What has passed for money, as a medium of exchange, has evolved through the millennia. Back in the day, exchanging sheep for coal required dragging sheep or coal around with you, which was awkward, to say the least. Representative currencies based on some commodity were created to solve that problem but required some level of trust that your trading partner would actually fulfill his obligation to pay you using that commodity. When economies turned to fiat currencies – based on faith that a central authority would maintain the currency’s value – acceptance was again met with skepticism in some circles as it was a matter of trust. Today, technology enables cryptocurrencies – P2P payment systems such as Bitcoin – that don’t require a central authority at all. In some circles, this is a bridge too far as the very notion stretches trust nearly to the breaking point. Trust requires understanding and understanding first requires at least a common lexicon.
Most bankers know that they have to keep an eye on cryptocurrencies. To many, cryptocurrencies pose a threat to banks and fintech companies because an ever-increasing portion of their income comes from payment services. Bankers, by and large, know that they’ll have to do something someday to compete with cryptocurrencies and many use words like “Bitcoin” or “blockchain” as if they’re synonymous. It’s far enough out, they believe, that they don’t need greater precision in their language. CTOs and CIOs know that the technology is here and could disintermediate bank payment systems. It’s closer than you think.
A few terms to know to understand this brave new world: blockchain, distributed ledger, and cryptocurrencies. It’s important to know now because these terms describe a model that goes beyond trade and currency.
Blockchain: The basic infrastructure, like the internet, is to email. Blockchain is a technical protocol where blocks of data are shared between sender and receiver (like HTTP, distributed among many players) to convey whatever the blockchain carries. Blockchains provide high integrity and high-reliability transmission because each block is hashed (to detect tampering) and are not dependent on any one actor in the transmission chain. Currency, contracts, voting, or whatever can be conveyed digitally can be transmitted via blockchains.
Distributed ledger: Distributed ledger is a data model that ensures accuracy, confidentiality, and security. Unlike traditional data models with a central ledger as the single version of the truth, a distributed ledger exists everywhere along the transmission from sender to receiver. “Blockchain miners” validate the accuracy of each block, pushes it to the next, and maintains a copy of the entire ledger, which is validated periodically through consensus of the miners. For their trouble, the miners receive a fee for each block they handle. The important idea with distributed ledgers is that they can be either public or private ledgers, which opens up this technology to a wider array of applications than people may trust with publicly distributed ledgers.
Cryptocurrencies: The first blockchain application to receive widespread attention is Bitcoin, a true P2P currency. The system of blockchain transmission and distributed ledger controls make cryptocurrencies like Bitcoin safe and secure without the need for a central authority. The technology itself assures the reliability of the transaction and the currency. There are competing cryptocurrencies, but Bitcoin’s adoption is exponentially larger than the rest. To gain some insights into Bitcoin, visit https://bitcoin.org. To see the rate of adoption of Bitcoin, visit https://blockchain.info/charts.
As with any new form of currency, the rate of adoption is based on trust. There was a time when people didn’t trust representative currency to trade their sheep and coal but eventually saw the advantages. Someday, we may look back to today and see cryptocurrencies the same way.