Blockchain technology appears poised to turn the online economy on its head. What is it all about?
Contracts concluding themselves as if by magic, transactions between strangers without a middleman and databases which cannot be manipulated: blockchain, the Swiss army knife of digital tools, can do it all. The influential consultant Don Tapscott has hailed it as the greatest technical development in a generation; others have compared its significance to the creation of the World Wide Web itself. And a group of experts from the World Economic Forum has predicted that in 2027, as much of 10 percent of global GDP will be handled using the technology. It doesn’t get much bigger than that.
The hype around blockchain only really took off this year, but the technology is already eight years old. The idea was first posited in late 2008. Shortly after the end of the last great world economic crisis, a developer or developers under the pseudonym Satoshi Nakamoto laid the technical foundations for Bitcoin. This crypto-currency permits peer-to-peer-based payments and should thereby render banks unnecessary. Nothing came of this vision, but Nakamoto’s invention is piquing people’s interest again, and more than it did before.
The great repurposing
It turned out that the technology behind Bitcoin, called blockchain, can be repurposed for use in a wide variety of contexts. Put simply, blockchain is a huge accounting ledger, which meticulously records every transaction and displays it forever. This database is decentralized. It is to be found on all computers where free Bitcoin software has been downloaded and it regularly synchronizes itself. All transactions are saved in data-blocks, which are linked with each other in chronological order.
This is how it works: If Katarina wants to send Lisa a Bitcoin from her digital purse, she pings off an order on the Bitcoin crowd computer. A subset of the computer checks the validity of the planned transfer: does this particular coin really belong to Katarina and has she already spent it? If all goes well, the transfer is accomplished. The sum is credited to Lisa’s wallet. Together with all the other transactions in the last ten minutes, the process is saved in a digital block. Then the block is added to the chain that has been built up so far. This is the blockchain, which is regularly extended in ten-minute intervals, as there is always another transaction block being added to the great database.
Money transfer and smart contracts
Further use of blockchain would see Bitcoin reduced to a mere exchange currency. That would involve an economically unimportant part of a coin being transferred—and its metadata is then used to record what it really is about. It could be recorded, for example, that a particular security had changed hands, or a patent or even ownership of a plot of land. Such transactions would be saved in the virtually impossible to manipulate blockchain database and would remain permanently available for consultation.
In addition, a piece of programming code can be built into a blockchain transaction that encodes an “if-then” condition. This is the basis of a new kind of contract, called “smart contracts”. As soon as the blockchain crowd receives multiple confirmations that a contractual condition has been fulfilled, then the contractually agreed-upon consequence will follow. Consultant Shermin Voshmgir (see interview) uses a simple scenario to illustrate the mechanism: the lending-out of a lawnmower, which is itself connected to the internet of things. The contract conditions are set out in a smart contract. The start and end points of the loan are recorded by blockchain. After the return of the mower, the appropriate loan fee is calculated and the crowd transfers the money from the neighbour’s wallet to the owner of the borrowed lawnmower. Voshmgir sees blockchain as a decentralized global computer which can do away with the existing structure of central platforms and databases.
The example illustrates blockchain’s greatest potential: it permits direct transactions between two people without the need for a central mediator. In the case of the lawnmower, no sharing platform is required, and the loan fee is handled reliably. The confidence which for many transactions is supplied by middlemen like banks, trading platforms or dealerships is generated here by the crowd. This means that transactions could not only become more direct, but also faster and cheaper. Numerous sectors of industry and society are rife with potential applications for a repurposed and adapted blockchain technology.
Banking goes blockchain
Paradoxically, it is the banks themselves who are currently most proactive in embracing blockchain. The bank Santander has estimated that the sector could save up to 20 billion US-Dollar a year in infrastructure costs. Transactions, whether they involve currencies, financial products or securities, must often “clear” as many as half-a-dozen intermediary stages, which process, check and document the transaction, before they are concluded. Traditional, centralized transaction mediation is thus slow and expensive. With blockchain, these middle steps disappear, rendering the sector faster, more innovative and above all, if staff could be replaced by the blockchain, more profitable.
All major financial institutions are currently researching the potential of blockchain. Meanwhile, the New York company R3Cev is developing, as a joint venture of the financial giants, common standards for a blockchain-based financial transaction system. This startup is supported by players such as Deutsche Bank, UBS and Goldman Sachs. If these developments continue apace, the boundless public Bitcoin-blockchain, will give way to a private blockchain variant with a closed circle of participants.
Contract processing and administration via blockchain
The disruptive power of the blockchain looks poised to impact another established sector: if agreements are automatically concluded via smart contracts, that could render lawyers redundant in various settings. They will not be needed to implement contracts anymore as contractual conditions will be documented over blockchain, and there is no longer any need to engage them to organize payment of contractual monies because the money is sent automatically.
A simple scenario is offered by the New York startup Smartcontract.com, whereby blockchain contracts can be set up at the click of a mouse. For a search engine optimization contract, a website operator names the domain which is to be optimized, a Google country domain (like google.com or google.de), a search term (for example, “Buy mobile phone online”) and the desired position in the results list. If the SEO agency takes on the contract and manages to bring the website up to the desired place, the agreed-upon sum is released.
This means that there are suddenly many scenarios for politics and administration in which official duties can be entrusted to blockchain. In Honduras, experiments are underway in decentralising the state-held land registry via blockchain, so that the size and nature of the network can prevent manipulation. The startup FollowMyVote proposes to disrupt an even more sensitive operation: voting by blockchain. Every voter can cast their vote using a cryptographic key and can then check whether their vote was counted correctly.
There are ideas for many other sectors, too: like an automated crop insurance policy, in which blockchain registers losses using climate data and insures premiums. The startup Ujomusic wants to create a global database of music rights which is built on blockchain, in which all music titles are marked with licensing-relevant metadata. And Slock.it, headquartered in Mittweida in Saxony, is building a smart lock with a blockchain connection which would permit properties, homes or bikes to be loaned out without any intermediary sharing platforms. They are not using the original Bitcoin-blockchain, but the alternative Ethereum, which is much more appropriate for smart contracts because it is easier to program.
A technology in its infancy
Entrepreneurs and investors in blockchain startups like to promise the total disruption of the internet economy or even all of society. But a closer look shows that at this stage we can really only speculate as to the real consequences. Often, concrete blockchain concepts are, at best, in an isolated test phase, and others exist only as visionary white papers.
Furthermore, there are many questions which remain fundamentally unanswered. They relate to security. The decentralized technology is said to be impossible to manipulate. The network architecture can also withstand attempts by individual participants to cheat. In order to retrospectively change a single transaction node, the majority of the network has to agree. But a so-called 51-percent-attack is theoretically possible. If more than half of the network nodes were controlled by fraudsters, the manipulated version would appear to be the valid one. The Bitcoin network, at least, is so big that such a hostile takeover is extremely unlikely. But on alternative blockchains at least, which are either mere clones or ambitious further developments, this safety-in-numbers effect is not quite as substantial.
And all scenarios which relate to regulated sectors have to receive state recognition. The state has to lend blockchain solutions the authority to document, for example, land ownership. And smart contracts would need a legislative framework for all automated contractual businesses so that they could operate in a legally safe manner, regardless of how clever the technology underlying them.
“Smart contracts” execute themselves, by recording an “if-then” logic in the metadata of a given transaction. If condition A is met (e.g. by activating a door lock), then action B is executed automatically (a payment). This is the same procedure by which the purchase of a song might be automated, only much more complex. For example, in international trade, partial payments could be made dependent upon
Public and private blockchain
The Bitcoin or Ethereum blockchain can be seen by anyone, and everyone can access it and validate transactions. That is what protects it against manipulation. Some businesses are experimenting with private blockchains, in which only authorized participants can see, activate and validate transactions. The banking startup R3Cev is planning such a system. The community is divided on whether such a model makes sense, as it would not make use of the real breakthrough in blockchain: maximum transparency and decentralization.
Bitcoin blockchain and alternatives
The Bitcoin blockchain was the first, but since then different technological variants have arisen. The use of the classic model saves resources and is comfortable, but the scope for design is limited. A blockchain variant offers maximum freedom, but is expensive to maintain. The most popular alt-chain is currently Swiss provider Ethereum, which permits a diverse range of smart contracts.