FXCM Insights

What Is The Blockchain?

The blockchain is a distributed ledger system that makes it easier to keep track of transactions and assets.1)Retrieved 20 September 2017 https://www-01.ibm.com/marketing/iwm/dre/signup?source=urx-16905&S_PKG=ov59289 While the first blockchain was rolled out for use with the digital currency bitcoin, it has since been used for many other cryptocurrencies. Technologists have speculated that this distributed ledger system could have a wide range of uses from storing property records to enhancing transparency in the sharing economy.2)Retrieved 20 September 2017 http://www.businessinsider.com/goldman-blockchain-beyond-the-hype-practical-uses-2016-5/#sharing-economy-building-trust-on-platforms-like-airbnb-1

Blockchain and Digital Assets

In addition to the aforementioned potential applications, the blockchain is already used by myriad digital assets.

Many organisations have held initial coin offerings (ICOs), which are similar to initial public offerings but distribute digital tokens to investors instead of more traditional securities such as stocks and bonds. When an ICO takes place, all transactions are recorded on this digital ledger system, providing a permanent record of who has owned what and when.

Some digital assets have produced very strong returns. The total market capitalisation (market cap) of all cryptocurrencies rose from roughly £13.1 billion at the start of 2017 to more than £130 billion in September of that year—an increase of more than 900% in less than nine months.3)Retrieved 20 September 2017 https://coinmarketcap.com/

Given all of this, it’s important for potential investors and those interested in cryptocurrency to learn more about the blockchain.

Decentralisation

When it was created, the blockchain used cryptography to create a secured, digital ledger that was spread across many different computers.4)Retrieved 20 September 2017 https://hbr.org/2017/03/the-potential-for-blockchain-to-transform-electronic-health-records All transactions recorded in this way were time-stamped, providing greater transparency.

At the time of report (22 September 2017), more than 9,000 nodes (computers) were running bitcoin software.5)Retrieved 20 September 2017 https://bitnodes.21.co/

Immutability

The first blockchain was immutable, meaning that transactions could not be erased once they were recorded.6)Retrieved 20 September 2017 http://www.chyp.com/mutable-and-immutable-blockchains/ The bitcoin protocol—the set of rules used for the creation and use of bitcoin—ensured this immutability.

Bitcoin’s blockchain represents a series of blocks.7)Retrieved 20 September 2017 https://www.coindesk.com/information/how-bitcoin-mining-works/ Each block contains several bitcoin transactions that have been processed by miners. Once these transactions have been recorded, they cannot be removed. By providing a ledger that was not only decentralised, but also immutable, the blockchain helped safeguard against fraud.

It is worth noting that while bitcoin’s blockchain was set up to be immutable, not everyone agrees that all distributed ledger systems should be immutable.

For example, Accenture released plans to create a type of blockchain that users could “edit” or revise, reasoning that such features could be quite helpful for enterprises. More specifically, it was stated at the time that providing this ability to edit the blockchain would make it easier to address new regulations like the “right to be forgotten.”8)Retrieved 21 September 2017 http://www.businesswire.com/news/home/20160920005551/en/Accenture-Debuts-Prototype-%E2%80%98Editable%E2%80%99-Blockchain-Enterprise-Permissioned Further, it would give businesses the ability to fix otherwise-immutable mistakes left on the blockchain that resulted from human error.

Transparency

Bitcoin’s blockchain was designed to make the digital currency’s transaction history available to the public, a feature that provides greater transparency by making transactions open to any and all interested parties. However, it’s worth keeping in mind that while bitcoin’s blockchain offered this clarity, not all such distributed ledger systems are public.

Private Blockchains

Some blockchains are private, meaning that they are not available to the public and their membership can be controlled by a central party.9)Retrieved 20 September 2017 https://www.ibm.com/blogs/blockchain/2017/05/the-difference-between-public-and-private-blockchain/

For instance, a company may set up one of these distributed ledger systems on an enterprise-wide basis. A perfect example of this would be a financial services institution that uses one of these distributed ledger systems to keep track of transactions. Because the transaction is private, only a limited number of parties need to know its details. The presence of a blockchain can provide an immutable ledger accessible only to certain people.

Permissioned Blockchains

Generally, private blockchains set up by businesses in this way will be permissioned, meaning that all users must obtain permission to join. The central party can invite potential members to the blockchain and then decide to approve them or have them conform to specific rules to join.10)Retrieved 20 September 2017 https://www.ibm.com/blogs/blockchain/2017/05/the-difference-between-public-and-private-blockchain/

By restricting the use of a blockchain to those granted permission, a central party (for example, a company) can derive multiple benefits.

Smart Contracts

Smart contracts are another possibility that exist because of the blockchain. These are agreements that are automatically fulfilled as soon as specific requirements are met.13)Retrieved 20 September 2017 https://blockgeeks.com/guides/smart-contracts/ The idea was originally proposed by Nick Szabo, a computer scientist and cryptographer.

“A smart contract is a set of promises, specified in digital form, including protocols within which the parties perform on these promises,” he wrote.14)Retrieved 20 September 2017 http://www.fon.hum.uva.nl/rob/Courses/InformationInSpeech/CDROM/Literature/LOTwinterschool2006/szabo.best.vwh.net/smart_contracts_2.html

One major platform that allows for these contracts is ethereum.15)Retrieved 20 September 2017 https://www.coindesk.com/information/ethereum-smart-contracts-work/ More specifically, the ethereum platform was designed to leverage these contracts. Through this platform, developers could potentially build decentralised applications (or “Dapps”) that use smart contracts.

Network Vulnerabilities

A blockchain could potentially be compromised if one or more miners consolidated 51% of the network’s computational power (or “hashing power”) in order to launch a “51% attack” and manipulate the distributed ledger system.16)Retrieved 20 September 2017 https://learncryptography.com/cryptocurrency/51-attack If this took place, the miner or miners could stop transactions from being confirmed. This would invalidate the transactions, which would then prevent users from sending bitcoin to one another. Such an event could enable the miner(s) to reverse transactions, which would consequently result in double spending.

Theoretically, a 51% attack could also go back in time and change prior transactions, though doing so would be very difficult.17)Retrieved 20 September 2017 https://learncryptography.com/cryptocurrency/51-attack

Hard Forks

Another potential risk to existing blockchains is hard forks, which create a permanent change in a digital currency’s protocol. Basically, once a network implements a hard fork, the blockchain won’t accept blocks using the prior protocol.

The ethereum platform, for example, underwent a hard fork in the summer of 2016 after a distributed organization named The DAO was compromised. This resulted in the loss of a larger number of ether tokens. This hard fork returned the funds back to the original investors, but it had an unintended consequence.18)Retrieved 20 September 2017 https://www.coindesk.com/ethereum-classic-explained-blockchain/

While the hard fork caused the original ethereum to follow a different protocol, some cryptocurrency enthusiasts continued mining using the previous rules. This caused a network split, resulting in a new and separate blockchain called “Ethereum Classic.”

Summary

The blockchain is a distributed ledger system that makes it easier to keep track of transactions. The first blockchain, which was rolled out to go along with bitcoin, was immutable. Being both decentralised and immutable helped safeguard against fraud.

The first blockchain was also public, which made its transactions available to anyone interested in learning more. Not all blockchains were set up this way. Some were created to be private to restrict the access of certain parties.

While some technologists, industry participants and market observers have stated that the blockchain could be used for a wide range of potential applications, it is important to keep in mind that these distributed ledger systems are vulnerable to 51% attacks.

Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.

FXCM does not endorse cryptocurrency. The information provided herein is for educational purposes only.

References   [ + ]

1. Retrieved 20 September 2017 https://www-01.ibm.com/marketing/iwm/dre/signup?source=urx-16905&S_PKG=ov59289
2. Retrieved 20 September 2017 http://www.businessinsider.com/goldman-blockchain-beyond-the-hype-practical-uses-2016-5/#sharing-economy-building-trust-on-platforms-like-airbnb-1
3. Retrieved 20 September 2017 https://coinmarketcap.com/
4. Retrieved 20 September 2017 https://hbr.org/2017/03/the-potential-for-blockchain-to-transform-electronic-health-records
5. Retrieved 20 September 2017 https://bitnodes.21.co/
6. Retrieved 20 September 2017 http://www.chyp.com/mutable-and-immutable-blockchains/
7. Retrieved 20 September 2017 https://www.coindesk.com/information/how-bitcoin-mining-works/
8. Retrieved 21 September 2017 http://www.businesswire.com/news/home/20160920005551/en/Accenture-Debuts-Prototype-%E2%80%98Editable%E2%80%99-Blockchain-Enterprise-Permissioned
9, 10, 12. Retrieved 20 September 2017 https://www.ibm.com/blogs/blockchain/2017/05/the-difference-between-public-and-private-blockchain/
11. Retrieved 20 September 2017 https://www.coindesk.com/information/what-is-the-difference-between-open-and-permissioned-blockchains/
13. Retrieved 20 September 2017 https://blockgeeks.com/guides/smart-contracts/
14. Retrieved 20 September 2017 http://www.fon.hum.uva.nl/rob/Courses/InformationInSpeech/CDROM/Literature/LOTwinterschool2006/szabo.best.vwh.net/smart_contracts_2.html
15. Retrieved 20 September 2017 https://www.coindesk.com/information/ethereum-smart-contracts-work/
16, 17. Retrieved 20 September 2017 https://learncryptography.com/cryptocurrency/51-attack
18. Retrieved 20 September 2017 https://www.coindesk.com/ethereum-classic-explained-blockchain/