Distributed Ledgers, Blockchains and Virtual Currencies: Are We Nearing A Pivotal Systematic Change?

Aug 2, 2016

Distributed Ledgers, Blockchains and Virtual Currencies: Are We Nearing A Pivotal Systematic Change?

Blockchain, Fintech, Startup, Trends, Valuation , , 0 Comments

“Right now, Bitcoin feels like the internet before the browser.”

-Wences Casares, Founder & CEO of Xapo

With the advent of HTML 1 in 1993, which standardized the language used to create web pages, the potential of the internet became unlocked. With applications written in HTML combined with a viable connection (and authorization), suddenly anyone could access a treasure trove of information from anywhere on the planet – and sometimes beyond. (Think Hubble and the Mars Rover). With HTML, the internet effectively sped up the process of globalization to light speed. What would be next?

Enter bitcoin, the virtual currency introduced to the world in 2009. Virtual currencies (aka crypto-currencies) seems to be the new technology ‘flavor’ of the year, with high-profile announcements from household names such as JP Morgan and Goldman Sachs highlighting the many potential applications. However, before we anoint virtual currencies as the next revolutionary step in the globalization of the planet there are some very significant questions we must ask. What is it? How does it work? And how will it affect me? The first two are easy to address. The latter is still speculative.

What is it?

A virtual currency is digital money. It is issued and controlled by its developers and accepted as payment for goods and services among those members of a virtual community who choose to accept it. But why should they accept it when we have perfectly fine, government-backed currencies such as the US Dollar, British Pound, Euro, and Japanese Yen, all of which are regularly wired digitally to pay of goods and services all over the planet. As a society, we have obviously progressed past the days of currencies with intrinsic value such as gold coins, but preferences for how we conduct transactions have largely remained intact. It is safe to say that, when given the choice, most people will choose highly liquid, easily transferable, well accepted, secure methods of payment vs. others. We want to transact in a system that is elastic, simple to use and, most importantly, stable. On the surface, these requirements don’t seem to align with what virtual currencies offer. And with no intrinsic value, no tactility, and certainly no backing from any government or central authority, and extreme volatility, virtual currencies might seem unlikely to gain mainstream traction. But virtual currencies do profess to offer some advantages including anonymity, transparency, and low transaction costs. If the world can be convinced that they are also safe and secure, they may well be well suited for conducting a wide range of transactions. And they do seem to be gaining some traction in some circles.

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How does it work?

Virtual currencies all rely on something called a Distributed Ledger – essentially a digital record of who owns the crypto-currency (or anything else that is tracked by the ledger, e.g., a property deed, mortgage documents, a stock certificate.) These “21st century ledgers” contain digital records of data in which records are replicated, shared, and synchronized throughout multiple sites, geographies, or institutions. Although ledgers have long been a commercial staple, it is these digital (distributed) counterparts, containing complex algorithms that enable a collaborative environment with capabilities that go far beyond that of traditional ledgers. Set up within a network, each participant is able to access their own identical version while the security and accuracy of the ledger’s contents remain uncompromised, through the use of keys and signatures (encryption). Since transactions are a two-way street, the number of keys and signatures can be customized to fit the needs of all parties. This is where the blockchain comes into play.

Think of the blockchain as the backbone of the ledger. It is a digital equivalent of DNA; they are both replicated stores of data. The stored data in a virtual currency, like bitcoin, is a series of transactions that can be likened to the genetic material stored with a strand of DNA. Blockchain is composed of aggregated transactions (“blocks”) that are repeatedly linked to pre-existing transactions (forming a “chain”). As the blockchain grows larger over time, it effectively evolves, just as human biology has, albeit at a much faster pace. To tie this analogy all together, we must bring up one of the fundamental ideals of evolution – natural selection – and how it ties into the Proof of Work framework. This framework dictates that data should be difficult to produce, in terms of cost and tediousness, but simultaneously easy for anyone to verify and satisfy mutual requirements. In the world of virtual currencies, individual blocks are able to be edited or modified, while DNA can be artificially altered and sequences. To come full circle, only altered data that is verifiable will be accepted by the network, weeding out any faulty links in the blockchain, just as weaker DNA would be weeded out by natural selection within a species. This results in a more resilient species – a transaction that is more secure.

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How will it affect me?

We don’t yet know if virtual currencies will take over the world. There are still significant questions that remain unanswered and that may be one reason why Bitcoin’s total market value (around $10 billion) is less than one tenth of one percent of the $1.5 trillion in circulation. The next largest virtual currency, Ethereum, is 1/10th that size. But banks are certainly spending money on them (see chart below).

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As with any new technology vying for mainstream consumer use, it would be helpful if the providers were to agree on a standardized framework for monitoring and ensuring safety and stability. There may be a role here for federal and state regulators, although many issuers of virtual currencies are sharply resistant to the concept. The technical code that is required to run these decentralized systems is itself an emerging market and companies are already capitalizing on it. The opportunity to do so is only going to grow. Security and privacy also remain major concerns as the digital wallets in use today become increasingly vulnerable; protecting the integrity of the ledger is vital.

Whatever the answer, it does seem clear that we are at the dawn of a new digital age in which blockchains and distributed ledgers will play an increasingly important role. It was not so long ago that people scoffed at the idea of the internet, and in its infancy even the most knowledgeable technologists couldn’t fathom the societal shift that occurred because of it.

So what comes next? This is up to governments, how willingly they accept a seismic shift in how consumers transact, and the subsequent need for evolution. The technology of tomorrow may have already arrived.

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