What is a blockchain? Building trust in bitcoin

Financial processes are dependent upon mutual trust between all parties involved. The reason why individuals lend money from a bank rather than, say, the wealthiest person in their town, is because they offer a greater level of security. However, using banks as the facilitator for all monetary transactions is not always practical and in any case, the 2008 financial crisis has damaged the trust upon which banking depends.

In this climate, bitcoin and similar cryptocurrencies have emerged, but they too are faced with the difficult task of creating a mutual feeling of trust amongst users. When you factor in that banks have been engrained within society for centuries while bitcoin is just a few years old, this challenge becomes all the more daunting.

[easy-tweet tweet=”#Blockchains contain records of all the transactions that have ever taken place using #bitcoin” user=”bquared90″ usehashtags=”no”]

The means through which bitcoin and similar cryptocurrencies create trust is through a network-based ledger known as a blockchain. Much like traditional ledgers used by banks all over the world, blockchains contain records of all the transactions that have ever taken place using the bitcoin currency. Unlike bank ledgers, however, blockchains are handled by a network of autonomous computers, not under the control or influence of any single individual or institution. Not even the operators of the blockchain’s various connection points, or nodes, can tamper with this inviolable ledger.

the blockchain is self-regulating

Bitcoin’s blockchain ledger is maintained by this network of nodes, essentially a network of computer owners that have downloaded a set of software tools that enable their devices to interact with other members of the network. The idea behind this is that each node checks the viability of every single blockchain transaction, ensuring bitcoins are not double-spent and only legitimising transactions once they have been checked against the existing ledger. To incentivise the community to legitimise transactions, bitcoin “miners” are rewarded for dedicating computer resources to this process in the form of new bitcoins. Thus, the blockchain is self-regulating as it is in the interests of all members of the network to reinforce the legitimacy of the currency. Without this level of trust, bitcoin becomes worthless.

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Perhaps more powerful is the emphasis on transparency lying at the heart of the blockchain. All records are public, anyone is free to view a history of all the recorded bitcoin transactions. When combined with the decentralised nature of bitcoin, this offers a level of transparency that stands in stark contrast to the impenetrability of large scale financial institutions. However, as many media outlets have been at pains to point out, bitcoin’s transparency only goes so far, which has both advantages and disadvantages.

Anyone viewing the blockchain will not be greeted with a list of names, IP addresses, or even recognisable purchases. Instead, each transaction will be accompanied by a string of letters and numbers ranging between 26 and 34 characters. Each address is connected to an owner and he or she is free to share this address in order that money can be paid into it, for example, but outside of this there is no easy way of making a personal connection to a blockchain address. This level of anonymity has, of course, led many to associate bitcoin with illegal actions, as the facilitator to a slew of shady transactions taking place on dark web black markets.

[easy-tweet tweet=”This level of anonymity has led many to associate bitcoin with illegal actions” user=”bsquared_90 and @comparethecloud” hashtags=”bitcoin, fintech”]

However, with enough legal backing and some investigative know-how law enforcement agencies have broken through bitcoin’s veil of anonymity. The FBI’s seizure of more than $3 million worth of bitcoins when it brought down the online marketplace Silk Road likely relied on bitcoin’s traceability. Unlike cash payments, digital currencies such as bitcoin always lead somewhere and although the exact details surrounding the Silk Road case are unknown, the public nature of the bitcoin ledger is more likely to have aided the prosecutors than the criminals.

bitcoin has a long way to go before it gains the level of respect and dependability that long established physical currencies have

Conversely, outside of the reaches of subpoenas and other more extreme legal methods, the identity of bitcoin users is largely protected. This brings with it many benefits, particularly for the millions of people all over the world without a bank account.  Similarly, in Saudi Arabia women are not allowed to open a bank account without their husband’s permission, meaning that they do not have full control over their own finances. Bitcoin offers these individuals and many others without financial autonomy the opportunity to conduct transactions on their own terms. In this respect, the anonymity offered by bitcoin is hugely empowering.

Of course, bitcoin has a long way to go before it gains the level of respect and dependability that long established physical currencies have – in the history of world finance, it may ultimately turn out to be nothing more than a short-lived experiment. But for now it offers an exciting alternative to the monopoly of global financial institutions: disruptive and empowering, anonymous yet transparent, decentralised but secure.

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