For some time, bitcoins and the underlying blockchain technology have been in fashion — the hype has been growing. Blockchain is pushed as the new revolution. Anyone not working on it, especially in finance, is or will soon be a ‘has been’…
When I do a presentation, I love to include a surprising touch of humor and irony. While preparing one particular presentation for senior managers around our new technology projects, I found a marvelous comic strip to illustrate blockchain. It shows the manager coming to his CTO to request blockchain. Wondering if he understands the subject or is just repeating something he heard, the CTO asks him which colour he wants for his blockchain. Guess what, the manager replies…? “Mauve”.
Through this joke (I love it), I just realized that indeed most people do not know what (exactly) blockchain is, or are confused (mixing bitcoin and blockchain), or they’re just plain wrong.
There are many papers available but they are often too simple (and miss too many concepts) or too technical. You have no tech background but wonder why on Earth your IT team is so thrilled and excited about blockchain? I will drive you through some very simple examples which will allow you to explain blockchain to a six-year-old kid, your mother, grandma or… to your executives.
Start with the basics
Before jumping into a blockchain explanation, you must understand some basics.
Everything starts with assets: anything, tangible, physical or virtual that you own and can transmit.
Let ’s go back to childhood: you are in the schoolyard with your marbles. These are your assets as you own them and they have value.
Most of the assets’ ownership can be changed. To do so, you do a transaction. Before transacting, you have to set rules and conditions: that’s your contract.
Back to school. You decide to play marbles with another kid. As the winner will receive the loser’s marble (your transaction). You agree which ones will be played and how the winner will be set (your contract).
You win! As agreed before the game, you should receive the loser’s marble. But, the loser is a real loser (I know, this never happens) and refuses to give you the marble. He claims that he never agreed on the terms. His word against yours. You are stuck.
For the next game, you decide to ask one of your trusted friends to be the witness and ensure that the marble exchange is done according to the agreed rules: you have now an intermediary for your transaction and contract.
You win again! You friend takes the loser’s marble and gives it to you. You have just done one transaction, based on one contract and proceeded by one intermediary.
Moving to a ledger
Later, another kid comes and claims that you have his marble which has been stolen. You now have two problems. As you play marbles every day, you and your friend cannot remember when (which transaction) and from whom you received it (the origin).
The solution is then simple. Your friend has to write down the description of each marble (each asset), who is the owner, its origin (the transaction and the contract together with the date). This is your ledger.
This is the precious book-keeping track of everything about the marbles in the school. So precious that your trusted friend (your intermediary) will keep the book with him all the time. As this book is unique and owned by a trustee, we call it a centralized ledger.
Is life now perfect? Not fully. Indeed, several problems could still occur:
- Your trusted friend spends all his breaks writing out all the transactions. This is boring so pretty soon, he will ask for compensation.
- Any centralized ledger needs a trustee to manage it. And this is never for free…
- The precious book could be damaged or lost! For safety, you must have at least one copy held at another place. Every evening, your trusted friend is now copying all the new transactions of the day in another book which he stores at another friend’s home. Lots of work… and lots of future compensation requirements.
- Such a ledger must have back-ups, which will increase the costs.
- Worst scenario: what happens if someone sneaks in and alters the information in the book? In the evening, your trusted friend will just copy the altered information to the other copy!
- A centralized ledger needs very strict and strong protection to guarantee that its information is never lost or altered. Again, this increases the costs…
A step further: the distributed ledger
Last but not least, other schools start to play marbles and you now have big games after school with all these kids. From then, when kids are playing in the other school, each time they have to come to your trusted friend at your school to provide all the information. You have reached some limits in the centralized ledger approach.
The solution is then to have one trusted friend per school, each of them having his own book to keep track of all the marbles, owners and games. Several times per day, all the trusted friends gather and exchange all information to update their books.
Could you imagine? All these trustees shouting their information to each other at the same time and trying to catch what all the others are shouting too? No, no, no… school directors would never accept such a mess for one thing.
As your own trusted friend was the first, he is elected as the Master: each other trustee provides the information to him so he fully updates his book. Once done, all the other trustees can update their books and go back to their school with accurate information.
We have now a distributed ledger. Indeed, the efforts to collect all transaction data are distributed across all trusted friends while keeping one master to guarantee that good and accurate information is distributed to all.
This marbles game is getting famous and many schools want to join the competitions and your incredible network of trusted friends. These new schools are further and further away and the number of them is growing. Your trusted friends system can’t keep up with the pace.
Even though marbles is an old-fashioned game, you are already in the digital age! You open a WhatsApp group for all the trusted friends to post each marble game: the winner, the loser, which marbles, which school and when. As they see all transactions, they can constantly update their book with the last information.
To be sure that all books are aligned, your Master organizes a meeting each weekend, when there are no games, for all trusted friends to compare and align the books.
Congratulations, you have just deployed a decentralized ledger. The transaction information is collected at the closest ledger (in the book from the trusted friend at the school where the game occurs), sent to all other ledgers at once (by WhatsApp) and each ledger is responsible to update based on the received information from the other ledgers.
As simple as that… You must be aware that this system has some disadvantages:
- You have multiplied the number of trusted friends. It’s a lot of work to keep their books up to date, each of them requests some compensation and it can become quite costly.
- Each book (ledger) must be individually protected. Altering any of them could spread false transactions. This is again a heavy cost.
- You rely heavily on your network (here the WhatsApp group used to post all games). If WhatsApp is down, you are stuck. If a fraudster sneaks into your network and injects false transactions (or alters transactions), all books could be damaged.
- Protecting your network and having a regular ledger synchronization will cost you again.
And now the revolution…
Understanding all these concepts is key as blockchain’s foundation is a decentralized ledger.
Before moving further, I have to insist first on an important point: bitcoin is not blockchain. Bitcoin is a virtual currency, a cryptocurrency, which uses blockchain technology as a protocol (as a way of exchanging accurate and trusted information).
As the marbles are the assets but not the ledger itself, the same goes with bitcoins (the assets) regarding blockchain (the ledger).
So what makes the blockchain such a revolution? There are two main reasons:
- the security approach is based on encryption, allowing you to drastically decrease all costs related to your data and system protection.
- you do not need any intermediary: no more trusted friends to manage your marbles games. We could say that this benefit is a positive impact from the blockchain encryption, together with the power of cryptography.
As you might guess, encryption in blockchain is THE key.
The foundation for this encryption is the use of public and private keys: anyone can verify that the information belongs to you but you will be the only one able to read the information.
This is like your home address: everybody can find it (public) but you are the only one able to enter with your home key.
Let’s focus now on the blockchain name. It describes the concept itself: a chain of blocks. Based on a common agreement (I will come back to this soon), the transaction receiver (the winner of the marble game) adds a block of information to the previous one (which belongs to the loser), building a chain.
Building a chain
To allow the construction of such chain, you need:
- a consensus: each block must have the same structure which is agreed and shared through a common agreement.
- a timestamp: the block order is essential as it describes the whole history. Just imagine your favorite novel with all its chapters mixed randomly… the story would become incoherent. The timestamp can be viewed as a shared and unique clock used by all to set the date and time of any new block.
- a hash code: a unique block identifier (see it as the block’s fingerprint). When a new block is created, it includes the identifier from the previous one, creating a strong relation on which the chain relies. This is fundamental. The game winner receives the marbles only if the loser’s marbles are fully identified. And they are identified because the loser won them previously against another loser who had identified marbles. And so on… and so on… until we come back to the marbles factory which sold them for the very first time. Each block contains the transaction source.
- The hash code is the unique result from a complex calculation based on the block’s information. Like your fingerprint, two blocks will never have the same hash code. This complex calculation is the cryptography.
Each block is built based on a consensus and includes, in addition to the transaction information, its date and time of birth (the timestamp) together with the transaction source (the hash code).
The block assembling (the chain of blocks) is then secured by a powerful encryption allowing all participants to read the public information while protecting the private data. Again, public/private key is part of the blockchain foundation: public visibility, but private inspection.
Gathering all the chains results in the blockchain, the ledger.
Last but not least
Another important concept for blockchain is the smart contract.
A smart contract can be seen as a trusted program defining a value (the marble in the previous example) and its rules (how to transact on the value, such as the marble games rules). The smart contract is then used during each transaction by both parties. As it belongs to the blockchain, the blockchain itself becomes self-sufficient and the trusted intermediates are not needed anymore.
Blockchain’s power is the combination of decentralized consensus and smart contracts. The transaction workloads can be spread across many participants in a flat, peer-to-peer manner.
All participants follow the same rules (the smart contract), have a view on each transaction’s origin (previous block) and are sure that each block belongs to the right chain. But… how are the participants validated? This is the last blockchain concept: the proof of work.
The proof of work is the right to participate in the blockchain system. Each one is secured by a hash code (again the power of cryptography) to ensure authenticity.
If you survived until this point, you now understand (I hope) what the blockchain is. To keep the explanations as clear as possible, I took some shortcuts. I hope that blockchain specialists will forgive me.
So what? Will blockchain kill all intermediaries worldwide?
It is still a bit too soon to conclude as blockchain has some challenges to win, especially to support high transaction volumes.
In addition, it requires new business models which none of us are fully ready for yet. It took about a dozen years for digital to rise up and become mature. We can expect that blockchain will take fewer but it will still take some time.
Nevertheless, the future is at our door, I already hear it knocking…
Editor’s note: At TM Forum Live! in Nice in May, we have a number of sessions around blockchain, including the impact of blockchain and smart contracts in banking and beyond, and a panel debate on the role of blockchain and smart contracts in strengthening the IoE economy.