Advantages and Challenges of the Blockchain Technology (1/2)

Despite influential developments at the intersection of technology and business, the general public remains skeptical regarding the acceptance of the blockchain technology and its implementation in everyday life. While the exact reasons for this may only be determinable in hindsight, a common notion amongst finance professionals and many bankers alike is the lack of understanding of the value added by block chains – and more fundamentally, what they in fact are.

Decentralisation is the key-word of the blockchain technology; this is what differentiates a block chain from a conventional database. Instead of storing data in one centralised point, for instance in one large group of servers, it is distributed across its peer-to-peer network, and thus – given its ongoing use – is continuously expanding the block chain similar to a living and growing organism. Block chain’s main area of application is as a data structure that safes immutably transactional records in a transparent and decentralised manner. The blockchain technology itself is not unalterable.

What gives it its name is the fact that these transactional records are stored in the forms of blocks of a certain size. However, a company deciding that a specific product requires a decentralised network to live up to its potential, can determine the storage size of these blocks itself. Thus, depending on the expected amount of traffic in that network, the designers and programmers of the block chain will calculate the optimal size of a block as well as they can in order to ensure a smooth-running operation. Not every bit of information that enters the system is accurate. Therefore, there are several different so-called consensus algorithms in place that organise the way the participants of the block chain reach an agreement over the correctness of data and aim to eliminate fraudulent activity.

The more active users there are contributing to such a system, the more decentralised the process becomes, and the more efficient. The oldest and most prominent application of the blockchain technology is that of the Bitcoin transfer system. Here, person X wishes to send money to their friend Y. However, since banks and other third parties charge a hefty fee for these transferrals – as it is their business model – person X rather decides to buy bitcoins and sends those to the Bitcoin account of their friend Y. Y subsequently exchanges those Bitcoins for fiat money, the money humans consider “real”.

The advantages of this approach are that the fees are incomparably cheaper. Just this week, a user moved 40,000 bitcoin tokens, in total worth almost $212 million, from his account to another one. This took about ten minutes and costed the user three dollars 93 cents. The average service provider charges 0.7% and more, which in the here presented ideal case would be $1,484,000 million. This is enabled by cutting out these profit-oriented third parties. As explained in our article on the mining of Bitcoins and the concomitant energy consumption, the validation of transfers is done by so called miners. Those are individuals or companies offering their computing power and are remunerated in Bitcoins – 12.5 of those worth about $74,000 in early May 2019 – for every created “block” of verified data.

The more participating computers, or “nodes”, there are, the more “trustless” can the system and blockchain based product be. The difficult aspect for companies with an interest in implementing blockchain technology is to create a product so good that the creation of a new cryptocurrency token to remunerate the entities serving as nodes seems attractive, and holding these tokens becomes reasonable as, over time, the product finds so many users that the relative price of the cryptocurrency increases.

Naturally, when using terms such as “trustless”, the main target audience is that with a background in computer science and formal training, since the average person still needs to trust all of the programmers and business developers of this entire system. We still need to trust these people to understand their responsibility and have only the best intentions, which seems like a lot of trust indeed. A way to change this is either through education or through the creation of a clear user interface which can be seen as a gate of communication between the logical-mathematical world of written code and the actual users interacting with the product.

In the second part, we will have a closer look at the challenges and mistakes made by firms that have created their own cryptocurrency.

Author: Patrick Lehner