When most people think about bitcoin – the cryptographic digital currency launched in 2008 by the pseudonymous programmer Satashi Nakamoto – they think of an obscure, online money scheme subject to wild swings in value, fraud, and illegal activity. This is the narrative the media has told. But what is often missed is an understanding of the underlying concept and technology that supports bitcoin, called the blockchain. It has the potential to be a revolutionary and disruptive force in society, and worth paying attention to if you work in finance, law, or real estate; plan to get get married, have children, or buy a house; or live in a developing country with no access to banks or financial resources. Yes, it’s potentially that important.
I won’t discuss the technical details of the blockchain – Wikipedia does a good job of that – but it’s important to understand how the world works now and why blockchain technology is different.
Today, we depend on central authorities to function. Think of the government and banks. One important problem they solve is trust. If I want to buy a car from a dealership, how does the the dealership know I have the financial resources to do so? In other words, how do they trust me? Well, they look at my credit score, social security number, possibly bank statement or work history, etc. to verify who I am and what I have. This is all verified by some central authority – an authority that holds records – a private ledger – about me in some protected vault or server.
But there are several problems with this. First, sometimes central authorities abuse their power – think of the financial crisis when banks collapsed because of fraudulent lending and millions of people lost their jobs. Second, sometimes central authorities lose records, or make recording mistakes. It happens all the time. Third, other people can steal my records or the hack the system to access my record for fraudulent purposes e.g. identity theft. Fourth, a system dependent on central authorities such as credit card companies is expensive. Finally, central authorities can sometimes be inaccessible, especially to the underprivileged. There are a lot of poor people who are “unbanked” – they can’t get access to a bank or don’t trust banks.
So how does the blockchain technology get around all this? In one sentence: it is a decentralized, verifiable, permanent, unhackable, and multipurpose public ledger. What does that mean? Ok, let’s unpack all those adjectives:
- Decentralized – no one owns the blockchain transaction system (you can set it up on your computer if you want)
- Verifiable – all transactions are confirmed by multiple, independent sources (e.g. computers) in the system
- Public – anyone can access it from anywhere, as long as you have an internet connection
- Permanent – transactions are irrefutable and inviolable; once a transaction occurs, you can’t change it (not corruptible)
- Unhackable – because the system is decentralized and exists on millions of computers, the computing power needed to hack the system is impossible to acquire (unless we invent quantum computers)
- Multipurpose – it’s more than a currency, but a system that benefits any transaction that requires trust
So how does this apply to our lives? Beyond money, here are some potential applications:
- Protected digital identities
- Easily auditable databases
- Open and verifiable asset registries and property titles
- Enforceable smart contracts
- Accurate credit scores
- Affordable cross-border mobile payment systems and remittances
- Accurate birth certificates, college transcripts, and marriage certificates
- Verifiable patent and copyright claims
- A true sharing economy where anyone can trade with anyone
So the next time you hear about bitcoin, don’t think about a currency – think about the underlying blockchain technology. Sooner than later, it will change our world. Central authorities won’t go away for good reason – we need them – but change will happen. A good analogy is the TCP/ IP protocol that the internet in built on. It decentralized communication. The blockchain and bitcoin decentralizes trust in transactions – meaning new products and applications that can lower costs, protect identities, stamp out corruption, and empower the underprivileged. This is why some of the smartest and most sophisticated investors in the world are pumping billions into blockchain applications today. Oh yes, and the U.S. government is on board too.
Learn more at our Future of Financial Planning Seminar Series.