(Any views expressed in the below are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.)
Last month we jumped right into the deep end with NFT’s, this month, let’s get back to the basics.
What is a blockchain?
The problem: To understand what a blockchain is we must first understand the problem it solves. For years, in order to transfer anything valuable we have depended upon third party intermediaries to act as a medium between us and the party we want to exchange value with. Why? Simply put, trust. Intermediaries prevent the need for us to place trust in another party. The presence of a third-party to establish trust is not necessarily a bad thing. However, intermediaries often create inefficiencies, add cost, and create a single point of failure, each of which can be undesirable. Blockchain technology seeks to solve the problem of trust between parties and remove the need for central intermediaries.
But how does this work in practice? For a Blockchain to be effective there must be enough people who would like not to depend on a third party. For a Blockchain to operate you need at least three people participating in the exchange of value with one another. To help crystalize how a Blockchain works, let's walk through a very simplified example:
For our example, we will assume five individuals want to give up on banks (yes, this is becoming possible via decentralized finance, more on that in the coming months). Upon mutual agreement, they have details of each other's accounts all the time - without knowing the other's identity. Each of the five parties has an empty folder and a sheet of paper with nothing on it. They will write down any transaction that occurs in the system.
Now, individual #1 wants to send $10 to individual #5, individual #1 shouts to everyone in the group "I want to transfer $10 to #5. So, everyone please make note on your papers." Next, everyone checks whether #1 has enough balance to transfer $10 to #5. If she has enough balance, everyone then makes a note of the transaction on their blank pages.
Transactions continue happening and the above exercise continues until everyone runs out of space on the current page. Let's assume the page has space for 10 transactions. Now that everyone has run out of space on their page (note all pages have recorded the same set of 10 transactions), the group seals the page in their folders with a unique key. Everyone in the group agrees upon the unique key and by sealing it we will make sure that no one can make any changes to the sheet once its copies have been put away in everyone’s folder — not today, not tomorrow and not even after a year. Once in the folder, it will always stay in the folder — sealed.
This is effectively how a Blockchain works. A Blockchain is a secure transaction ledger database (the sheet of paper stored in the folder in our example) that is shared by parties participating in an established, distributed network (most commonly a distributed network of computers, not individuals with folders 😊).
As the folder in our example, the Blockchain records and stores every transaction that occurred in the network. Our example is a bit oversimplified to in effort to break a Blockchain down to its root components. If you are not interested in the technical details of how this works, I’ve detailed the key technical properties that make Blockchains unique here. If you are more of a visual learner, this is a great 20 min visual explainer of Blockchain technology. Lastly, if you learn best by listening, this is a great podcast from Chris Dixon, a Partner at a16z.
Why does any of this matter?
A blockchain is a virtual computer that sits on top of a network of decentralized computers (miners / validators) that can make commitments. The commitments of a blockchain are merely programmable computer code that is accessible to everyone. For the first time, a computer system can run autonomously, self-governed by its own code, instead of by people, so does not rely on the “trustworthiness” of individual participants, organizations or governments.
Trust is generated from the consensus process itself rather than centralized parties. Autonomous computers can be relied on and trusted in ways that human-governed computers can’t. The first and most prominent use case of blockchain technology is Store of Value, made famous by Bitcoin, as a form of digital currency.
Aside from Bitcoin, and other cryptocurrency's, what are other use cases for blockchain technology?
Physical asset ownership:
Land / Property title - would allow everyone to have access to a decentralized source of record saying who owns a given parcel of land or property
Cars, art, musical instruments, etc
Gaming / virtual worlds - allows for the purchase of in game virtual goods, with the blockchain serving as the ownership repository
Supply chain - Corporations like Walmart and Nestlé are partnering with IBM to improve food sourcing and tracking. By creating hard to alter records of where each food item is sourced and processed in near real-time, retailers are hoping to be able to isolate and respond to foodborne outbreaks much more quickly than is typically possible
Voting - Just as blockchain can be used to securely source and track goods and services, some are looking to use the tech to securely track election ballots. States like West Virginia and Utah have started using blockchain apps to help overseas troops cast absentee ballots
What are the tradeoffs inherent in using blockchain technology vs a centralized system?
Scalability, performance, user experience - For a blockchain to work lots of participants need to hold up-to-date copies. This means that the same database is held by thousands of computers, a fairly inefficient process
Who did what this month?
Coinbase, the largest cryptocurrency exchange in the US, IPO’d via direct listing on NASDQ https://bit.ly/3e8lhok
Top Wallstreet banks to offer crypto to wealth clients:
JPMorgan Chase is preparing to offer an actively managed bitcoin fund to certain clients, becoming the latest, largest and – if its CEO’s well-documented distaste for bitcoin is any indication – unlikeliest U.S. mega-bank to embrace crypto as an asset class.https://bit.ly/3nzuKIy
Goldman Sachs is offering its private wealth management (PWM) clients. https://bit.ly/3t6WPbp
Morgan Stanley is going a step further and actively planning to invest in crypto assets. The firm has presented filings to allow five of its mutual fund families to invest up to 25% of its total assets directly in bitcoin through cash-settled futures contracts and Grayscale’s bitcoin trust. https://bit.ly/333okrM
Chiefs Tight End Sean Culkin to Convert Entire NFL Salary Into Bitcoin: Kansas City Chiefs player Sean Culkin will take the entirety of his 2021 base salary – $920,000 – in bitcoin. https://bit.ly/3e3yO0G
SEC Punts Long-Awaited Bitcoin ETF Decision to at Least June: The U.S. Securities and Exchange Commission said in a filing that the agency is pushing its decision on whether to “approve, disapprove or institute proceedings to determine whether to disapprove” the structure to June 17. The delay comes a day before the SEC was due to rule on an application from VanEck Associates Corp., one of at least 11 issuers weighing a Bitcoin ETF. https://bloom.bg/3vvI6YZ