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What is blockchain?

Blockchain symbol

By now you will have heard of Bitcoin, Ethereum and possibly even tripped over the technology that supports them all – blockchain.

If you haven’t I’m a little jealous, because you’re probably also blissfully unaware of Facebook, Instagram, Fake News and the fact that Donald J Trump is the leader of the free world.

Assuming none of that’s true and that you’re as shell-shocked as the rest of us, then you’re probably also aware that 2017 was a defining year for cryptocurrency, with the market leader Bitcoin increasing in value from USD1,000, to a peak of USD20,000 before year end.

That’s a staggering increase in value, almost incomprehensible even for us poor souls living in New Zealand’s overheated housing market. The principles that are driving this growth, or the lack of them - is certainly fascinating, but the technology that underpins these currencies is pretty interesting in itself. While blockchain has many uses outside of cryptocurrency, we’ll use Bitcoin to help visualise how it works.

Money, as we’re accustomed to it - is managed by the banking system. Transactions are written and stored in databases managed by the banks. The data belongs to them (mostly), and we choose to trust that transactions recorded against our accounts are legitimate. We are trusting that they are safeguarding our interests in a vastly more complicated digital environment than anyone of them could have envisaged when taking their first deposit. You’re money isn’t protected in the event of failure, but they have the Reserve Bank watching over them, and they are highly motivated to protect the trust that keeps them in business, so they spend heavily to maintain it.

Banks have huge departments dedicated to fraud, both internal and external. They have equally large teams protecting your money from cyberthreats, managing critical technology systems, and all the while trying to innovate digitally. This is obviously expensive, and it follows that the cost of banking is also expensive.

Blockchain provides an alternative to these centralised databases. By creating a highly distributed database across an unlimited number of nodes on the Internet - blockchain provides a way for cryptocurrencies to record digital interactions without the need for a trusted third party - trust is inherent to a network of peers and the blockchain protocol itself. Transactions are broadcast to the entire network, with each node picking up the transaction and attempting to verify it using the blockchain’s protocol. Once the transaction is validated, it is added to the blockchain (effectively a ledger of transactions), and again broadcast to the rest of the network.

This verification process is conducted by highly specialised mining computers that sit on the network and solve complex validation codes (hashes) that are embedded into each transaction. This is the crypto part of the currencies’ moniker, and this is how miners make their money. Miners are independent auditors of the blockchain and are paid when they successfully solve a hash. Bitcoin miners for example, currently receive 12.5 bitcoins for each hash that is solved, but only if they're first. At today’s exchange rate, that's a lot of money - so there’s a lot of competition out there if you’re thinking of becoming a bitcoin miner. You’re also going to need quite a bit of power, because the machines you need to mine are usually loaded with multiple high-performance graphics cards that draw a lot of juice. On the upside, if you’re doing it in your basement, your house will be warm all winter.

Basically blockchain is a special kind of database, one that is built in a system of distributed peers, rather than centralised servers, and which uses a network of users to validate each record before writing it to the database. It is also anonymous, in that while each transaction is a matter of public record, the two sides of the transaction are not.

Blockchain is a disruptive technology, with the potential to dis-intermediate the banking system, and replace other forms of trusted centralised databases; but it’s still in its infancy.  Understanding the opportunities and risks will be critical for both private and public sectors over the coming few years.

By Rowan Schaaf
Rowan Schaaf

About the author

Rowan Schaaf

Rowan is the co-founder and CEO of Pattern. He has been involved in a number of technology start-ups, and has also held senior executive roles in both the technology, and technology marketing sectors.