Blockchain is the technology that underpins the Bitcoin cryptocurrency. Because Bitcoin is much loved by anarchists, drug dealers and fraudsters, blockchain (by association) is too easily dismissed as some weird technology sideshow. However, Bitcoin or another blockchain implementation can theoretically be used to anonymously verify any kind of transaction.

If blockchain technology is adopted more widely, its economic and social impact will be enormous and as explosively disruptive and world-changing as the worldwide web has been.

No wonder startups and venture capitalists are piling into this space with huge investments.

Transferring ownership using blockchains

There is a lot more to the underlying blockchain technology than the exchange of monetary value. Blockchains are a mechanism to establish trust between otherwise unrelated parties over an untrusted network like the Internet.

Bitcoin’s technology can be used to transfer ownership in other currencies, in financial assets and even in physical assets. For example, Colored Coins and Omni Layer, formerly Mastercoin, will soon release software based on Bitcoin to enable trade in financial assets, including stocks and bonds.

More ambitious vendors including AlphaPoint, Chain and Ethereum have either launched or are about to launch new blockchain products, similar but unrelated to Bitcoin, to encode financial instruments and other contracts.

R3 CEV is a consortium of over 40 of the world’s leading banks that is expected to design and deliver advanced blockchain technologies for global financial markets.

ChromaWay is using blockchain technology to develop a contract management platform that can digitally represent the complex workflows associated with contracts, assets and transfers of ownership in a secure, private and efficient way.

All these startups have received considerable funding from large banks, financial services companies and venture capitalists.

How do blockchains work?

A central component of blockchain technology is its distributed ledger. The ledger is a record of all transactions. It is stored across every computer running a specific brand of blockchain software. A cryptographic record of every transaction is shared across the peer-to-peer network to ensure that, once you’ve spent a unit of an individual cryptocurrency, you cannot spend it again. Similarly, once you’ve sold a financial or physical asset, you cannot sell it again or claim to still own it.

It’s this irreversible, public nature of the transactions that makes distributed ledgers an intriguing tool for other applications as well. The fact that the transaction itself is verified, not the identity of the people making it, is what allows people to use Bitcoin or other blockchain applications anonymously. For example, blockchains could be used to verify completion of a specified task, replacing the need for a physical signature to unlock an escrow account or release payment from a letter of credit.

In particular, blockchain-based systems could replace expensive middlemen, such as banks and clearing houses, in financial markets. For example, a distributed ledger could theoretically form the backbone of a next generation commodity futures market, handling both ends of trades without fees or delays.

Distributed ledgers could be used to exchange the information needed to validate a physical transaction. For example, a distributed ledger could prove authenticity in art, verify ownership of machinery, or even prevent copying of digital content. Similarly, blockchain has been proposed to improve land ownership registries.

One thing is clear: even if cryptocurrencies like Bitcoin turn out to be a fad, the underlying blockchain technology points to a set of tools that could change the face of how business is conducted in every sector of the economy.

Blockchain challenges

Blockchain faces challenges, beyond basic business practicality, that will dampen the technology’s adoption rate. The challenges include:

  1. Lack of universal standards. Multiple standards are currently being developed.
  2. Issues around regulatory governance. It’s naïve to think blockchain applications will operate without regulatory approval.
  3. High quality software. As the use of blockchain technology increases in importance, defect-free software will be essential to maintaining high availability of systems and end-user confidence.
  4. A shortage of engineers schooled in working with the blockchain software. Courses about blockchain technology are still in the future.
  5. Questions about scalability to handle the high volumes of transactions associated with most commercial transactions. Despite their age and occasional primitiveness, current systems can handle enormous volumes.

What do you think? Are blockchains a fad or will they change the world? To receive a reading list of recent articles related to blockchains, please send me an email.

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