Since I first got into blockchain technology about six years ago, I’ve been completely immersed in the field. I was so intrigued by its potential that I rarely thought about a simple, yet fundamental question which many beginners in the area ask themselves – why do we even need blockchain technology? In the video below I’ll try to explain in simple terms what are the main benefits of blockchain technology, especially in relation to the financial system (using Bitcoin as an example). Enjoy!
Recently I’ve discovered that I really like simple questions that don’t have a simple answer. Let me explain what I mean by that.
When I first asked myself how much stuff I own, I didn’t know whether it was a hundred things or a thousand. I realized that the answer is not simple and that’s what triggered me to go through my apartment. I created a list of everything that I own and now I live with only 64 things.
Along the process not only did I find out how much stuff I actually need to live a happy life, but I also became a lot more conscious about life in general. So whenever I come across a question that seems very simple but doesn’t have a simple answer, I’m intrigued.
Why do we need a blockchain?
I was asked, “why do we need a blockchain”? In the last 2 years, I got so entangled and fascinated by the technology itself, I rarely took the time to ask myself what is the stuff that we can do with it. Why do we need this technology and why is it going to make a big change in this world?
So in today’s video, I want to talk a bit about why I think blockchain technology enables us to do stuff that is important and that we weren’t able to do before. This answer is not obvious because there are rarely any consumer products out there. Especially not any with mass adoption. There’s a lot of ideas right now but when it comes to the blockchain, we’re still at the infrastructure level. This means we’re not really building applications on top of it yet. So if you compare it to the internet, it’s like having the internet without email, Facebook, Google, YouTube…
Now if you remove all of that and you go back to the 1980s and you ask people what do we use the internet for? That question becomes a lot more difficult to swallow. So today I want to go through one example – kind of like the core example that triggered all these, like, tokens to be generated and why I think that is a good example for why we need blockchain technology.
For more than two years have now I’ve been part of Dfinity where we build a much more powerful blockchain technology that’s going to hopefully power the infrastructure of many many more blockchain applications in the future.
Back in the old days…
But in order to motivate why we need blockchain technology at all, let’s step back 2,000 years.
So 2,000 years ago people exchanged things one for another. Let’s say I owned rice and someone else had fish and I want a fish and that person wanted rice – we both exchange it and we were both happy. That worked great as long as I had what the other person wanted. But let’s say I only had berries.
In that case, I would have to find a third party that exchanged berries for rice and then go back to the original person. While rice might be very easy to exchange at small quantities, fish might not be as easy because you can only split it into so many parts. Because this was inconvenient, humans came up with a new concept. They started to introduce something that was valuable because it was only available in limited quantities.
And they used gold or silver or any other precious thing or metal for that. So instead of exchanging fish for rice, I would now exchange my fish for gold and then the gold for rice or berries etc.
There are some problems with this concept as well because gold is heavy so it’s hard to transport over long distances. It can also not easily be split or combined afterward. This concept was still not ideal and so a few hundred years ago we invented cash and currencies.
Some of these currencies were backed by gold or another metal. For example, the US dollar was backed by an equivalent of gold. Cash has a number of benefits: it’s lightweight, useful for large denominations. So one dollar and a hundred dollars are almost equally heavy, cheap and easy to store.
The world has become a lot more global over the past few decades and now we don’t only exchange value with the people in our immediate vicinity but we also want to be able to exchange value with people across the globe or on a different continent. Now while we could use cash, put it in an envelope and send it somewhere, that has a number of downsides. We need to trust the mail service, we have to trust the other party to be honest when they say they haven’t received the cash we sent and a lot of the cash might get lost.
So this might work for very small quantities but it’s not good for global trade. During the same timeframe that our world became so much more global, we also invented the internet and thus we created this new virtual layer that could potentially help with this problem of transferring money. But there’s one fundamental problem with the digital world which is double spending.
So if in the real world I take this pen and I pass it on to someone else let’s, call it Alice. Alice knows that she got exactly the one pen that I had previously and that I don’t have access to this pen because it’s now in her possession. Now this works great in the analog world where one thing only exists once through its physical presence.
In the digital world, we all know that if you take a pen and you take a picture of it and you send a picture to someone, that person knows that it’s just a copy and copies are extremely cheap to produce. So I might be sending the same picture of this pen to twenty, a hundred or thousands of people at almost no cost on my side.
And this is how we avoid double spending in today’s world in our daily interaction with digital cash. We have banks and PayPal and other third parties that keep track of our balances and our transactions and make sure no dollar is spent twice.
Why the current system doesn’t work
The system is not flawless either, though. We trust a single central entity to keep track of our balances and transactions. This also means there’s one single place where an attacker can attack a lot of different individuals. If you compare this to cash, once you own it and physically have it in your pocket, someone would have to attack each and every one of us to get the cash from them and possibly apply force, whereas in a digital world an attack can also be easily copied and applied to many different accounts.
Also, if digital money is sitting on a single server it becomes very easy for someone with enough power to take it from us. So the system of different money as we have it today works well as long as we can trust that central entity and the system that governs it. But if we don’t trust that system and potentially the people behind it, it becomes very fragile.
1) Transaction fees
And there’s another problem with banks and these central entities which is that they are most likely businesses so they charge a fee for their services. So every time we want to transfer money, they might charge anything from like a small percentage to quite a hefty sum for international transfers.
2) Office hours
Second, they have opening hours, so while I want to maybe send money tonight at 8 p.m. to somewhere in the US where it’s still daytime, my bank might already be closed and it might delay the transfer until the next workday.
The answer: Blockchain technology
So let’s recap what we want.
1) A currency that can be split into very small units so it’s both good for very small purchases and large purchases.
2) Something that’s easily transportable so that we can spend it either here in our local village or somewhere else on the globe for an international purchase.
3) Something that avoids double spending, meaning each and every unit of that currency can only be spent once and not be duplicated easily.
4) We don’t want any fees, we want something that is quick and cheap.
5) And last but not least, we want to trust a system and not a third party, so everything is transparent.
At least on paper blockchain promises to be the answer to all of the above and offer a solution.
How does it work?
In very simple terms this is what blockchain technology does: It takes the ledger that was previously stored at this third party central place and distributes it to everyone in the network. So now everyone in the network:
a) has a complete list of balances
b) a complete list of all transactions that happen in the network.
Now everyone has a copy but how do we update this? I think this is exactly where the innovation of the blockchain comes from. What we want to do is randomly pick one person amongst our group that is then tasked with updating the balance sheet with all the latest transactions since the last update and then redistribute that copy amongst everyone else.
Because there’s a bit of work involved we also want to reward that person. In Bitcoin, for example, we pay them one Bitcoin to do this task. Pack all transactions into the shift update it and then send it out to everyone.
Another simple question with a not-so-simple answer
Now what the blockchain does is it allows us to pick this random person from our group. Think about this. This is another thing that sounds very simple but actually isn’t. How would we randomly pick someone from our group of let’s say, 20 people? You may come up with things like rolling dice with 20 sides and whichever side is up is selected. But that doesn’t work because of who rolls the dice. Whoever would roll the dice in that scenario has control over the outcome.
We could add up our birthdays and just count – wherever we stop that person is the random person. But that’s not random, it’s completely deterministic. If I know everyone’s birthday I know which person it’s going to be. A third option could be everyone yells out the number. We add all those numbers and then we go in circles until the sum is reached.
But if I hear everyone else yelling their number, I can just adjust mine. It may fall on a person that is favorable and maybe that would be me. So picking a random person from our group is actually a very sophisticated task and not easy at all.
And that’s where the blockchain helps us. The term that we use for this is called consensus mechanism. It helps us pick one random person that then updates the sheet. In Bitcoin, that’s done through a riddle. Without going into specifics, you can imagine it as every one of us is handed out a Rubik’s Cube. We all start solving it at the exact same moment. Then we work on it until the first person has the solution and yells “Got it”.
The “Block” in Blockchain
The person that got the Rubik’s cube first is going to include how they solved it. They’re going to pack all the transactions and they’re going to create something that they call a block. That’s where the word of block and blockchain comes from.
They’re going to create a block which essentially is a new version of the ledger or the excel sheet. They’ve now updated it and they’re going to send this out to everyone else.
Because we want to thank them for putting all the energy into solving the riddle, we pay them a reward. This is one Bitcoin on the Bitcoin network. Once this is done, everyone gets a new cube and the whole thing starts all over. Everyone starts solving again until someone is quick enough to solve it first. They get a reward, update the sheet, distribute it to everyone and we all start solving the Rubik’s cube again.
And this is why I think we need blockchain technology. It enables us to trust a system instead of a third party or a person. We call these “trustless systems” because we can witness everything transparently and verify ourselves if things are done right. If you only take one thing away from this video, then please remember that the blockchain technology enables us to trust a completely transparent system instead of having to trust a group of people or a person or any third party.