A beginner’s guide to Blockchain (explaining to a 5-year-old)
“The blockchain is an indestructible digital ledger for keeping track of economic transactions, which can be programmed to maintain not only financial transactions but virtually everything that has value.” – Don & Alex Tapscott, Blockchain Revolution 2016
What is Blockchain?
Blockchain is a term nearly everyone has heard of and yet many still do not know exactly what it is.
For centuries consumers have used financial institutions like banks in financial transactions. The bank or other financial institution oversees and administers the financial transaction, such as paying bills, paying a mortgage or withdrawing or paying money from and to accounts.
The digital world has now challenged the monopoly that banks and other financial institutions once held.
Although it is now possible to access and use a bank account online rather than visiting a branch, blockchain has now removed completely the need for an agent such as a bank to provide the means of paying bills or carrying out other financial transactions.
When you make a financial transaction using blockchain, it is recorded electronically on a digital ledger that is open to everyone’s scrutiny if they are also on the same network as the computer the transaction is made on.
Those who own Bitcoins – or other cryptocurrencies such as Litecoin – as well as other assets held virtually have access to the network using a password issued to them.
As a safeguard against fraud or other irregularities, all the other computers on the network must approve the transaction, just as the teller or chief accountant at a bank might scrutinise a financial transaction before approving it.
As soon as the transaction has been sent to all the computers in the network, it is added to the network’s electronic ledger and is indelibly recorded there.
Each transaction is recorded using a hash – eg 00001# – and the blocks of new transactions form a chain so that they are connected to one another. Each block refers to the previous one, making fraud very difficult to carry out because the whole chain is affected is anything is changed.
Each computer on the network will also have a copy of the transaction on record, which is why it makes blockchain transactions less vulnerable to fraudulent activity. Because each block in the chain refers to the previous block, making illicit changes is almost impossible without detection.
Once approved by the network, the financial transaction takes place and will remain as an entry on the digital ledger, which is available to view publicly forever.
The blockchain system of transactions also checks to make sure that each Bitcoin involved in a transaction is only used once.
History of Blockchain
Blockchain has been around since 2008, when an anonymous person using the name Satoshi Nakamoto developed the system to enable remote financial transactions online using Bitcoin. Blockchain is essentially the public ledger which records cryptocurrency transactions.
You may recall that 2008 was also the year of the global banking crisis, which exposed flaws in the banking system.
Since blockchain was developed, many have promoted it as the new, safe way to transfer money and assets.
The identity of blockchain founder Satoshi Nakamoto has never been revealed.
The basic purpose of blockchain is to act as the digital ledger of cryptocurrency transactions and also asset transactions. Assets can be referred to as Ether, so in this case there are two types of blockchain – Bitcoin Blockchain and Ethereum Blockchain to record the different types of electronic transactions.
It is being suggested that cryptocurrencies and blockchain will eventually make traditional banking using an intermediary, such as a third party financial institution, unnecessary, as consumers can send money to each other and pay for goods directly anywhere in the world using blockchain.
The Pros and Cons of Blockchain
Advantages of Blockchain:
The advantages of blockchain are that it enables electronic transactions to be made directly without the need for a bank and so is much quicker, giving the individual more control and eliminating errors.
It also allows parts of the world without any banking facilities to be able to transact with one another. Residents in Venezuela began transacting in bitcoin recently when the value of their local currency (Bolivar) began experiencing hyperinflation.
It is estimated a blockchain transaction is ten times faster than current banking technology.
The system also gives added security to financial transactions, reducing fraud, because of the way it operates using cryptography, with each transaction referring to the previous one in a chain and being recorded permanently in that chain on a digital ledger sheet that is public.
There is also no government interference in the currency or technology as yet, as with established currencies subject to government interference.
Disadvantages of Blockchain:
Cryptocurrencies – despite not being subject to government interference –
have still proved to be volatile when subjected to market conditions. Because Bitcoin is new to the markets, the rate can fluctuate daily and sometimes dramatically, according to the actions of those investing in the currencies.
To use blockchain technology requires a certain amount of computer knowledge – just as using digital banking does. Using blockchain involves creating a virtual “wallet” to store your cryptocurrency or assets – and maybe even using another system of digital storage to transfer currency or assets to, known as “cold storage”. Cold storage wallets are offline – not connected to the Internet – making them secure because they cannot be accessed except by the owner. There are companies online offering this offline virtual storage. For the less technically minded who are not used to the virtual world, setting up blockchain wallets and transferring cryptocurrency and assets to offline wallets might prove a challenge.
Financial institutions are already investing in Blockchain and developing their own brand of the technology.
Research from the World Economic Forum’s Global Agenda Council reveals that currently just 0.075% of global GDP is held in blockchain – around $80 billion; but if the technology becomes widely accepted, it means anyone with access to a computer can make transactions without the need for a bank.
Banks and other financial institutions are already spending millions on developing the technology, so it appears that, in the future, blockchain may well become the accepted way to pay bills, send money or transfer assets.
The future surely looks bright, with other companies such as Facebook and Whatsapp are also considering using blockchain technology others include cloud storage.