on June 29, 2017 Industry Talk

Blockchain 101: How it works & how it can benefit everyday life

Form title

Since my first blog about Blockchain in February last year the world of fintech has continued to innovate and develop. Melbourne is about to become a fintech hub. Bitcoin has re-emerged, and not just as the hacker’s currency of ransom. And blockchain? Well, companies are springing forth to offer blockchain services to a range of businesses across financial services and other sectors. 

Universities are adding blockchain to course lists (demand exceeds availability), the recruitment market for blockchain experts has been described as “red hot” and demand for expertise is coming from all sectors.

There seems to be an inverse relationship between talk about blockchain and understanding…it therefore seems timely to go back to basics and look at blockchain. What is it? How does it work? And importantly, how will it impact life on a day-to-day basis?

What is blockchain? (the explanation I hope my mother can understand)

I know it’s a bit twee to write the explanation ‘my mother can understand’ however (apologies to her in advance) she is a useful yardstick. She dutifully reads my blogs and then confesses to have no idea what I’m talking about. Lucky she’s not my target audience!

I’m going to use a notebook as the analogy. Picture a spiral bound notebook, in which information is recorded, line by line.

  • I buy 1000 CBA shares – that is a line item in my notebook.
  • I receive a dividend, which is reinvested and a further 124 shares are issued – another line item in my notebook.
  • I buy 1000 Alumina shares – that’s right, another line item.

Dividends come in, rights issues occur, shares are bought, shares are sold…and so it goes. Each and every transaction is dutifully recorded in my notebook.                             

However, there is not one single notebook. There are tens of thousands, located around the world. Every time I enter a line item in my notebook, it’s replicated across each of these notebooks, wherever they’re located.

This is called a distributed ledger – because it is a record of information that is stored in a ledger, distributed across thousands of locations.

Fortunately, this is all computerised and not reliant on thousands of diligent workers dutifully replicating my notebook entries.

The series of entries is the chain, each individual entry is the block. As an investor, I have my own blockchain detailing all aspects of my share ownership. Blockchain creates a transparent paper trail that anyone can access but no one can alter.

Simple!

To step it up a notch, from notebooks to computers, blockchain is:

  • A digital distributed ledger that documents information; this information is replicated across thousands of computers around the world, synchronised via the internet
  • A series of transactions grouped into a ‘block’, then stored in a ‘chain’ by linking each block with the preceding block
  • An irreversible record that is timestamped and is stored into perpetuity
  • Verified by multiple computers that have to agree that a transaction is authorised and legitimate before approving that line item; if a change is made to one ledger which then does not match the others, the blockchain becomes invalid and the error is broadcast to all computers hosting that ledger.

 

The benefits – in layman’s terms

Security

As I write, corporations in Europe, the US and even Australia have been subject to another ransomware attack. The Cadbury factory in Hobart is offline as a result, a calamitous outcome as many will agree!

The enhanced level of security that comes with a distributed ledger provides security from hacking or cyber crime – the perpetrator would have to be able to target every copy of the distributed ledger, or blockchain, simultaneously – a most unlikely outcome.

Using Cadbury as an example, blockchain could be used to record information pertaining to purchases, production, orders in, deliveries out, financials…and across each of the different lines the company produces. There would be no demands from shadowy characters for 300 bitcoins to release their information!

No mistakes

Once a piece of information is in the ledger it needs to be verified. Once verified it can't be changed unless everyone agrees – this means no human mistakes, no fraud.

If there is an error, a new item is created. All information remains in the blockchain, always.

Audit

Bitcoin provides an audit trail. It could be a financial audit trail that would be an unalterable financial trail of a company or an individual. It can also be used to audit things.

Here’s an example:

  • I buy a new car. The purchase, manufacturing information, warranty, finance details, registration and extra features are the first block in the chain called “Tracey’s car.”
  • I insure my new car – block number two. It keeps track of the terms of the insurance, the insurance value of the car, windscreen option, excess and nominated drivers. Block two.
  • After six months, the new car has its first service; details are recorded in block three.
  • Two months later, a little mishap sees an insurance claim and the car visit the panel beaters – details of the job form block four.
  • In four years’ time, I trade in this vehicle for a new one; while my personal details might be stripped out, the car’s blockchain could move to the new owner, so a full history of the car is always available to the current owner, insurer and other relevant parties. That should put a dent in the endemic car theft plaguing our cities!

Any transaction with a serial number can be easily recorded and managed on blockchain.

Flexibility

Using blockchain technology doesn't mean that the system needs to be a public ledger; in fact, there are many applications where this would be undesirable. However, there are those uses where some sharing information would be beneficial.

Here’s an example in healthcare:

  • I take my baby to be vaccinated several times over her first five years – each is a block in her chain.
  • I can elect to make that information visible to relevant third parties; the government for childcare rebate, kindergarten and school.
  • Other health-related information not relevant to those third parties remains private.

Identify theft & personal information

If we each have a personal blockchain, it surely will be harder to lose your identity to nefarious criminal types? With key information at your fingertips, no more sending away for a copy of your birth certificate. It would enable the simple validation of information – visas, education and work history. It would then, of course, be harder to fake things – exaggerated claims on resumes and LinkedIn would become a thing of the past!

Low cost

Blockchain was originally developed to facilitate trade in cyber currency bitcoin. It enables institutions to securely trade and transact with each other directly, no middle-man. In theory, this should mean significantly reduced costs and speedier transactions. With blockchain, even very small exchanges are easily enabled – you stream a song on Spotify, the musician can be paid directly.

Where’s the chain?

It appears to be more block than chain at the moment. Universities are struggling to keep up with demand for courses on this nascent technology, and companies are struggling to find sufficiently knowledgeable and qualified staff.

There’s still uncertainty in the regulatory environment, and talk about the huge amount of energy that a global distributed ledger will consume. While blockchain potentially offers tremendous savings in transaction costs and time, the high costs of implementation could pose a barrier to implementation.

While the proliferation of fintech start-ups focused on blockchain continues, no one major organisation has yet fully implemented a blockchain solution, although there are reported to be many in the pipeline.

And what of the ASX replacing CHESS with a blockchain solution? Since last year’s resignation of CEO, Elmer Funke Kupper, the Exchange has been somewhat quiet about its plans. I guess that’s a whole other topic!


General Advice Warning
The information provided in this post is general information only and is not designed for the purpose of providing personal, financial or investment advice. Any examples are presented for illustration purposes and past performance is not a reliable indicator of future performance. The information provided does not take into account your particular investment objectives, financial situation or investment needs.

Tracey Franks (OM blogger)

Tracey Franks is an experienced freelance writer, communicator and marketer. She has worked in financial services for over 20 years, for businesses spanning stockbroking, funds management, research and consulting, as well as financial planning. When not writing about finance-related topics, Tracey is working on her first novel.