Tue, 12 Apr 2016

Why Bitcoins and Blockchains Represent the Future

The finance industry is digitalising at a rapid rate. Introduced to the public in 2008, bitcoins are the first form of cryptocurrency that was written and coded. The emergence of bitcoins as a digital currency has revolutionised the way payments are being made. Currently, 15.4 million bitcoins are in circulation out of the limited supply of 21 million coins. More importantly, is the technology behind the bitcoins – blockchain; which has the potential to reshape the global financial system.



What are bitcoins and blockchains, and their advantages?


Bitcoins are a decentralised form of digital currency that allows its users to transfer payment directly from one user to another using a peer-to-peer model. Not only is this system extremely cost effective and efficient, it takes away the vulnerabilities of a trust-based model.


Unlike in traditional online banking, where hackers are able to duplicate their digital currency and send it to merchants while retaining the original, the use of bitcoins prevents this. The propensity for fraud or double-spending to occur will be reduced because payments cannot be reversed. Through other payment methods, it is possible for merchants to implement charges without the users' knowledge; bitcoin users on the other hand can have full control of their transactions. The use of bitcoins also provides stronger protection against identity thefts because users can pay using bitcoins without connecting their personal information to the transaction.


Bitcoins take away the need for an intermediary during the transaction. Without a third-party or central authority in place, users' assets cannot be seized nor destroyed by an attack on the controllers. For instance, by using bitcoins, you do not need to go through a bank intermediary to perform a transaction. Your money will not be lost should there be an attack on the bank and you will not be subject to unilateral policy changes by the banks. This also means that you do not need to pay third-party transaction fees but can still send over and receive payments securely.


Bitcoin's ability to ensure that double-spending does not occur can be attributed to the blockchain. The blockchain is a publicly visible but partially anonymous online ledger that verifies and records all bitcoin transactions. It is essentially a timestamp network that is made out of an ongoing chain of 'hash-based proof-of-work'. Hashing refers to the application of a mathematical formula that is unique to each block. Mining then takes place where miners will solve this mathematical formula which generates the proof-of-work.


Once a CPU satisfies the proof-of-work, a block can no longer be changed without redoing the work. For the network to run, a node (a programme that validates transactions and blocks) will find a proof-of-work and will always work on the longest chain of blocks, continuously extending it. As long as honest nodes control the majority of CPU power, an attacker will find it very difficult to outpace the honest chain. Hence, the propensity for fraud or double-spending is reduced, if not eliminated.


Since the blockchain is publicly visible, it allows for transparent transactions. However, it maintains the privacy of users by keeping public keys anonymous. Similar to how stock exchanges work, people can see transactions taking place but the information of transactions are not linked to any specific individuals. While information security of users is generally not an issue, users are advised to use a new key pair for each transaction. This is so that if the identity of a key's owner is revealed, other transactions would not be easily linked to the same owner. However, it should be noted that some linking might be unavoidable when it comes to multi-input transactions.


The use of bitcoins is convenient and internationally viable as people become increasingly connected online. The implementation of bitcoins and the blockchain system is extremely easy. All you need is an Internet connection to download a mobile application which generates Elliptic Curve Cryptography (ECC) keys or a digital signature. The blockchain system does not require any fees or charges, and everything is Internet-based and self-organising.


Who is already on the 'blockchain bandwagon'?


Bitcoins and ultimately, blockchains, represent the direction in which the world is moving towards. The cryptographic system is evolving so quickly, it will facilitate not only payments but the re-engineering of business processes. Blockchains will improve workflow, Internet-of-Things (IoT) security and eventually, the use of digital signatures will become commonplace. Some examples of blockchain applications include currency creation, crowd funding, issuance of shares, and data publication and verification.


Traditional banks are realising that soon they may well be disintermediated with the rise of peer-to-peer electronic payments. As a result, many of them are organising hackathons to explore the provision of banking services through blockchain systems. In February 2016, BNP Paribas completed their first 'bizhackathon' which led to the confirmation of their commitment to the use of blockchain technology applications.


It is not just banks who are jumping onto the bandwagon. An increasing number of individuals and businesses such as Wordpress and Reddit have already started using bitcoins. Even governments are looking into the use of cryptocurrency. China and the United Kingdom have already set in place plans to issue their own cryptocurrency that is backed by the Central Bank. This is to prevent money laundering or ransomware payment which is the biggest form of illegal activity that takes place with bitcoins since it cannot be tracked. However, cryptocurrency issued by countries can be regulated. It will not be long before the Singapore government too, looks into the use of cryptocurrency. Separately, companies are starting to use blockchains to create offshoots of bitcoins. One such example is Nxt, which has created its own cryptocurrency known as NXT and functions similarly to bitcoins, albeit improved.


More than just currency creation


Blockchains are also used to enhance the security of financial documents and facilitate the creation of smart contracts. Open Trade Docs (OTDocs) makes use of the blockchain to identify, store and verify entities, international trade documents and transactions. In May 2016, Standard Chartered Bank, DBS Bank and Infocomm Development Authority of Singapore (IDA) sought to enhance the technology of their finance invoicing services through the utilisation of 'Ripple' technology, a parallel platform to blockchains.


Smart contracts too, employ blockchain technology. Smart contracts operate autonomously without any human oversight. Computer protocols facilitate, verify and enforce the negotiation or performance of a contract. Smart contracts have a user interface and follow the logic of contractual clauses. They aim to provide a higher level of security than that of traditional contracts while reducing transaction costs. Ethereum, is the largest and most well-established decentralised system that runs smart contracts. It creates a contract that will, depending on the outcome, hold or securely return a contributor's money when a given date or goal is reached.


On top of smart contracts, blockchain technology allows for crowd funding to take place securely as well. An example would be the use of BlockTrust, which uses multi-signature wallets and no funds are solely held by the platform. This ensures that malicious developers cannot move the funds because BlockTrust themselves, act as a co-signer for all transactions.


On top of varying industries making use of blockchains, bitcoin itself is evolving to become more viable for micropayments. This form of payment is expected to be used extensively in the future. MicroBTC, a micropayment scheme which uses a hashchain technique, allows bitcoins to support fair and efficient micropayments. It also has a refund mechanism so as to reduce the propensity for indefinite waiting and will condense two transaction models in the basic MicroBTC into one. Bitspark is a micropayment organisation which leverages on bitcoin as one of their means of transmission. It is the world's first 'cash in cash out' remittance platform where money can be sent to more emerging markets, faster and cheaper.


Reshaping the world with Bitcoin 2.0


The introduction of bitcoin itself may have disrupted the fintech industry. However, its true potential and focus lies in its blockchain technology, forming the premise of 'Bitcoin 2.0'. Applications such as Ethereum prove that distributed ledgers are being rapidly adopted by varying industries as developers continue to explore the potential of the blockchain. It goes as far as conceptualising the idea of a Bitnation. A Bitnation provides the same services as traditional governments but in a decentralised and borderless manner. Bitnation will be powered by the Bitcoin 2.0 blockchain technology where a cryptographically secured public ledger will be distributed amongst all its users. Blockchain is not perfect and raises questions regarding social issues such as the potential of newborns being registered into the blockchain without being given a choice. However, we cannot discount the fact that the power of the blockchain technology has and will continue to introduce business processes to a more secure, trusted, efficient and cost-effective means for growth.


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