Blockchain’s mysterious origin and promising future

The origin of Bitcoin sounds like the plot of a far-fetched thriller. It opens with a nine page whitepaper published by an anonymous scientist (or is it scientists?) under the pen name of Satoshi Nakamoto. The paper outlines in detail how to create an entirely new cryptocurrency based on a resilient distributed architecture and a sophisticated mathematical formula. This new currency allows complete strangers who don’t trust each other to exchange value in cyberspace separate from any existing monetary system.

Bitcoin and its elusive creator(s) has all the elements of a blockbuster. And while everyone focuses on the currency, I believe the underlying platform—blockchain—may have more lasting impact than Bitcoin itself. Though it is important to note that bitcoin in its current implementation with blockchain does have some key limitations:

One of the downsides of bitcoin is that, because it is not “fiat money” currency, it is subject to the law of supply and demand. This has resulted in massive shifts in the value of bitcoins. On Nov 20, 2012, one bitcoin was worth $12.00. A year later, the price had jumped to $1,145. At present, one bitcoin is worth $417.

Second, there is no safety net, for either merchants or consumers, when transactions take place. There are inherent benefits of the current trusted third-party model whereby payment networks, like Visa, and financial institutions provide a set of capabilities to back up every transaction like chargebacks and dispute resolution.

Third, there is the issue of scale and speed of transactions. There are currently 36 million bitcoin transactions a year, compared with almost 100 billion transactions processed on Visa’s network. A bigger drawback is that it takes an average of 10 minutes for a bitcoin transaction to be confirmed. This might work for large transactions like a house or car purchase, but not for everyday purchases like coffee or groceries.

Lastly, bitcoin is essentially like cash on the Internet. As a result, they are not conducive to certain financial services like prepaid or credit lines. So consumers using bitcoin can only transact with the stored values in their bitcoin wallets to pay for goods or services received.

Underneath all of this lies some very interesting technology and an architecture that is built to be very resilient and scalable – Blockchain. The Blockchain technology is essentially a public ledger that records every transaction between complete strangers. The official blockchain public site allows anyone to see these transactions in real time and review the key stats of the system, such as the number of blocks created, time between blocks, mining costs and most interestingly even the electricity consumed to mine bitcoins and the cost per transaction, which is currently $7.55.

Blockchain is a peer-to-peer network based on the concepts of distributed computing. The network in fact has minimal structure so anyone can become a node by downloading the open source software and connecting to the system. Any node can join and leave the network at will. It’s a system based on the underlying assumption that nobody can be trusted and there is no central authority: ledger maintenance is performed by the network nodes all running the same software. Network participants can validate transactions, add them to their copy of the ledger and then broadcast the updated ledger to other network participants.

The reward for doing this is the creation (mining) of bitcoins that the node receives. These nodes (also sometimes called miners) get paid 25 bitcoin every time they find, unlock, and verify a group of transactions thereby adding a new block to the chain. The effort involves complex algorithms and significant processing power to discover and verify the new blocks of bitcoin transactions.

Like gold, there is a finite number of bitcoins to be mined. Today, approximately 15.2 million “coins” are in circulation and the upper limit is 21 million. And like gold, the more coins that are mined, the harder it becomes to extract the remainder. The incentive for nodes to create and add blocks of transactions to the chain can also be funded with transaction fees. In the future, after the predetermined number of coins have entered circulation, the incentive will likely transition entirely to transaction fees.

To use conventional banking as an analogy, the chain is like a full history of banking transactions. Transactions are entered chronologically in the chain just like bank transactions. Every node has a copy of every transaction and its chronology since the beginning of time. Blocks, meanwhile, are like individual bank statements containing a finite set of transactions. Unlike a bank however, everyone knows about all transactions.

Despite some of the systemic drawbacks I noted earlier, blockchain technology does have some underlying characteristics that are worth exploring:

1. The topology of blockchain is based on a distributed architecture and reflects how computer systems are evolving. The same principles that power blockchain technology are being used in large data platforms that are built on “pessimistic design principles” with assumptions of failure at every component of the architecture. Nodes can leave or rejoin the network since the proof-of-work will verify what has happened in their absence. In theory, blockchain technology could assist in the innovation of technologies that manage digital asset (such as gift card value, stocks) and even commercial contracts and payments.
2. The pure security architecture of blockchain is very intriguing as well. All transactions begin with the broadcast message that specifies sender, receiver and amount. There is a special password that protects (encrypts) each message. This is done via a digital signature that uses mathematical algorithms and is different for every transaction even from the same sender. It is very clever in its design. In addition to the digital signature the cryptographic math used by nodes to confirm transactions is both unique and very interesting. For a new block of transactions to be created and added to the chain, the block must contain the answer to a math problem that is designed to become harder over time (using a cryptographic hash) so it always takes approx. 10 minutes. Any node can collect a set of unconfirmed transactions into a block, solve the math equation and broadcast it to the rest of the network as the next block in the chain. Both these techniques hold promise in the way we think about encryption and transaction confirmations.

In recent months, there has been speculation about how payment networks like Visa may apply the technology in payments processing. It’s simply too early to tell but we are studying blockchain, among several other emerging technologies, in our Visa Research group to determine if and how it can be used to benefit Visa, our clients, consumers and partners.

We have a long way to go before determining the use of blockchain technology in high scale and diverse payment transactions that need to be verified and settled in milliseconds. But we know one thing for sure, it will be a thought provoking and an interesting journey. At Visa we are always open-minded and analytical about any new technology and always eager to learn.

What do you think of blockchain technology and its potential beyond its current uses?