Blockchain and Bitcoin for Digital Marketers

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Overview

Bitcoin is a cryptocurrency, or secure digital medium for exchange that was created mysteriously in 2009 and quickly rose to global fame. The technology behind Bitcoin is called blockchain. Blockchain is an open-source, decentralized, and secure protocol often referred to as “the trust protocol”. With over $1 billion in venture capital invested over the last five years, many people think that blockchain has amazing potential in nearly every industry. As such, blockchain technology has been applied to numerous industries outside of its origin of cryptocurrencies including supply chain, copyright, smart-contracts, identity management, healthcare, and many more.

My goal is to discuss blockchain but, to start off, I am going to cover Bitcoin because it is a good metaphor to help explain the technology behind it, which is blockchain. If you want to understand the relationship between Bitcoin and blockchain just think of what email is to the Internet. Email simply leverages the technology of the Internet, but the Internet is actually capable of doing a whole lot more. Bitcoin is the first major implementation of Blockchain so, as a result, the two words have become intertwined when used in common vernacular. But make no mistake, Bitcoin and blockchain are not the same. By the end of this, you’ll know the difference.

What is Bitcoin?

To put it simply, Bitcoin is a currency or cryptocurrency to be specific. It is a currency because it is a medium of exchange, just like a dollar or euro. At today’s exchange rate one Bitcoin is worth $2578.53. It’s a cryptocurrency because encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds. And, as a nice bonus, this one happens to operate independently of a central bank, which is really important.

Trusted 3rd Parties and Double Spending

Throughout the 1990’s many people and groups of people attempted to implement a digital equivalent of cash. Unfortunately, many of them failed. One of the prevailing issues was what’s known as the “double spend problem”. In the real world when someone buys something they hand over cash in exchange for goods. That cash is no longer in your wallet or purse, but now exists in the cash register of the vendor you purchased goods from. In order to spend that same dollar again at another store, you’d have to first steal the dollar back. This isn’t easy to do, and it’s even harder to get away with.

In the digital world, it’s actually quite easy to copy digital files. If you take a picture, for instance, and copy-and-paste it, you now have two pictures. One picture becomes indistinguishable from the second. So if we were to play a brain game where you imagine having a digital image of a dollar that you can actually spend, you can begin to see the inherent risk of digital currencies. Simply copying that dollar would allow you to spend it two, three, or hundreds of times. This is called the Double Spend problem.

But what about credit cards, PayPal, and other online transactions? Aren’t they digital currency? Actually, no. Just because something has been adapted for online use does not make it digital. These currencies are still what’s known as a central authority, or trusted third-party.

The way trusted third parties work is that an entity, usually a bank, facilitates interactions between two parties who both trust the third party. So if I want to buy something online, for instance, I do not actually give funds to the seller. I give funds to the third party and they verify the transaction. This is usually done because I have a bank account or line of credit with the third party. Once verified, the third party signals to the seller that the funds are there, the transaction is valid, and they may release the goods. Since the seller also trusts the third party they ship my item and we’re all happy.

Problems with the current model

Authorize, batch, clear, fund, shave a little off the top, repeat.

Unfortunately, there are a couple of problems with this model. The first is that although your transaction is quite quick that’s not the end of the story. It only seems as though your swipe of the credit card gave instant approval or that your Amazon checkout experience took less than a minute. The reality is you’re only seeing the first step, which is called authorization. The authorization process only confirms that the buyer has enough funds or credit, to complete a transaction. This reduces the risk to the merchant of handing over goods for which the buyer can’t pay.

There are actually lots of steps after authorization, and they take several days or more to complete. They’re called batching, clearing, and funding. To sum it up quickly, this is where all the day’s transactions are gathered and sent, payment is requested from the issuer (ex: Visa or Amex), and funds are deducted from the payer's account. In the case of a credit card, a statement is then sent every month to the user where you eventually start the process over again by transferring funds from a bank.

Believe it or not, the version I just presented is actually quite simplified. In reality, there are a few more players to consider. Overall it’s quite complex and often accompanied by fees. These fees can include interchange fees, transaction fees, franchise fees, discount fees, and probably a few more. All-in, these fees can add up to over 3.5% if it’s a domestic transaction and more than double that if it’s an international transaction.

Centralized Authority

Another consideration is the central authority model. In this model, there is a single central authority figure that controls the communication and access to resources on the network. This central authority is responsible for transaction management and the issuing of money. Historically this model was very good because, to be blunt, we didn’t trust each other. Introducing a central authority and trusty third party meant we didn’t have to in order to do business. This also meant that a well-funded central authority could build and implement infrastructure. So for a long time, the central authority model has worked very well.

Unfortunately, there are also some downsides to the central authority model. First, there is a single point of failure. This means that hackers know where to look if they want to steal your information. Or, in the case of governmental intervention, can be simply taken away or frozen.

This also means that if the central authority does something shady or makes some bad decisions, there’s very little you can do about it. The entire basis for the central authority is tracking and validating transactions. Those transactions can be faked (think embezzlement or the second hidden “real” ledger we see in mobster movies and the Shawshank Redemption) when there is only a single, central authority.

Further, this model means that the central authority has access to all your personal information, purchase history, and more, and can do with it as they please. In many cases, this information (think name, address, and phone number) is supplied to the seller. In extreme cases, this information is aggregated and sold or rented for marketing, research, or other purposes.

And last, but certainly not least, we sometimes take it for granted that we have access to things like banks where our money is safe and insured. But that is certainly not always the case on a global scale. It may seem obvious when I say it, but the central authority model requires that you do business with the central authority. In the case of finance, this will mean that you need to have a bank account, which is simply not an option for everyone. In fact, people of many countries neither trust their banks or their government as assets can be seized, land titles reallocated, and fiat currency devalued.

As I said, a good model, just a few downsides.

Fiat Currency

From Investopedia.com, fiat money is currency that a government has declared to be legal tender, or official medium of payment. Fiat money is not backed by a physical commodity like gold or silver. Instead, the value of fiat money is derived from the relationship between supply and demand, or trust and credit, rather than the value of the material that the money is made of.

On a global scale, this can be quite unnerving to some. A fiat-money currency greatly loses its value should the issuing government or central bank either lose the ability to, or refuse to, further guarantee its value. The usual consequence is hyperinflation, or a rapid loss in the real value of the currency (think $1000 for a loaf of bread). Some examples where this has occurred are the Zimbabwean dollar, China in 1945 and the Mark in the Weimar Republic in 1923. More recently Venezuelan inflation could go as high as 1600%. As a result, more than 85,000 people have begun switching to bitcoin in just two years.

Let’s talk Blockchain

By now you may have noticed that I’ve spent a lot of time talking about Bitcoin when I should be talking about blockchain. There’s a very good reason for this – Bitcoin is the original and most famous implementation of blockchain technology. So to understand the complexities and value of the blockchain, it helps a lot if you understand the complexities and value of Bitcoin first. In my research, this is a pretty standard approach to learning. Unfortunately, as a result of this approach, most people probably do not realize that blockchain and Bitcoin are not the same things. So let’s talk blockchain for a bit.

The short version is that bitcoin is a cryptocurrency while blockchain is an open-source, decentralized, and secure public ledger protocol. What do all those words mean? Let’s break it down and take a look:

Open-Source:

I’ll start with open-source, because that’s an easy one. Open-source software is software whose source code is developed collaboratively by independent contributors in a public manner. The license for open-source provides the copyright rights to study, change, and distribute the software to anyone for any purpose. There are many benefits to open-source development, which I won’t get into here. Blockchain being open-source means that it is created and maintained openly by a community of people and is available at no cost. In short, it’s free.

Given this, we can evolve the short definition blockchain to include a more descriptive definition of open-source. A longer definition of blockchain then becomes: a decentralized and secure public ledger protocol that is created and maintained openly by a community of people and is available at no cost.

Protocol:

In its simplest form a protocol, within the computing sense of the word, is a set of rules governing the exchange or transmission of data between computers or devices. Essentially these rules govern how to start the “conversation”, in what order the conversation takes place and how, and eventually how to end the conversation.

There are actually a lot of different protocols, some of which may be familiar to you. HTTP, as we’ve all typed into a web-browser at some point is the Hypertext Transfer Protocol. HTTP makes the internet as you know it work. Computers use HTTP to send and receive webpages.

Another familiar protocol is the Simple Mail Transfer Protocol, or SMTP. Just like the acronym states, SMTP is used for transferring e-mail. FTP, or File Transfer Protocol, is another protocol used for showing and copying files between devices.

I could go on, but I think you get the point that protocols are very common. Given the above explanation, we can expand the short definition of blockchain to be: a decentralized and secure public ledger, which sets forth rules governing the exchange of data between computers, that is created and maintained openly by a community of people and is available at no cost.

Ledger:

The non-digital form of a ledger is very basic, and digital isn’t that much more complex in principle. The simple idea is that a ledger is a record and total of transactions. That’s it. Traditionally ledgers have their roots in finance handling the debits and credits of economic transactions, but they don’t have to.

The reality is that, in today’s integrated global economy, transactions take place in many types of marketplaces. Digital has connected producers, consumers, 3rd parties, intermediaries, and many other market stakeholders. Each of these roles has an interest in some asset, physical or digital, and that interest can be transferred to someone else. The record of that transfer would be recorded in a ledger.

As such, any kind of asset transaction, physical or virtual, can be stored in the ledger. In fact, the Hyperledger project (hyperledger.org) is a collaborative effort to create a cross-industry blockchain including leaders in finance, banking, Internet of Things (IoT), supply chain, manufacturing, and more. Within blockchain, the ledger is the full history of whatever transaction is being stored. It could be the ownership of a digital music file, the rights to a piece of art, or the deed to some land. Bitcoin, as the most famous implementation, stores currency as a bank account would – debits and credits.

Again, I could go on, but I think basic ledgers are simple enough. Given the above explanation, we can again expand the short definition of blockchain to be: a decentralized and secure public record of transactions, which sets forth rules governing the exchange of data between computers, that is created and maintained openly by a community of people and is available at no cost.

Secure Public Ledger:

So now that you’re familiar with ledgers, let’s go a little deeper into what a secure public ledger is. The “public” part of “secure public ledger” is actually pretty simple. We call it public because it is open for all to see. It’s public.

The confusing part is considering that the ledger is both “public” and “secure”. To understand how that is possible we’ll have to discuss exactly what a blockchain is. To start off, blockchain is more than just the name, it’s also a description of the technology. Blockchains are just that, a chain of blocks of data that together make up the ledger.

To build on the ledger definition, a block is a group of transactions. If this were a physical ledger, as one would use in finance, we would consider each block a page within the ledger. Each page, or block, would then log in list form the multiple transactions in chronological order.

Here is how blocks work:

First, as we’ve discussed, transactions happen. Again, Bitcoin focuses on currency, but a blockchain can be adapted to fit any type of transaction. Then, every ten minutes or so, all the transactions that have occurred in the last ten minutes are gathered together and verified. The verification process is a bit complex, so I won’t get into it right now. Suffice to say the output is a timestamped “block” of transactions in chronological order. The new block is then linked to the last block. This linking of blocks together every ten minutes is what makes the “chain”. Thus, every ten minutes, a new block of verified transactions is added to the blockchain.

The chain structure itself is actually part of what keeps the Blockchain technology secure. By linking each block to the one that comes before it a hacker could no longer simply change a single transaction. To hack a transaction in the blockchain someone would have to hack the block it is stored in. To change a block, someone would also have to change the previous block it is linked to. But to hack the previous block one would have to hack the block that comes before that one, and so on. And thus to change any transaction someone would have to hack the block it is contained in and every block back to the beginning of the chain, all at once, without anyone noticing.

Given this new understanding of the block and chain technology that makes up the blockchain security, we actually do not need to update our simplified definition. What you have done is gained a better understanding of the definition of the blockchain itself, which remains: a decentralized and secure public record of transactions, which sets forth rules governing the exchange of data between computers, that is created and maintained openly by a community of people and is available at no cost.

Decentralized:

If the block and chain structure of a blockchain is not enough to secure it, there is also the decentralized or distributed nature of the blockchain. So what does distributed mean?

Let’s start with a metaphor. If you have a file, like an excel sheet, that you want to work on with someone else the current paradigm is one of multiple copies. First, you create an excel sheet and add your content. Then you save it to a drive or send it to someone. There, they either lock you out while they are editing, or make a copy, edit it, and send you the new version of the file. If you add more than two people editing this document, it begins to get complicated very quickly. Over time there are many copies and diverging changes within the document that gets very hard to track and integrate. There are many opportunities to update the wrong version and have to go back to merge the files later. After a short period of time, it may become confusing as to who has the latest or original version of the file. Ultimately things get confused, missed, and lost, which is not a great model.

In a collaborative model, everyone can update the document, all at the same time. There is one document that’s shared, and it’s public and instantaneous with its own history or version control. As I update the document and share it with you, you can immediately see my changes. As you begin to modify the document, I can immediately see your changes. If we add more people editing the document, we all see all of each other’s changes instantaneously.

Blockchains actually have very little to do with editing an excel document. But that story is a good metaphor to begin learning the benefits of a distributed architecture. As the technical definition goes, a distributed architecture has components of the model located on networked computers which communicate and coordinate their actions. These components interact with each other to achieve a common goal.

So, rather than the blockchain data being stored on one central computer, the data is stored on many computers, called member nodes, that all work together, or what is called peer-to-peer. Any time the blockchain is updated, all of the member nodes get a copy of it and have to agree on the content of the ledger. They do this by using some fancy cryptography called hashes and signatures, which I won’t get into right now. When all of the member nodes agree, this is called consensus.

A few good things happen as a result of the distributed architecture of the blockchain. First, the security of the blockchain is increased beyond the already complex chain nature. As I noted above to change one transaction someone would have to change all the blocks back to the beginning of the chain. The distributed architecture makes this difficult because someone would have to do this on all the computers that contain copies of the blockchain and participate in the consensus validation, which is not likely with today’s computing power.

The second benefit of the distributed architecture, if you think way back to the beginning, is the lack of a third party, or trusted authority as I called it, and all the benefits of time, cost, and security that come along with removing it from the process.

The long definition

When I started this section the simplified and short definition of a blockchain was an open-source, decentralized, and secure public ledger protocol. At the time that may have been confusing, or even intimidating. After breaking it down and defining the component parts, it’s actually not so bad. The longer definition now becomes:

“Blockchain: a set of code which sets forth rules governing the exchange of data between computers that is created and maintained openly by a community of people and is available at no cost, distributed and executed throughout many member computers rather than a central authority, whose purpose is to maintain a secure and public record of all transactions back to the first.”

Smart contracts

Blockchain has the power to remove intermediaries from transactions and thus streamline the process making it faster, more reliable, and less expensive to complete. Further, once the transactions are digitized they can actually be programmed. This is called “smart contracts”.

Per Wikipedia, smart contracts are computer protocols indented to facilitate, verify, or enforce the negotiation or performance of a contract such that many kinds of contractual clauses may be made partially or fully self-executing.[i]

What that means is the contract itself can execute the terms of the contract. This can work because, unlike static paper contracts, code and logic can actually be inserted into the contract itself. To simplify the idea of smart contracts think, “if this, then that.” If the order is delivered, then transfer the funds. If the song is downloaded, then split the profits six says at specific percentages. If a payment is made, renew the lease.

Of course, that’s the simple version of the smart contract. They can actually get quite complex. Think about uptime on a server or machine tolerance on a production line. Additional complexity can be added in a kind of stepped logic. A smart contract with an insurance agency could charge different rates for safe drivers. In healthcare insurance can be paid directly for medications and procedures, and as an added HIPAA bonus, only the pertinent information would need to be released.

Of course, not all contracts are right for smart contracts. In some cases, judgments are incorporated into the contract intentionally, and technology has not yet caught up to that. But the reality is that in the decade to come as infrastructure and business models adapt to allow for them, smart contracts will become a part of everyday life.

What this means for you: applying blockchain to your organization

For those of you not familiar, Gartner publishes several reports every year called The Gartner Hype Cycles. Per Gartner, the Gartner Hype Cycles provide a graphic representation of the maturity and adoption of technologies and applications, and how they are potentially relevant to solving real business problems and exploiting new opportunities.[ii] Each Hype Cycle drills down into five key phases of technology’s lifecycle called the Innovation Trigger, Peak of Inflated Expectations, Trough of Disillusionment, Slope of Enlightenment, and Plateau of Productivity.[iii] For a deep description of these check out the Gartner website.

In 2016 Gartner’s Hype Cycle for Emerging Technologies positioned Blockchain just at the top of the Peak of Inflated Expectations alongside Machine Learning, Connected Home, and Smart Robots. What this means is that blockchain and the programmable economy has a positive outlook in the longer term (by 2035). But in the shorter term (five to ten years), which is the focus of the Gartner Hype Cycles, there is still considerable misunderstanding.

What this means for you is that there is a ton of advantage to blockchain technology, which no one is denying. But until industry models and regulations catch up projects should be selected carefully.

Considerations for a blockchain project

Blockchain is a foundational technology, not a disruptive one. When considering if a project is right for blockchain there are several key factors to consider. Not only do you want to ensure successful delivery of the project, but you’ll also want to make sure that it will be used in an ongoing way and the implementation was architected appropriately for the objectives.

First, consider the properties of the blockchain vs. those that the project requires. Will it be an advantage to maintain all the transactions back to the beginning? If so, how important is it for them to be immutable. Is double spend a problem that needs addressing? Is anonymity key to the success of the project, or will the transactions benefit from anonymity in any way?

Next, consider distribution and disintermediation and if there is any need for it? Who will become the nodes, or transaction validators? As the transactions occur, would they benefit or will service be enhanced by the removal of a trusted third party? If the answer is yes, then those benefits should be listed out. Will transactions occur faster, be cheaper, or be more secure and reliable? And, in doing so, will the project benefit from having multiple readers and writers to the blockchain, with each having potentially different access to information?

And last, but certainly not least, consider the programmatic benefit of the contract or transaction. Think about how the project would benefit from instituting fixed and automated rules into the blockchain itself. Also consider if those rules require judgment or intervention of any kind, and how that would be integrated into the system.

Putting it all together

Bitcoin is a cryptocurrency, and Blockchain is the technology behind Bitcoin. Blockchain is a secure, distributed, peer-to-peer protocol that only releases the data pertinent to the transaction. Records on the blockchain cannot be altered, and the blockchain itself can be programmed.

The real power of the blockchain is in its nickname, “the trust protocol”. Blockchain is architected to remove intermediaries from transactions – all transactions. Bitcoin can remove banks, and smart-contracts can remove lawyers. Within healthcare, there are huge barriers due to interoperability and security challenges. Leveraging blockchain as a foundational access-control manager for health records addresses both of these concerns promoting the development of precision medicine, advancing medical research, giving patients more access and control over their data, and inviting them to be more accountable for their own health.[iv]

As the January-February 2017 issue of Harvard Business Review noted, blockchain is not a “disruptive” technology. There is no traditional incumbent model being attacked. Instead, blockchain is a foundational technology with the potential to create new economic and social systems. Change like that can take quite a long time to seep into existing infrastructure steadily over time, not immediate and suddenly.[v]

Sources:

[i] (Wikipedia, n.d.)

[ii] (Gartner, n.d.)

[iii] (Gartner, n.d.)

[iv] (Linn & Koo, 2016)

[v] (Iansiti & Lakhani, 2017)