Blockchain: How it works by Mattia Tino

Over the past two years, everyone has heard about the rise and fall of currencies like Bitcoin, Ethereum and Ripple. Experts call them “Cryptocurrencies” and behind their operations, is an extremely complex engineering structure.  The software, blockchain, may rewrite the way which we manage transactions.

Blockchain is a ledger, a register, which records transactions which occur. Each unit of the register is a “block”, and the blocks are linked together in the same order which they were created. Blocks are connected using cryptography, which binds them in a virtually non-editable way. To simplify it, let’s compare Blockchain to Spotify. You decide to start a new playlist and each time you add a song, you create a new version of the same playlist, which is a new “block” in the chain. The new block contains the new song and all the previous ones. If your cousin decides to add a new hip-hop song to the playlist, he creates a new block in the chain. To become a new playlist version, that block is then approved by all participants, and added to the chain. If your cousin decides to delete a song from the playlist, the new block will contain the information that the song existed in the playlist, but it has been deleted. The blockchain does two things: records events and ensure that recordings will never be deleted. This makes it particularly useful in situations where two people want to make a deal, but they do not trust each other.

This introduces the idea of “Smart contracts”. These contracts are programmed to ensure that something happens in a predetermined way. For example, if Person A is renting an apartment, the smart contract may require Person B to transfer $1,000 to Person A, in exchange for the apartment’s door code. The blockchain eliminates the risk of having an intermediary who frauds both sides of the transaction, or who steals the money.

Bitcoin was the first cryptocurrency based on this technology. It was created in 2009, following the instructions contained in a paper written by Satoshi Nakamoto, whose true identity is still unknown. The original idea was to create a form of electronic cash that could be exchanged “peer-to-peer”, without going through a bank. The lack of a central server to attack means hackers cannot take control make unwanted changes. The blockchain also protects users from having to rely on institutions, such as banks, which often make decisions for their own interests. One of the reasons why it is so difficult to change blocks is that a blockchain is distributed through a widespread network of computers, which must approve all the changes happening in their network. This procedure is called “consensus” and is considered one of the main advantages of working with blockchain.

On the other hand, there is a negative aspect. Each application built on a blockchain processes the entire history of that blockchain, each time a change is made. This means that compared to normal transactions, transactions happening on blockchain are much slower. Bitcoin, for example, can only handle 7 transactions per second, while Ethereum handles about 13 transactions. For greater use of Bitcoin, engineers must increase its speed in order for it to achieve its full potential.

Anyone can create their own blockchain, but many companies have chosen to use existing blockchains with larger networks, because existing technology has been tested and improved. Two of the most popular blockchains are Ethereum and Hyperledger Fabric, both of which facilitate the construction of blockchain tools for start-ups and large companies. Ethereum is a public blockchain, where anything that happens is publicly visible. It was created in 2013 by a nineteen-year-old, Vitalik Bruterin. Ethereum’s blockchain has its own cryptocurrency called Ether, which is worth about $100 per unit. This blockchain has become the platform for a series of startups that are building a range of products, from an app like uPort, which aims to replace state-issued identity documents with an authenticated digital identity, to GridPlus, which uses the Ethereum blockchain to track energy consumption, with the goal of lowering bill costs.

Hypderledger Fabric is a public/private hybrid blockchain created by the Linux Foundation, which offers more privacy to create blockchain products in an easier way for large companies. It has been adopted by a number of large companies such as IBM, Cisco and Oracle.

IBM has multiple blockchain projects, including a product that aims to prevent foodborne illnesses by improving the system tracking products from farms to grocery stores. The company is also collaborating with the financial engineering startups Stellar.org and KlickEx Group to use blockchain technology to process financial transactions that transcend borders and currencies, a previously slow and prohibitive process for small business owners, especially those located in developing areas with small banking institutions.

 

Even though this new technology is trying to secure money interchange, the speculation behind the most popular cryptocurrencies has been wild in the past year. Last year in December, Bitcoin and Ethereum reached their historical maximum ($19,000 and $1,350), but in the last 11 months, their prices suddenly dropped to $3.816 and $106 (12/09/2018 closing prices), over -80%. In October, the Chief Investment Office of UBS published a report entitled “Cryptocurrencies: Beneath the bubble”, estimating that by 2027 blockchain technology could add $300 to $400 billion of value globally. The report says that while this technology could lead to “significant and disruptive technologies” over the next 10 years, some “technological failures” need to be resolved before it is clear which applications are most profitable. No matter what will happen with the crypto bubble, the technology behind the blockchain is extremely revolutionary and it will probably shape a completely new way to plan transactions.

 

Mattia Tino

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