More than Money: Get the Gist on bitcoins, blockchains, & smart contracts
Proponents say Bitcoin will decentralize power away from banks and other institutions while distributing it across whole communities. If these promises hold true, Bitcoin will only be the beginning. Bitcoin’s related technologies, the blockchain (also known as a distributed ledger) and smart contracts, are primed to move beyond money to other real world applications. Eventually, these technologies could move automation straight up the corporate ladder to the executive level, making even CEOs redundant, with similar far future implications for public organizations.
In many ways these technologies are similar to the internet in the early 90s. They are too complicated for average consumers to understand, but developers and investors are flooding them with resources. Average consumers fail to understand how Bitcoin or any other virtual currency can be successful without any physical representation of the currency’s value, but banks handled $410 trillion (more than 5 times global GDP) in non-cash transactions in 2013. The following year in 2014, the banks earned $1.1 trillion of revenue from these non-cash transactions.
More concerning is the amount of money lost through bank fraud each year. In 2013, a total of $9 billion was lost just in card-not-present transactions which are performed via online hacks, telephone scams, or mail order cons. The total is expected to reach $19 billion by 2018. Many banks, 62% of those surveyed by Bank Info Security in 2014, say they often do not know about fraud until their customers inform them.
Cryptocurrency, blockchain and smart contract proponents promise that these technologies will offer more secure, more efficient, and less expensive services for financial transactions. If these technologies can reduce bank fraud, perhaps they can eventually protect against voter fraud, simplify medical record management, increase electric grid efficiency, and handle much more than just money.
What are bitcoins and cryptocurrencies?
Bitcoin has been a growing phenomenon since it was released as open source software in 2009. It is the most successful example to date of digital currency (virtual money which can be used to purchase physical goods such as real estate) and the first cryptocurrency (money that relies on encryption instead of the processes of central banks for creation and transferal). However, Bitcoin is not the only cryptocurrency, and several similar communities are popping up.
No cryptocurrency is currently backed by any centralized institution, and they are generated and governed electronically using algorithms that solve mathematical equations. They are controlled by a distributed community which anyone is capable of joining, and cryptocurrencies are produced electronically by individuals and businesses all over the world. The computer systems required for creating and validating them are growing ever more expensive even as the value of cryptocurrencies fluctuate.
What is a blockchain?
A blockchain is a public database of transactions that is similar to an Excel spreadsheet, but it is not owned or monitored by any single individual or organization. The ownership is instead distributed to the decentralized members of a disparate community (Bitcoin or otherwise).
Although Bitcoin’s blockchain can be anonymous regarding the real world people using an account, the account itself is public. A private key is assigned to the user of each unique account to allow for increased security over passwords. The most important part is that the blockchain is capable of securely identifying the online persona of the account holder operating it with the private key. Once the real world individual connects their real life identity via a credit card, fingerprint, or other unique identifier; the blockchain can securely identify who is using it. However, that means the anonymous nature that many value in the technology is then lost.
The blockchain also adds another level of security that many other online technologies do not have, consensus and permanence. The blockchain’s community must provide a majority consensus on every transaction and any other changes made on the blockchain. Since every update to the blockchain is incapable of being deleted, the blockchain allows for audits to be completed with increased trust.
What are smart contracts?
They are codes that allow an exchange once pre-set conditions are met (i.e. if this happens, then that happens). Smart contracts are largely what is driving the so-called Internet of ThingsFootnote 1. If a homeowner’s car is within 10km of home, then the lights turn on and the heating/ air conditioning is optimized. However, smart contracts can also act based on information provided in a blockchain to automate tasks.
The blockchain enables real world data management to function more like a computer with the automation of tedious tasks such as processing payments. If a borrower’s monthly payment adds up to the total of the mortgage, then the borrower is automatically registered as the full owner of the house. Smart contracts can automate escrow processes. If a bet is made, then the money is held by a third party account which the smart contract accesses to pay the winner. Derivatives and insurance are therefore obvious applications for automation via smart contracts.
What is a Decentralized Autonomous Organization (DAO)?
As the distributed model that the blockchain offers combines with the automation of smart contracts and other technologies, organizations may be capable of automating their operations and distributing their governance.
Even if the centralized company dissolves, the service would remain and function as normal since all of the systems and processes are distributed and autonomous. A sole proprietor could more easily run a multimillion dollar service.
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