By: Josh Owen, CTO, Flourish
Date: Jan. 13, 2022
Before you invest in any cryptocurrencies, make sure you understand the basics.
Since the launch of Bitcoin in 2009, cryptocurrencies have emerged as a multi-trillion-dollar asset class. As part of that growth, cryptocurrency investing has gone mainstream: Coinbase, the most prominent retail exchange, reports 68 million users,1 while 8 out of 10 financial advisors have recently received questions about crypto from their clients.2
Before investing in any asset class, it’s important to understand the basics of the space. Ensuring you can answer questions about the blockchain—the technological foundation of cryptocurrency—is a great place to start.
What is blockchain technology?
A blockchain is a special kind of database. In a regular database, anyone with access to the filesystem can add, change, delete, sort, and manipulate the data. As a result, the database can only be shared with a trusted group of people; otherwise, there could be major issues with security, errors, and version control.
Blockchain, in contrast, is a public, “decentralized” database—one that’s accessible to anyone, but where novel technology prevents manipulation. This kind of database can be used for tracking financial transactions around the globe, which was previously impossible without a trusted intermediary such as a central bank or payment processing company. In fact, some of the earliest developers of the internet theorized about including this kind of technology in the internet to manage internet cash—just like “IMAP” and “SMTP” managed email—but they didn’t have the technology to secure the database.
Emerging uses of blockchain technology
Cryptocurrency transactions are typically the first thing that comes to mind when thinking about blockchain. After all, the original use case of blockchain technology was sending cash over the internet without requiring a trusted financial intermediary.
However, just like traditional databases, blockchain technology can be used for far more than cash transfers. And because blockchains are inherently decentralized, anyone with an internet connection can develop new applications on top of these blockchains—which has helped spur an incredible amount of innovation.
Technologists and major companies are exploring other uses:
- Paxos Trust Company, LLC received a no-action letter from staff of the U.S. Securities and Exchange Commission and is working with companies like Société Générale and Credit Suisse to use the blockchain for securities settlement, which could revolutionize the decades-old clearing and settlement infrastructure by increasing speed, unlocking capital held in reserve, reducing cost and more.
- Spotify uses blockchain to manage royalties, tracking who owns rights to pay songwriters and artists.
- Walmart is using blockchains to track food; from where it was grown to how it was shipped, allowing them to pinpoint supply chain issues around product recalls.
- Mastercard patented using blockchain to protect identities of cardholders and prevent identity theft.
- Other blockchain uses include smart contracts, tokenization of assets from art to real estate (commonly referred to as NFTs), medical data sharing, cross-border payments and remittances, money laundering prevention, and more.
Three ways that blockchains differ from traditional databases:
1) Data is added to the blockchain in “blocks,” akin to adding many rows of transactions to the database at one time. These blocks are strung together sequentially, as links in a chain—hence the term blockchain. Each sequential block references the block that came before it through cryptographic technology, ensuring that once data is entered onto the blockchain, it cannot be altered.
2) The blockchain is decentralized or distributed—meaning it is publicly available to anyone who wants to view or enter data, and no single person or entity controls it. Every computer interacting with the blockchain—each one called a node—simultaneously records data entries independently and cross-checks them against all others. Because it is decentralized, anyone with internet access can build new applications on top of the blockchain, leading to rapid innovation.
3) Millions of nodes are recording and validating each block of data. If any node tries to falsify an entry, millions of other nodes would detect it and correct it. Further, blockchains offer economic incentives to participants in order to validate the data. The Bitcoin blockchain, for example, is secured by an incredibly powerful, distributed network of “miners” who leverage highly-specialized computers to validate transactions in exchange for economic rewards—effectively leveraging the power of the free market to secure the blockchain.
While blockchain technology is still new, it’s clear that the potential for innovation is massive—from cryptocurrency transactions today to a growing number of new use-cases in the future. Massive technological change can come hand-in-hand with new financial winners and losers, and so it is important for investors to understand the basics of this emerging space.