Everything you need to know about the blockchain

What is the blockchain?
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Blockchain is one of the biggest buzzwords in technology right now. But what is it? And why are all your friends and family talking about it?

Let’s start from the beginning. The first major application of blockchain technology was bitcoin which was released in 2009. Bitcoin is a cryptocurrency and the blockchain is the technology that underpins it. A cryptocurrency refers to a digital coin that runs on a blockchain.

Understanding how the blockchain works with bitcoin will allow us to see how the technology can be transferred to many other real-world use cases.

Bitcoin is the brainchild of a mysterious person or group of people known as Satoshi Nakamoto. Nobody knows the identity of Nakamoto, but their vision was laid out in a 2009 whitepaper called “Bitcoin: A Peer-to-Peer Electronic Cash System.”

The bitcoin blockchain

The blockchain behind bitcoin is a public ledger of every transaction that has taken place. It cannot be tampered with or changed retrospectively. Advocates of the technology say this makes bitcoin transactions secure and safer than current systems.

So here are a few facts about bitcoin:

  • It is not issued by a central authority.
  • There is a limit of 21 million.
  • Currently just over 17 million are in circulation.
  • The first transaction using bitcoin is widely believed to be carried out by a programmer named Laszlo Hanyecz, who spent 10,000 bitcoin on two Papa John's pizzas in 2010.
  • The identity of bitcoin creator Satoshi Nakamoto remains a mystery.
  • Bitcoin has often been used to buy illicit products such as drugs.
How does it work?

The bitcoin blockchain is “decentralized,” meaning it is not controlled by one central authority.

While traditional currencies are issued by central banks, bitcoin has no central authority. Instead, the bitcoin blockchain is maintained by a network of people known as miners.

These “miners,” sometimes called “nodes” on the network, are people running purpose-built computers that are actually competing to solve complex mathematical problems in order to make a transaction go through.

For example, say lots of people are making bitcoin transactions. Each transaction originates from a wallet which has a “private key.” This is a digital signature and provides mathematical proof that the transaction has come from the owner of the wallet.

Now imagine lots of transactions are taking place across the world. These individual transactions are grouped together into a block, organized by strict cryptographic rules. The block is sent out to the bitcoin network, which are made up of people running high-powered computers. These computers compete to validate the transactions by trying to solve complex mathematical puzzles.

The winner receives an award in bitcoin.

This validated block is then added onto previous blocks creating a chain of blocks called a blockchain.

How the blockchain is tamperproof

One of the advantages of blockchain is that it can’t be tampered with. Each block that is added onto the chain carries a hard, cryptographic reference to the previous block.

That reference is part of the mathematical problem that needs to be solved in order to bring the following block into the network and the chain. Part of solving the puzzle involves working out random number called the “nonce.” The nonce, combined with the other data such as the transaction size, creates a digital fingerprint called a hash. This is encrypted, thus making it secure.

Each hash is unique and must meet certain cryptographic conditions. Once this happens a block is completed and added to the chain. In order to tamper with this, each earlier block, of which there are over half a million, would require the cryptographic puzzles to be re-mined, which is impossible.

Pros, cons and alternatives
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It may seem like an unnecessarily complicated process for moving money. But the blockchain has its advantages.

With traditional methods of payment every transaction in the world is registered on privately-held databases owned by corporate and state entities. These databases are not accessible by the public and are therefore closed. They are also usually owned by one entity. Because of this nature, they could be open to fraud or to being hit by an attack that could cripple a network, unlike bitcoin’s blockchain. Now think about the blockchain as a beefed up database. It records all transactions in bitcoin, doesn’t allow repeat payments, and requires several parties to authenticate the movement of the digital coin.

Because the blockchain is not centralized, it also means that if one part of it went down, the whole network would not collapse. There are many different parts of the bitcoin network that require it to work. So even if one miner went out of action for example, transactions would still work.

Problems with bitcoin’s blockchain

Bitcoin’s blockchain was designed to be a decentralized network. With that, however, has come a number of problems.

One big issue is that transaction times and costs in bitcoin have soared as the network has become more congested. This has actually led to disagreements by a number of parties that uphold the network regarding how the technology should develop in the future in order to address these issues.

For example, last year, a group of developers that didn’t agree about the future of bitcoin, broke off and split the underlying blockchain. This led to the creation of a bitcoin offshoot known as bitcoin cash. Another so-called fork happened, resulting in bitcoin gold.

And forks bring their own problems. New coins that are created are often dominated by a smaller number of miners. Should a miner control more than half the mining power of a cryptocurrency, they could potentially falsify the blockchain ledger. This has happened recently with bitcoin gold.

A number of other issues have also been flagged up, including the presence of illicit material buried in the bitcoin blockchain. We know that a single block contains data required for a bitcoin transaction to go through. But within that data, researchers have found some instances of content such as child pornography. These standard image or video files would be encrypted alongside the legitimate bitcoin data and so are very difficult to find.

One other weakness of bitcoin’s blockchain is also the very thing that makes it attractive: rewards. As mentioned earlier, miners who maintain the network are rewarded in bitcoin. But mining costs a lot of money in the form of energy to run the purpose-built computers and specialist hardware. There are different estimates as to what price bitcoin has to be to be profitable. One of the most recent studies came from Wall Street analyst Thomas Lee of Fundstrat who said $8,038 for one bitcoin would be profitable for miners. But if bitcoin remains below that for a long period of time, many miners could theoretically walk away, causing transaction times to increase further and pushing users away. The result could be a meltdown of the bitcoin network. So far, this has not happened.

But this kind of volatility and infighting is clearly not fit for business. Therefore, many companies began looking at the principle of blockchain technology and adapting it to what would work for their business. The parts of blockchain technology that have so far attracted companies include the ability to have a shared ledger of activity to help to make transactions more efficient, a reduced number of intermediary parties involved, and lower processing costs. When we delve into real-world examples of blockchain technology, it’s clear that many of the things that have caused problems with the bitcoin blockchain have not been adopted.

What other blockchains are there?

The bitcoin blockchain is not really made for companies to build apps and processes on. But a number of other companies have created blockchain platforms to help firms interested in the technology build processes.

Ethereum, Ripple, Hyperledger, IBM, R3, are just a few names that have developed such platforms.

Ethereum is essentially a blockchain platform that specializes in smart contracts. It has a digital coin known as ether linked to it. This is the world’s second-largest cryptocurrency by value. Like bitcoin’s blockchain, Ethereum’s is also public. Think of how companies like Apple and Google release software developer kits to allow people to build apps on their various platforms. Ethereum does something similar, allowing people to build “decentralized apps” on its platform, leveraging its blockchain and potentially using the digital coin ether to power their product.

Smart contracts are contracts that automatically execute when certain conditions are met from all interested parties. The automation can help to speed the process up, ensuring no mistakes along the way.

Meanwhile, Ripple is a blockchain specifically designed for cross-border currency transactions. The movement of money from one currency to another across the world, particularly for large businesses, is expensive and takes a long time. The process involves lots of different parties from banks to clearing houses. Ripple’s blockchain system, known as xCurrent, helps to cut out some of the intermediaries, cutting down a cross-currency transaction to seconds.

Ripple also has a cryptocurrency attached to it known as XRP, but it is not necessarily needed to power its xCurrent product.

The financial services industry has been one of the first movers when it comes to experimenting with the blockchain. CNBC spoke to two major banks who are trialing the technology.

Banking on the blockchain
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The promises of blockchain technology have been praised by the banking industry in particular. They see it as a way to reduce costs, make processes more efficient and potentially underpin a lot of their operations.

Banks often call blockchain “distributed ledger technology” or DLT to distinguish it from bitcoin’s blockchain. Many major banks have begun carrying out blockchain experiments.

CNBC spoke to BBVA and Santander about what they have been doing with the technology.

BBVA and the $90 million loan

Spanish bank BBVA carried out a pilot project in which it issued a 75 million euro ($89.7 million) loan using blockchain technology to a company called Indra.

The current loan issuing process requires lots of back and forth between various parties, a number of different versions of one contract, and lots of time and effort. BBVA’s solution, which was built-in house, is aiming to try to cut down the time and cost. It is based on smart contracts explained above.

To execute this loan, BBVA and Indra were both using an app developed by the Spanish bank. In this, Indra would put all the details required to request the loan. BBVA would then put in changes. This back and forth would continue, but each step would be registered on the blockchain — so it created a ledger of activity.

When all parties had agreed to all the parts of the loan agreement, the contract was executed.

The final contract was recorded on the private, internal blockchain developed by BBVA.

Only the people with permission would have access to this. But BBVA then also cryptographically secured the contract and hosted it on the Ethereum blockchain. The BBVA loan can be seen on the Ethereum blockchain.

“We saw that blockchain was not just disruptive tech but it could have an impact with the way we run our current products.”
Alicia Pertusa, head of digital transformation, BBVA

Alicia Pertusa, the head of digital transformation at the investment banking division of BBVA, said that she estimates a 40 percent to 50 percent time saving when issuing a loan on the blockchain versus the traditional process.

“We saw that blockchain was not just disruptive tech but it could have an impact with the way we run our current products,” Pertusa told CNBC by phone.

Even though the loan was put on the public Ethereum blockchain, BBVA stressed that in no way is the loan linked to the ether cryptocurrency.

BBVA’s blockchain loan trial was just between two parties — the bank and Indra. But Pertusa spoke about a process where this technology will greatly help processes of syndicated loans where many parties are involved, for example.

“That is what we are building. We wanted to build it step by step. Then we can add more parties to our system,” she said. “We saw that blockchain was not just disruptive tech but it could have an impact with the way we run our current products,” Pertusa told CNBC by phone.

Santander and cross-border money

Spanish lender Santander launched a service known as One Pay FX that works on the ripple blockchain product known as xCurrent, described earlier in the article.

It allows customers to send money from one currency to another across a number of countries including Spain, the U.K., Brazil and Poland.

Ripple’s xCurrent technology sends messages between the banks involved which carries the data required for the transaction. Next, a pre-transaction phase takes place which includes verification checks. Since all the banks involved have all the necessary requirements for the transaction, it can be verified. The funds are then held across all banks and the transfer made.

“As an industry, we recognize international payments is not the smoothest. Users of this technology are able to mitigate those pain points.”
Ed Metzger, head of innovation at Santander U.K.

It happens on a distributed ledger system that allows verification of all the details across the various banks. Customers can see how much money will arrive and the cost of the transaction in their app.

“As an industry, we recognize international payments is not the smoothest. Users of this technology are able to mitigate those pain points,” Ed Metzger, head of innovation at Santander U.K., told CNBC in a recent phone interview.

Who else is trialing this technology?

The simple answer is any entity hoping to make processes cheaper, faster and more traceable. Let’s take a look at a handful of examples across different industries, not just the banks.

Last year, stock exchange group Nasdaq partnered with Swedish bank SEB to trial a blockchain-based mutual fund trading platform for example. Nasdaq also trialed blockchain to allow shareholders of listed Estonian firms, who weren’t physically present for meetings, to vote.

Blockchain technology can also be used to track products across a supply chain or route. For example, diamond producer De Beers recently announced that it had trialed the technology to trace the stones from the time they were mined to delivering them to a jeweler. The blockchain can also be used to track ownership of assets such as fine art of even property.

Elections are another space which blockchain technology could be applied to. In West Virginia’s primary election in May, some voters were able to vote via a mobile blockchain-based platform.

What’s next for the blockchain?
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Despite the hype and promise of blockchain or DLT, it’s not something that will be widespread in the next few months.

The current state of play sees banks experimenting with the technology, but not adopting it on a wide scale. It’s being used for singular processes, such as loans in the case of BBVA or cross-border currency movement like Santander is testing. But there are a number of other use cases and even industries that blockchain can touch. Insurance, health care and government agencies just to name a few.

Still, there are a number of stumbling blocks that the technology needs to overcome to be viable across major organizations and industries at large.

One of the major ones is interoperability. Essentially, how will blockchains developed by one firm work with DLT run by another company? There’s a number of companies as outlined before developing blockchain platforms. But there’s no guarantee that each one will be compatible with another.

It can be likened to the early days of mobile operating systems, where there were several systems including iOS, BlackBerryOS, Android and Symbian. Now iOS and Android dominate the smartphone market.

Another big factor is whether these blockchain systems can scale and be able to handle the large transaction processes needed across industries.

“It’s unclear how the bank blockchains will be structured. This is a source of debate and confusion.”
Garrick Hileman, researcher at Cambridge University and CEO of Mosaic.io

Also, while many of the blockchains in existence are public, major companies are trialing a private version of the technology. But in the case of BBVA, they used both a public and private version of blockchain.

“It’s unclear how the bank blockchains will be structured. This is a source of debate and confusion,” Garrick Hileman, researcher at Cambridge University and CEO of Mosaic.io, told CNBC by phone.

Some of the blockchains we have discussed, in particular Ethereum, rely a lot on the ether digital token to help power it. But so far, banks have been reluctant to touch anything that looks or feels like cryptocurrency.

“I don’t necessarily see the need to use tokens. They are a useful tool for many constructs out there, but there are ways to use public blockchains without them.”
Garrick Hileman, researcher at Cambridge University and CEO of Mosaic.io

There are still negative connotations with cryptocurrencies including wild price swings and the link between bitcoin and people buying illegal items from the dark web. Pertusa at BBVA says that while tokens might be useful for some applications there are ways to use public blockchains without them.

“I don’t necessarily see the need to use tokens. They are a useful tool for many constructs out there, but there are ways to use public blockchains without them,” she told CNBC.

Whether this remains the case is not clear. Digital tokens will be the subject of CNBC’s next in-depth feature in this series.

While blockchain technology is being experimented with across a number of industries, the future is still uncertain and the power and limitations of this technology is still unclear.

Whether blockchain begins to power the world and is the biggest disruptive force since the internet, as some have suggested, remains to be seen.

Credits
Writer: Arjun Kharpal
Design and code: Bryn Bache
Editor: Matt Clinch
Images: CNBC