Before understanding the “blockchain” and how this technology is rapidly changing the world, it is essential to understand the background of past electronic and digital money platforms. A comparison between electronic bank transfers, centralized digital currency, and the newer decentralized blockchain transactions, will illustrate the advantages of blockchain technology.
In late 1913, the United States formed the Federal Reserve System and gained control over the banking industry. Through this control, from 1913 through 1996, the government was able to supervise and regulate the electronic transfer of funds in the U.S. The government at least partially achieved this control because it owned and operated the bank’s electronic infrastructure through which all funds moved.
Until 1996, if an individual or company sent an electronic transfer of U.S. funds, it moved over this government supervised network. The Fedwire is a real-time gross settlement fund transfer system operated by U. S. Federal Reserve Banks which allowed the government to oversee, regulate, and control every electronic money transaction in the United States. For almost a century, the Fed banking platform was the only game in town. Developing a digital infrastructure that could replace or compete with the Federal Reserve was far too complicated and expensive for any one person or company.
In 1996, the commercial Internet emerged with a new global decentralized digital network. The Internet offers an instant transfer of digital information at virtually no cost providing a secure financial transactions platform. The Internet bypassed the government’s monopoly over the electronic transfer of funds. Using the Internet, anyone could digitally transfer value to anyone else without using a bank or the government’s network. Because of this new freedom, many people concluded that the Internet would eventually become a robust platform for private digital versions of currency. After 1996, anyone in the world, was free to create their version of electronic digital currency that would circulate over this new digital infrastructure. By 1997, banks and the government had lost their monopoly over the electronic transfer of money.
Savvy groups of entrepreneurs quickly began creating software platforms that could circulate new versions of private digital currency between online users. While these early pioneers had set out to create a mirror image of “digital cash,” they were unable to accomplish this task. Unlike cash, every version of electronic money requires a digital ledger. This ledger records all transactions and changes that occur in account balances. If a digital unit of currency is not tracked and recorded through this electronic ledger, then, similar to real cash notes, those digital units could be counterfeited and used over and over again; which is also known as double spending.
Physical cash uses no ledger. However, all versions of digital money must operate with this electronic ledger. Unable to create a digital unit that could mirror cash and circulate without this ledger, the early digital currency pioneers finally gave up on building this version of digital money.
Shortly after these early attempts at “digital cash,” an electronic ledger, similar to what was being used by banks, which requires all transactions to move through a central point was quickly adapted for online use; and centralized digital currency was born. Centralized platforms operate as closed digital ledgers recording credits and debits. These digital transactions represent value moving from one account to another. The ledger keeps track of account balances and transactions.
Even though these new centralized server platforms were not exact replicas of “digital cash,” the networks functioned exceptionally well and flourished around the world.
Digital currency has many advantages over conventional banking. One primary benefit was the ability to move funds outside of the highly supervised and regulated banking system. Value is circulating online, through a private digital currency platform, and these transactions were at first mutually exclusive of all government supervision, bank regulations, and money transmitting controls. Starting in 1996, anyone could set up an Internet-based digital currency network and bounce an unlimited amount of digital value around the globe without verifying the users or monitoring their activity! Billions of dollar’s worth of unregulated digital money soon began moving over the Internet outside of the highly controlled and supervised Federal Reserve System.
When the value of a commercial digital currency system circulates through ledger transactions, there is virtually no cost. The sending and receiving of funds are instant. Unlike a bank, sending a million dollars in digital currency from the U.S. to a user in Russia or Iran was simple, required no ID nor credit card, generated no financial reporting, and cost the user virtual nothing in fees.
Internet digital currency sparked an epic change in the financial world. By 1998, anyone with an Internet connection could instantly set up an online account and remotely send or receive digital currency valued in national money or other global assets such as precious metals.
Through 2012, hundreds of centralized digital currency platforms had emerged around the world. However, proposed U.S. regulations, attempting to supervise and control the industry, overshadowed this growth. Because, all centralized digital currency transactions circulated through one central point (the server), monitoring these new networks was relatively easy. By accessing the platform’s primary server, any supervising agency could easily record, block, or track the movement of digital units; and or seize the funds. For violating U.S. financial regulations, from 2003 through 2012, all unlicensed U.S. centralized digital currency systems and agents were forcibly shut down and had their assets seized by the government.
In 2009 an anonymous person or persons, using the name Satoshi Nakamoto, published a paper on a new type of person-2-person software platform called the blockchain. This innovative P-2-P platform utilized a native currency call Bitcoin. Compared to all previous versions of centralized digital currency, Bitcoin functioned more like cash and offered several cash-like features. Instead of having one central server that supervised account information and recorded transactions, like all previous digital currency systems, Bitcoin’s blockchain removed the primary ledger and required each participant in the network to maintain a full copy of the digital ledger. Without this critical centralized point in the movement of all funds, Bitcoin became the first decentralized person-to-person digital currency in the world. This new blockchain operated without a central point of failure, and all transactions moved from person-2-person. Additionally, because Bitcoin has no business backing the platform, there is no company or legally responsible individual representing the system that could be held accountable for the network activity. Similar to the Internet, the Bitcoin blockchain is decentralized and cannot be shut down by anyone for any reason.
How does the blockchain work?
Instead of recording all account and transaction data through one central server location, the blockchain requires users to maintain a full copy of the ledger on their computer. The blockchain user interface needed to access the platform automatically downloads a full ledger copy for each user. When the participant’s wallet has a verified copy of the ledger, the core data is confirmed and shared by all users.
During a blockchain payment, the value moves from one person to another person (P-2-P). Seconds after the transfer, the wallet automatically broadcasts that transaction data to all connected users in the network. The blockchain software protocol groups all individual transactions in blocks, and about every ten minutes a new block is published to the chain and broadcast to the entire network. Once released the blocks cannot be changed or altered.
A version of the Bitcoin client wallet software is required to transact on blockchain network. Through this interface, each wallet automatically receives the network’s transaction and account history, then stores a copy with each user. There are many more moving parts to a blockchain equation which can be reviewed in future articles.
The recognized advancement that has emerged from the blockchain is this ability to make person-2-person payments without the needs of a trusted central party. Consequently, the blockchain has eliminated the need for a bank.
A simplified version of blockchain activity is described here:
Accessing an online bank account requires a user interface, which is downloaded to a customer’s phone or computer. The software facilitates the customer’s direct connection to the bank’s server and accesses an account. When a BoA user logs into the network, the account holder is sending and receiving transaction information through that bank’s server. This central point in the bank’s system holds an electronic ledger recording and preserving all of the bank account’s data. As previously discussed, every bank transaction moves through the bank’s central ledger.
Blockchain users also require a software interface for an online connection to the network. However, users logging in are not connecting to any central point. When a Bitcoin user goes online, the wallet interface connects their computer with other Bitcoin users through a massive decentralized network. Transactions on the blockchain move from one party to another without any outside supervision or control.
When the blockchain user makes that network connection, their wallet software automatically begins downloading a full copy of the electronic ledger. If the customer has previously used the Bitcoin wallet, then, once connected the interface will start updating and downloading any new transaction data to the existing ledger copy. Each time the user’s Bitcoin wallet links to the network, it automatically begins updating the wallet’s ledger.
Over the years, Bitcoin users have made significant advances in the network software. In 2018, many consumer wallets are much more convenient and do not require a full download of the blockchain. Only users operating a “full node” on their computer are still downloading a full copy of the blockchain. Having a full node provides some benefits for a user. However, it also requires a robust Internet connection and some disc space.
It is also important to recognize that there are no such things as Bitcoins! Blockchain “cryptocurrency,” including Bitcoin, is merely a set of entries in the digital ledger. When one user “sends” coins to another, the platform is only recording the debit and credit entries into the digital ledger. No coins or files are moving between the wallet accounts.
Compared to old bank platforms, and centralized digital currency, the newly decentralized blockchain offers substantial advantages.
The blockchain is a public ledger, and all transactions, wallet accounts, balances and payment details are available for public viewing. With widely available software called a block explorer, anyone can quickly track down a wallet or any transaction that has previously occurred in the Bitcoin blockchain from day one.
Because there so many copies of the blockchain’s digital ledger, plus each one is automatically updated and compared, it is virtually impossible to reverse a transaction or alter the ledger. Every transfer, small and large, is broadcast to all individual copies of the ledger. Through this comprehensive documentation, it is impossible to locate all of these copies and alter or reverse an entry before being discovered as a fraudulent transaction and discarded.
The blockchain’s security measures are unlike those of a bank’s centralized electronic ledger. Financial server and bank account data can be easily altered, deleted, or duplicated by a malicious party or bad actor. Compared to a distributed blockchain, bank ledgers are insecure and dangerous. However, because the blockchain decentralized platform has no central point of failure, the network better withstands malicious attacks. Users can trust that Bitcoin transactions will be executed appropriately as the protocol directs.
Reduced Operational Cost
As the blockchain is a “user-powered” platform, there is a minimal cost associated with its operation. Transactions move from one person to another, and no expensive centralized bank server or computer security is ever required. Consequently, the costs for transacting business over the blockchain is comparatively lower than banks or centralized online payment platforms such as PayPal.
Funds arriving through the blockchain settle much quicker than banks or credit cards. The full balance of an incoming blockchain transfer is available for use and can be withdrawn immediately upon confirmation receipt. Everyone knows that bank wires can be slow. International bank transaction can be exceptionally slow and expensive. However, blockchain transactions which move over the Internet, are completed in minutes. Blockchain payments moving around the block or the world are finished in the same short timeframe.
Blockchains can be used for a variety of tasks other than just transferring funds. Transactions published to the blockchain may contain financial data or other media. It is possible to encrypt and publish medical records, prescriptions, identification documents, property sale records, voting records, or any other data that can be easily accessed in the future. The fact that this information can be instantly obtained through a public Internet ledger costs little to store, and is impossible to change; affords many benefits over centralized electronic records and data storage.
Because all blockchain data is available through a public ledger, does not mean that everyone’s private information is available online. P-2-P blockchain transactions do not include any of the user’s data. In a Bitcoin transaction, the only possible public information is the wallet ID numbers and the IP address of the originating node. This level of privacy is substantially higher than a merchant credit card transaction. Credit cards were not designed for the Internet and are high-risk consumer financial products.
During a credit card purchase, the information that changes hands includes the card holder’s name, address, and other personal data. Throughout a card payment, the consumer’s personal information is exposed and can be “skimmed” or stolen by bad actors. Even, after a card transaction, that same individual information resides on the merchant’s servers; which are often hacked and accessed by bad actors. Doing business on the blockchain removing this personal information from the transaction and offers substantial protection for consumers.
Because the blockchain removes the requirement for a central trusted third party, decentralized payments have begun to change how the world does business. Part two in this series will be available soon.