavaScript console can be mounted on a running node for invoking web3 APIs. The key advantage of this technology? Speed! These transactions boast unprecedented efficiency.