Unless you've been living under a rock, you've probably heard of Bitcoin, Ethereum, and other cryptocurrencies. Fortunes have been made and lost trading these “mysterious” digital coins. But what is the technology behind them? What is a blockchain and how do they work? We will explore these topics below in part one of our series on blockchain technology.
In 1991, Stuart Haber and W. Scott Stornetta introduced the concept of a cryptographically secured chain of blocks. These blocks would add a timestamp to digital documents to prevent tampering. The idea mainly went unused until Satoshi Nakamoto adapted it in 2009 to create a decentralized, peer-to-peer electronic cash system called Bitcoin. In 2013, Vitalik Buterin developed a new blockchain-based distributed computing platform called Ethereum. Today, Bitcoin and Ethereum are the largest and most widely-known blockchains.
A blockchain is a digital shared ledger system that gives stakeholders shared access and control of data. It is like a giant Google spreadsheet that users can access and edit. However, there is one key difference. Unlike a shared Google Sheets file, a blockchain is not stored in one centralized location. Instead, it is decentralized, meaning that the information stored in a blockchain is owned and verified by every node in the network. This makes blockchains much less susceptible to hacking. If a hacker gains control of one node and attempts to edit the data, all the other nodes would reject the attempt. Thus, there is no single point of failure. Once data is entered onto a blockchain, it is nearly impossible to change it. This feature is known as immutability.
Let's look at an example of how a blockchain processes a transaction:
Blockchain technology's chief benefits include decentralization, immutability, accessibility, and transparency. Decentralization and immutability, as discussed above, are features that increase security. Blockchain's accessibility means that anyone with internet access can use it, which is particularly useful for citizens of less-developed countries with less access to trusted third parties. Public blockchains are transparent, meaning that their contents are visible to anyone with access to the network. Each time a new node joins the network, they receive a full copy of the blockchain. Thus, blockchains are known as being distributed. This characteristic adds another layer of security.
Challenges associated with blockchain technology include environmental impact, the threat of “51% attacks," regulation, and hacking.
Blockchain technology has many exciting features as well as obstacles to overcome. Understanding how blockchain works is essential because it is the foundation of the digital assets that have ballooned in popularity. Our next post will dive deeper into different blockchain algorithms and begin our discussion of blockchain digital assets.
This article was written by Matthew Lui, CFA, CAIA, Vice President, Investment Research. As a member of Canterbury’s Research Group, Mr. Lui is responsible for sourcing, evaluating, and monitoring traditional, long-only equity managers. Mr. Lui serves as the chair of Canterbury's Global Equity Manager Research Committee and the vice chair of the Hedge Funds Committee. He also sits on the Capital Markets Committee. Prior to joining Canterbury, Mr. Lui was a trader and research analyst at Knightsbridge Asset Management. He received his Bachelor of Arts in economics from University of California, Berkeley. Mr. Lui is a CFA® charterholder and a Chartered Alternative Investment Analyst.