An explanation of blockchain technology

Blockchain is a form of distributed ledger technology, a distributed ledger being a radical alternative to a centralised database. At its most abstract, its characteristics are:

l There is no centralised, ‘trusted’ version of the database or ledger; everyone on the network has an identical copy.

l There is no centralised, ‘trusted’ authority: any change or update to the database is by the agreement of everyone on the network.

l Communication (or the transfer of any data) is not through a centralised, ‘trusted’ exchange: it is ‘peer-to- peer’, from one user to another.

l It is (said to be) extremely secure. If one copy is hacked or corrupted, copies on the rest of the network remain intact.

l It is ‘data-agnostic’. Because there is no central organiser, anything can be stored as long as it is in digital form.

In summary, a distributed ledger looks like a centralised database because it accepts inputs from multiple parties and appears to present everything from one source. However, its distributed structure overcomes the centralised model’s vulnerability to attack. In decentralising and becoming ‘trustless’, distributed ledger technology disrupts large parts of the current infrastructure. We are used to the (costly) intermediation of ‘trusted’ central authorities, especially in finance where everything passes through a bank. Consider a simple asset transfer, in this case of money. You instruct your bank which alerts the recipient’s bank. The money passes from your account to the bank’s account in ‘clearing’ at the Central Bank. It goes through here into the recipient bank’s central bank account and from there, finally, into the recipient’s account. The two banks then exchange confirmations. This is time-consuming and expensive, and appears ridiculously archaic.

On a peer-to-peer (blockchain) network, the asset (bitcoin, a crypto- or digital currency) passes directly from one account to another. Transactions are anonymous. Everyone might see the entire transaction history of an address but can have no idea who uses that address. This anonymity protects users from identity-theft; nevertheless, it has given rise to criminal activity. Blockchain is secure: no bitcoin has been stolen from an address, but there have been thefts off-chain, either through accounting fraud or from websites that use bitcoin. As a result, the FBI is one of the largest holders of (recovered) bitcoin.

Blockchain’s innovative security protocol uses a (conceptually) simple mathematical tool to check for changes in every transaction, in every link between transactions, in every block into which linked transactions are bundled and in every link between blocks in the chain. It does this every time there is an update, creating a complex web of cross-references from transaction to block to chain. The smallest change anywhere will cascade through the web and become immediately apparent. Furthermore, it can check the transaction history of every bitcoin (or part thereof) back to its origin. This is analogous to following the ownership history of a bank note.

PropTech 3.0: blockchain and AI

Chapter 7

Transactions are made and secured with pairs of ‘keys’, which are strings of characters and numbers unique to a new address (or account). The Public Key can be used by anyone to view the address; the Private Key is known only to the user and enables access to the address. The keys work only in tandem to encrypt and decrypt a ‘hash’, which is a fixed-length, mathematical representation of a file’s contents. The ‘hash’ ensures that a file (usually a bitcoin transaction) has not been hacked or changed when sent over the public network to the counterparty’s address. The sender encrypts the file hash with her Private Key to create a digital signature” and transmits the file, signature and corresponding Public Key. The recipient decrypts the signature with the Public Key to confirm, with the ‘hash’, the integrity of the file’s contents.

‘Mining’ is how the network is updated simultaneously and new bitcoin are created or ‘mined’. Transactions are bundled together into a block, and the miner broadcasts the block to the rest of the network. A complex puzzle is attached to the block which must be solved to ensure the validity of the transactions in the block. Each miner is in competition to solve the puzzle first and is rewarded with bitcoin, creating an economic incentive for mining. Each block is tethered to the previous block, creating the blockchain. After a block is solved and has been broadcast to enough nodes, work begins on the next block. The process requires huge computing power, electricity and time (10 minutes for a confirmation). These are ongoing issues; however this is the required trade-off for a secure system that enables peer-to-peer transactions without a central authority.

In order to effect a transaction, it is not necessary to run the entire network which would require heavy downloading and constant synchronisation of the blockchain. Instead there is a process of Simplified Payment Verification (SPV) that allows users to make ‘light’ transactions. A user needs only the ‘block header’, around 80 bytes, of the most recent block to confirm that the transaction has entered the blockchain.

Smart Contracts are used for the automated movement of funds, data and agreements. They are contracts written in computer code which can react to information sent to them from a storage system, which can be the distributed ledger it is stored on. Smart contracts can be self-executing and self-enforcing, meaning that a contract can enforce a pre-determined outcome once the required criteria are met. They can be standard, multifaceted, multi-party or tailored to individual needs and can eliminate timing differences by making an exchange simultaneous. Currently, Smart Contracts do not have a legal status and are used as a guide to protocols of exchange. However, like eDocs and eSignatures, they will eventually acquire legal status and be able to enforce these protocols in the future, most likely working in tandem with traditional, paper-based legal practices where human judgement will still take precedence.

While the bitcoin blockchain itself has not been hacked, Blockchain is not, unfortunately, foolproof. Garbage can be maliciously uploaded – collaborative consensus is needed to push it out. The identity of the uploader of garbage is known, and any upload can be disputed and changed so that eventually there is a consensus, but there is no third party arbitration and the system relies on trust and collaboration. In practice, this may reduce to a reliance on professional advisors participating in the system and acting effectively as arbiters.

PropTech 3.0: blockchain and AI