Bitcoin & Blockchain Baby Steps
Before getting into the Blockchain Explainer videos, audios and posts, I thought it would be helpful to take some baby steps first by oversimplifying Bitcoin and Blockchain, or, cypto-assets, crypto-economies/token-economies, and distributed ledger technologies.
Crypto Assets, or, Tokens
First, let’s take one baby step back and define “money”, as we know it today.
Paper money or coins of little or no intrinsic value in themselves and not convertible into gold or silver, but made legal tender by fiat (order) of the government. Fiat money is an intrinsically worthless object, such as paper money, that is deemed to be money by law.
Fiat Money Definition from Financial Times Lexicon
Imagine scanning one piece of fiat money into a PDF, or, image file on your computer & emailing it to two, or, more people as payment. That would be like creating your own digital asset and double spending it. That’s a problem.
A cryptocurrency (or crypto currency) is a digital asset designed to work as a medium of exchange using cryptography to secure the transactions and to control the creation of additional units of the currency.
Cryptocurrency – Wikipedia
Crypto assets are digital assets secured using cryptographic technologies, that among other benefits, prevents double spending. They’re also known as digital currency, cryptocurrency, crypto-tokens, or, simply tokens. Bitcoin is the most commonly known crypto-currency.
As an analogy, think of an air travel, or, other loyalty rewards program. The points you earn are like digital assets, or, tokens. While not secured by cryptography, they’re secured by a central authority – the organization providing the loyalty program service.
Crypto-economies, or, Token Economies
The viability of a crypto-asset is based on its ability to bring value to the network it operates in, or, its crypto-economy. So crypto-asset is a fiat money like a crypto-economy is a government’s economy.
However, by definition, fiat money’s existence & value is based on a central authority – its government. A crypto-asset’s existence & value is based on a decentralized free market – its crypto-economy.
A crypt-asset’s, or, token’s liquidity can be determined by its acceptance in other networks, or, whether it can be exchanged for other tokens, even “real” government issued currency – fiat. The greater the token’s liquidity, the less risk there is in holding it, the greater its demand and networks’ valuation.
The air travel rewards program is like a token-economy, where the points are tokens that can be earned & spent within its network. The network’s valuation is based on its tokens’ supply and demand. There’s no value in accumulating a lot of points if the rewards are limited, or, not worth the trouble trying to redeem them.
But an air travel rewards program could add value to its network if its central authority could strike a deal with another network’s central authority, or, even a fiat money’s government. That may be a challenge.
Ledgers
A Ledger
At the root of Distributed Ledger Technologies is a ledger – a list of transaction much like a typical bank statement. Money comes in, and money goes out. If you want to keep track of your transactions to make sure there are no surprises, then depending on your age, you could use your checkbook or a spreadsheet.
Think of a spreadsheet like a poor man’s database. There are columns (fields) like date, check number, payer, payee, description, and the amount paid. There are rows (records) that you use to record money coming in and money going out.
Imagine you have a spreadsheet saved on your computer that you use to manage your travel rewards program. Every time a member earns points, you add a row to your spreadsheet. Every time a member redeems points you add a row to your spreadsheet. You are the central authority of the spreadsheet.
A Distributed Ledger
If you want to keep your records safe (not necessarily secure), then you could keep the original on your computer and store copies on other computers. Every time you add a new row to one copy, you then have to add the same row to the others. Your records, or, database is now distributed and always up-to-date.
Now your boss walks in and tells you a deal was made with another rewards program and you have to share your spreadsheet with the other program’s central authority.
Unless one of you central authorities have agreed upon a process you’re going to have a pretty tough time figuring who made the most recent, valid updates.
Alternatively, you both could delegate your central authority to an entity like Google and let their cloud technology manage the security and validity of the spreadsheet. By today’s standards, that’s pretty good – until there’s breach in their security, or, a bug in their software. Not likely, but then again that’s what we thought about Yahoo! and Equifax.
Distributed Ledger Technologies
Distributed Ledger Technologies use cryptography to enable the secure transfer of stored value of digital assets across all computers in a network. A digital asset may be a song, an e-book, a will, a title of ownership, or, even a Bitcoin. Blockchain is a type of Distributed Ledger Technology that securely transfers Bitcoin, a type of token, digital/crypto asset.
The cryptography is like a game played by the network’s computers to reach consensus the contents of records are valid. Once consensus is reached, then copies are made across all the computers. This is why all the data can be trusted.
There are many Distributed Ledger Technologies, some are private, some are public. One getting much attention of late is Ethereum. Ethereum allows developers to write the business logic, or, Smart Contracts to control the transfer of the stored value – not just Bitcoins.
So let’s go back to that spreadsheet on your computer. This time, you’re going to use cryptography to lock it with a key and share it with every computer in the two reward program’s network. And everytime someone, not just the two central authorities, wants to add a row to that spreadsheet, there’ll be a contest among all the computers owners to confirm the contents of that row are legit.
They can’t see the contents, that’s where the cryptography comes in. The first person to confirm the contents are valid shares the secret to how they did it with the others. They, in turn, verify the secret works, or, reach a consensus and then make a copy of the new spreadsheet row in their computer’s copy. The winner receives a reward for their time and energy, and the others receive consolation prizes for theirs. However, if consensus, is not reached, then the “winner” is penalized.
That spreadsheet now resembles a distributed ledger and the prizes are in the form of crypto-assets. The decentralized consensus mechanism ensures everyone remains honest and is what ultimately replaces the central authorities.
Smart Contracts are executed, or, run on the decentralized network – not a central authority’s like Google, or, your company’s server. One of its advantages is that Smart Contracts and the data they contain can only be attacked, or, fail if every computer on the network is attacked or fails. Think of the entire Internet going down.
A Decentralized Autonomous Organization (DAO), runs distributed applications (dApps) enforcing Smart Contracts, within its own crypto-economy rewarding and paying in crypto-assets.
The multiple centralized rewards programs could be replaced by a Decentralized Autonomous Organization. The disintermediation, or, “bringing the ends of a transaction together” would greatly reduce the costs and complexities of trying to run their centralized versions, and certainly their integration.
The beauty of the technology is that anyone with a computer connected to the Internet can participate, even the old central authorities.
Reality Check
We’re not there yet. We are, as it’s been said in the “dial-up days of blockchain”. But we measure things now in Internet Time. So it’s not good enough to wait and see. In it’s simplest form, Blockchain is a digital distributed ledger. That means that organizations need to digitize and automate the right processes and start building for these technologies. Because the right token economy will gain the fastest network adoption, meaning if you’re a follower, then barrier for entry is going to be pretty tough to get over.
Next Steps
Check out my collection of Blockchain Explainer videos, audios and posts.