In other words, once data has been written to the database and has been agreed by at least 51% of the 5,000 independent computers, it is locked permanently and cannot be altered.
As with the photographs of me stealing your phone, where I would have to change at least 2,500 individual photographers’
images to change the truth, so it is with the blockchain. At least 51% of the computers would have to be altered to change the stored data. The significance of this is that there is no longer just one single point of attack.
Many well documented financial hacks have occurred in the past, where bank data has been changed and re-directed fraudulently to a new account. These changes have typically been made by attacking one central point of weakness – one point of attack, where records are stored and changed. Under a blockchain type of structure, the system is not only decentralised to take away that central point of attack, but the data is also distributed across multiple computers. In our example of the 5,000 computers on the network, this significant centralised weakness is removed. Any hacker or attacker would need to access at least 2,500 computers at the same time to change the data – a significantly harder task.
Hacking is a very sophisticated art within the major criminal organisations world-wide. It is not the cliché-ridden Hollywood view of a spotty teenager hacking the systems and making off
with millions in a split second. Instead, attacks and hacks are often planned months in advance, the perpetrators patiently stalking financial institutions and their key employees over a period of time, gradually encroaching into the institution’s system. The “infection-to-cash cycle”, as it is called, usually starts with infected malware. This is often embedded within other files that finishes up working its way through an organisation’s administrative systems even, for example, to the point of opening the internal camera systems. Gradually and painstakingly the hackers work their way through to locate the weaknesses of a centralised system until their chosen point to strike is identified.
With a decentralised, distributed blockchain that has multiple copies of the same database, this process becomes a nightmare.
Cyber stalking now has to be multiplied across multiple computer systems across multiple institutions that will comprise
“private blockchains”, where only known parties are allowed to participate – e.g., other known financial institutions that have high standards of security. The hackers’ workload increases almost exponentially, making it so much harder to access and change financial data for their own benefit. As in nature, there is safety in numbers.
While the cat-and-mouse games between institutions and hackers will always continue to play out, you can probably begin to see, from this comparatively simple structure, the potential of the blockchain from a security point of view alone. This is just one aspect of the blockchain’s potential and power.
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The Importance of Cryptocurrency Miners The concept of mining
is an important one to understand as it is an intrinsic part of the infrastructure of the Bitcoin blockchain and most other blockchains that have superseded it.
As we saw above, once
data is collected together, it is put into blocks, and the blocks are then cryptographically sealed. It is the miners that seal these blocks.
While anyone can mine Bitcoin with the right equipment, Miners are typically companies that have access to extensive computer power. This power is usually in the form of banks of specialist, very powerful computers. The miners also usually act as nodes on the network (one of the 5,000 computers in our example above).
The Bitcoin protocol requires miners to solve a cryptographic puzzle. By successfully solving the puzzle, the cryptographic seal is then applied to a block of data. Miners compete with each other
to solve the puzzle, and whichever miner solves the puzzle first is rewarded with a Bitcoin.
So, by providing the security for the blockchain, the miners themselves get rewarded with a Bitcoin. Miners also get a second reward for providing support for the underlying infrastructure – by getting rewarded with the transaction fees of keeping the blockchain running. So, for example, if I send you a Bitcoin, there will be a transaction fee for administering the transfer of that Bitcoin. While small (around 3 - 10 cents), it is another reward for being a miner and providing the infrastructure for the Bitcoin network.
The Dynamic between Mined Cryptocurrencies and Transactions
Miners are commercial entities, with commercial drivers. To mine Bitcoins, for example, requires miners to have extensive banks, even warehouses, full of computers. As a result, there are direct costs of mining – electricity, the depreciation of the hardware, the teams to administer the network, etc., etc. The harder it is to mine, the more computing power and electricity are required to mine and the greater the costs. So, for a commercial Bitcoin miner to generate a profit, the combination of the value of the Bitcoin and the transaction fees they generate from administering transactions have to be sufficiently more than the costs of mining for them to generate appropriate profit levels. This narrative is particularly important.
As part of the Bitcoin mining protocol, the number of Bitcoins that are available to be mined is limited in nature. So, for Bitcoin, only 21 million coins will ever be issued, with the last Bitcoins due
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to be available in around the year 2140. Also, every four years, the annual number of coins available to be mined is halved. This changes the dynamic of mining significantly.
With fewer Bitcoins available to be mined, all the competing miners have fewer opportunities to earn Bitcoins. The overall costs they incur, however, still need to be paid. So, unless the value of Bitcoin rises, making it worth their while to continue to mine Bitcoins, the cost of transactions on the Bitcoin network will need to rise to compensate. As a result, we tend to see this see-saw effect between Bitcoin values and transaction fees, resulting in volatility in mining fees and Bitcoin prices, which presents any Chief Financial Officer (CFO) with significant risks when looking at cryptocurrencies. Now, if the number of transactions a CFO administers is low, and the fees are at the level of cents, this won’t present a significant problem. However, if the number of transactions rises significantly, this volatility will become an increasingly difficult issue to manage.
Different cryptocurrencies are trying to address this issue of the costs of mining and their relation to transaction fees – but it is important to understand this uncertainty as it presents risks in the adoption of cryptocurrencies in general.
Introduction
Bitcoin was an amazing invention. The more I have written about Bitcoin and more latterly the blockchain, the more I have been impressed by the underlying strengths of the very foundations that Bitcoin created. It has opened so many new possibilities that have never been seen before. It is these possibilities that are catching the imagination of so many people, including the media.
Media hype, however, is a double-edged sword. On the one hand, it is great in terms of promoting the technology and generating awareness, but on the other, it generates an over-exaggerated expectation that it is too early for the technology to deliver.
Gartner Inc., the global information technology research, and advisory company summarise this very well within their regularly produced “Gartner Hype Cycle” for emerging technologies.
In their latest Hype Cycle report from August 2016, they have included the major emerging technologies and where they are, in terms of expectation versus delivery. Their summary is shown below:
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As we can see, blockchain is regarded as being very close to the peak of inflated expectations, undoubtedly fuelled by the high levels of media coverage that have been seen over the past 12 – 18 months. Indeed, within the Gartner Hype Cycle diagram above, you can see that they believe it will be 5 – 10 years before the blockchain hits mainstream adoption. For financial services, I believe this is probably pretty accurate, but there are various applications that will hit the mainstream earlier, that we will discuss later in the book. These will tend to be simpler ideas and ones that include the idea of provenance or ownership.
In this and the next chapte, we will consider the ten core strengths and the ten core weaknesses of the blockchain.
Both are vital to understand, as they will provide you with an
understanding of both the motivations to develop the technology and the core features that are likely to inhibit its adoption and growth. While we will be considering the relative merits of the technology, it is important to understand that the technology is still very new and is still developing and growing.
As the whole blockchain ecosystem continues to develop worldwide, its wheels greased with ever-increasing venture capital funding, we will see constant improvements in the technology. Many of the weaknesses we will look at will be ironed out over time, and many of the inhibitors to adoption will fade away. That said, the blockchain ecosystem is dynamic, with its DNA still being forged. As a result, while extensive improvements are likely over time, they will have with them added challenges – the dragon’s teeth effect, if you like. Solving one problem may prompt others to rise in its wake, creating an ever-increasing game of catch-up.
The blockchain ecosystem will tend to be on shifting sands over the next few years. It will undoubtedly be full of iterations and deep changes in the short to medium term, as it creates its path towards long-run maturity, stability, and extensive commercial usage. So, let’s look first at the ten core strengths of the blockchain.
As we begin to consider the ten pillars of strength for the blockchain in general and cryptocurrencies, in particular, we will also notice that some of the strengths can ironically be seen to be weaknesses as well. While this might appear strange to you now as you read this, you will understand how this is the case as we progress, with this becoming more apparent as we explore the strengths further.
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1� Creating a digital currency that cannot be copied
A right click of your mouse; a quick scroll; “Save as…”. It’s that easy to copy images on line.
Whether it’s photographs, spreadsheets, research papers, videos, the power of the internet has been driven by its intrinsic capability to share almost anything quickly and easily. That is very powerful. On the flip side, however, it is also one of its greatest weakness – just ask the Hollywood studios or the independent photographers squeezing out a living from their creative art, seeing their livelihood being eroded away, one right click at a time. Copying anything digital is easy. Bitcoin, as a digital currency and the world’s first cryptocurrency, however, was different.
To have a secure digital currency that will instil confidence, we need a digital currency which cannot be copied or reproduced.
This has been an ongoing problem that has caused so many headaches for digital currency enthusiasts and cryptographers over the years – the issue of what is known as “double spending”.
Double spending relates to the ability to spend the same digital currency twice. Let’s use an example to give this some perspective. If I take out a $10 note from my pocket to buy you a cup of coffee and give it to the barista, we both know that the barista has received the banknote. While the note could be forged, the barista can see, touch and feel it; it is in his hand.
I cannot give the same note to someone else. However, what happens with digital currencies?
If I give the barista $10 worth of a digital currency through my smartphone, how does he know that he will get his money and
that I won’t go to another café straight away and buy a sandwich, thus spending the same money twice?
Every single transaction ever made on the Bitcoin network since its inception in 2009 is stored on each and every node that makes up the Bitcoin network, i.e., the computers that are connected to the network. Everyone on the network knows about any confirmed transaction and has an agreed form of this database of transactions, a ledger if you like. Currently the size of the Bitcoin Blockchain on each node is around 90 gigabites in size. This means that the history of every previous transaction of every Bitcoin is permanently available for everyone to see, and for every node to reference and process. So, it is easy to audit the fact that your Bitcoin address has valid Bitcoins available at a given point in time. The only down side can come from the length of time taken for a Bitcoin transaction to be formally confirmed by all computers on the network.
Size of the Bitcoin blockchain Source: Blockchain.info
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While different cryptocurrencies have different times for the creation of each block, it can take six confirmations for a Bitcoin transaction to be confirmed. With each block on the Bitcoin network taking 10 minutes to be created, six confirmations is about an hour. This delay can leave someone open to fraud from what is known as a double spending attack.
Here’s how it works. In our case, we have bought a cup of coffee from Barista 1 with Bitcoin. Barista 1 then gets his Bitcoins after six confirmations. However, if we go to Barista 2 directly afterwards and buy a second cup of coffee, whoever gets six confirmations first will get the cleared Bitcoin payment, and the person who comes second will get nothing. This becomes a challenge if the coffee has already been released by both baristas. The best practice, in principal, is for the barista to wait for one hour for the confirmations before releasing the coffee – which is not always going to be practical.
As we can see, the ability not to double spend the same Bitcoin is a great strength but the practicalities of having to wait for sixty minutes for confirmation is a weakness. The strength of the security becomes a weakness. Many companies are looking at speeding up the confirmation timings because it is impractical
to have to wait for a commercial transaction for an hour, especially in fast-paced environments such as equity trading.
2� Removing the Need for Trust
If we think back to the Global Financial Crisis (GFC), one of the key reasons behind the whole crisis getting increasingly worse was the lack of trust that grew between financial institutions.
Once Lehman Brothers, at one time the fourth largest investment bank in the US, collapsed, there was the contagion effect of no-one knowing which bank was going to be next. There was an air of suspicion and distrust.
The global banking system is made up of financial institutions that lend money and borrow money from each other in the course of day-to-day dealings and then settle their accounts usually at the end of the business day. The domino effect of lacking trust and not knowing who might be the next to cease trading made banking very difficult. It is not surprising that Bitcoin was launched at the time of the GFC in January 2009.
A Bitcoin transaction directly between two parties is based solely on their private keys and public keys. You send a Bitcoin via your private key, and you receive a Bitcoin via your public key. There is no third-party bank or credit card company required in the middle to approve or validate that the transaction has occurred. It is the blockchain technology itself that validates the transaction.
In essence, by removing the potential need for trusted third-party institutions, we as individuals have the capacity to be our own banks by controlling our own cryptocurrency wallets that contain our cryptocurrency coins.
I hope you enjoyed your free sample of the book. If you would like to buy the book please visit the Amazon Kindle Store here.
Thanks for all your support.
Tim