Since the world embraced computers, connected via the internet, and converted mass amounts of sensitive data into digital form, several problems have arisen.  Hacking, identity theft, and manipulation of digital data plague businesses, consumers, and governments daily. It’s very difficult to trust and verify the identity of someone you’re conducting business with on another continent, that you’ll receive what they claim to be selling, and that your payment will get there securely and quickly.  

These problems slow commerce down and create costs, usually in the form of lawyers or other middle men doing the verification leg-work.  Blockchain technology helps eliminate concerns about hacking and trust, greatly reducing transaction costs and processing times.

Even if Bitcoin fizzles out tomorrow, the underlying blockchain technology is not only here to stay, but primed to grow exponentially…and soon.  You can look at Bitcoin like Myspace, one of the first social media platforms. Even though Myspace failed, the concept of social media lives on in countless other manifestations.  Many pundits believe blockchain technology will be “the next Internet.”

Smart Contracts

A “smart contract” is a commonly discussed application for blockchain technology.  A smart contract is automatically executed when certain predefined conditions occur (if X does Y, then execute Z).  Smart contracts theoretically allow individuals or companies to craft contracts with highly detailed conditions, but without the need for a legal document written by a lawyer.

Currently, if parties to a contract either don’t perform or don’t pay, the aggrieved party must sue the breaching party to get paid or get their money back.  This all costs time and money, even if the contract is honored.

The blockchain replaces lawyers and courts in a smart contract.  Let’s say I create a smart contract with the following conditions: I want 5 bushels of apples at a price of $200 delivered in 5 days.  Johnny Appleseed accepts and our smart contract becomes part of the blockchain, with its precise terms fixed and recorded across thousands of other computers.  Upon acceptance, $200 would automatically be deducted from my account, but not yet given to Johnny. If the apples arrive on the 5th day, that $200 automatically transfers to Johnny.  If Johnny fails to deliver on the 5th day, I automatically get my $200 back.

Additional conditions could also be built in, such as automatically giving me $10 from Johnny’s account if he fails to deliver by Day 5, charging either party $5 for backing out before Day 5, automatically refunding my account the price of however many apples he shorts me, etc.

The bitcoin blockchain does not have the capability to incorporate smart contracts; bitcoin was designed to only process payment transactions.  The second-most valuable cryptocurrency is called Ethereum; its blockchain was designed for monetary transactions, as well as smart contracts. Ethereum’s added functionality may give it an edge in the long run over bitcoin.

Research by Accenture estimates that investment banks alone could save up to $12 billion per year using blockchain and smart contracts for financial transactions.[1]  There will be many practical and legal kinks to work out before smart contracts gain widespread use, but businesses and consumers will certainly jump at the opportunity to avoid dealing with contract lawyers and the judicial system once a viable alternative presents itself.

Other Uses

Major players in the global food supply chain are poised to adopt blockchain, with IBM announcing a collaboration with several grocery chains and food suppliers such as Walmart, Kroger, Dole, and Tyson Foods.[2]  The goal is to streamline the entire process by securely and transparently tracking goods at every step, from the farmer to the store shelf.  Blockchain will reduce inefficiencies with ordering, shipping, and billing; most importantly, it will increase food safety by tracing sources of contamination, helping to quickly stem the spread of illness.

Coca Cola and the U.S. State Department are launching a project using blockchain’s digital ledger technology to create a secure registry for workers that will help fight the use of forced labor worldwide.[3]

Practically every industry is now analyzing how blockchain technology can reduce inefficiencies and establish trust through verification in a secure and transparent manner.  Blockchain has the potential to revamp even historically bureaucratic fields, such as healthcare, real estate, automotive/land title work, insurance, and the judicial system.

[1] https://www.forbes.com/sites/rogeraitken/2017/11/21/smart-contracts-on-the-blockchain-can-businesses-reap-the-benefits/#6d23a8461074

[2] http://www-03.ibm.com/press/us/en/pressrelease/53013.wss

[3] https://www.reuters.com/article/us-blockchain-coca-cola-labor/coca-cola-u-s-state-dept-to-use-blockchain-to-combat-forced-labor-idUSKCN1GS2PY

Black Market + Money Laundering

An attractive feature of bitcoin is that while every transaction is transparent and public, the parties involved are anonymous.  If Party A transfers 3 bitcoin to Party B, they would only be identified by their bitcoin address or “public key.” A user’s “private key” serves as their signature or password and remains hidden.  However, no personally identifying information is necessary to complete the transaction.

Bitcoin was initially adopted by true believers of blockchain technology’s potential, but also by a less savory bunch.  Bitcoin’s anonymity and lack of regulation was enticing for criminals and those looking to fly under government radar.  Thus, bitcoin’s early days saw it become the lifeblood of the digital black market.  For several years, a criminal marketplace known as the Silk Road flourished on the “dark web.”  Before it was shut down in 2013, one could purchase illegal drugs, guns, child pornography, and even hire hit men.  During this time, 30% of all bitcoin transactions took place on the dark web, but now that number is down to 1%. Bitcoin was initially cheap and relatively stable, but this past year’s catapult to nearly $20,000 and subsequent volatility has led the criminal element to adopt other cryptocurrencies.  When the FBI shut down the Silk Road, they seized what is now worth $1.2 billion worth of bitcoin.

Increased government regulation is also making bitcoin less appealing for criminal transactions.  Most popular bitcoin exchanges now require identifying information to create accounts in order to comply with IRS regulations.  Although the public key may just be numbers without personal information, law enforcement has now developed methods of identifying users if necessary.

While criminal transactions using bitcoin have dropped, it is still an attractive option for money launderers.  New research shows bitcoin has led to a large upswing in money laundering.  Now that bitcoin is more mainstream, a growing number of real estate purchases are being made with bitcoin, offering ripe opportunities to convert illicit funds into legitimate assets and cash.  However, the law surrounding money laundering and bitcoin is still being settled, including whether it is subject to the same federal banking regulations as traditional currency.

Valuation 

Numerous factors make bitcoin an extremely risky investment.  Bitcoin was created out of thin air by computer code. Bitcoin has no underlying value, other than what people are willing to pay for it.  Its valuation isn’t tied to performance like a company’s stock price, but simply by the whims of market demand.

 Bitcoin’s recent roller coaster price changes have caught the attention of government regulators.  The wild west of bitcoin will likely soon be tamed by the Commodity Futures Trading Commission and the Securities and Exchange Commission.  The uncertainty about future regulation and its effects will continue to fuel bitcoin’s volatility.

Another major issue for volatility are the exchanges where bitcoin is bought and sold.  One of the most popular, Coinbase, has experienced severe growing pains since demand ballooned so quickly.  At the height of the recent bitcoin boom, the Coinbase exchange crashed several times due to the volume of trading occurring.  With huge price swings occurring by the minute, the inability to sell for hours at a time caused many to lose thousands of dollars.

Competition

Bitcoin was the trailblazer of the cryptocurrency world, but there are now thousands of other cryptocurrencies and blockchain platforms.  Bitcoin also only serves a specific function – transferring money. Bitcoin cannot be rewritten now to include added functionality that other cryptocurrencies have added, like “smart contracts.”  This inflexibility may hurt bitcoin in the long run.

https://www.forbes.com/sites/johnwasik/2018/03/21/how-new-ruling-will-curb-crypto-bitcoin-bubble/#699f9e42ae2b

http://fortune.com/2017/12/22/coinbase-bitcoin-crash/

You’ve likely heard Bitcoin discussed on the news recently.  At one point, Bitcoin skyrocketed to $19,000 in a matter of weeks, only to plummet in value shortly thereafter (it’s valued around $8,000 as of 4/18/18).  It’s not unheard of for its value to fluctuate 20-30% daily. Bitcoin will likely remain a highly volatile investment as the general public, Wall Street, and world governments come to terms with it.  So what exactly is Bitcoin?

Bitcoin was invented in 2009 to be a new, purely digital currency (known as a cryptocurrency).  Satoshi Nakamoto developed bitcoin as a peer-to-peer electronic cash system allowing online payments to be sent directly from one party to another without going through a financial institution.[1]  Satoshi Nakamoto’s true identity is a mystery, as this name is widely believed to be a pseudonym.  Whoever Nakamoto is, he or she is a billionaire. When bitcoin’s value surged to $19,000, this anonymous owner of 980,000 bitcoins was worth $19.4 billion.[2]

What differentiates bitcoin from traditional currency is its decentralized design.  It is not created and distributed by a central authority, in the way the US Federal Reserve and other central banks mint and control their currencies.  The bitcoin system is maintained by an open network of computers spread around the world.[3]  Central banks can manipulate their currency’s value relative to others by controlling its supply.  Since Bitcoin isn’t controlled by a single entity, its value cannot be manipulated by fluctuations in supply.  The supply of bitcoin is tightly regulated by its underlying algorithm, only releasing a few bitcoin each hour.  People can “mine” bitcoin by using specialized computers to solve highly complex mathematical equations, which verify and authenticate each bitcoin transaction.  Bitcoin is the reward for performing this service, a self-sustaining incentive helping maintain the integrity of the bitcoin system.

The mechanism for recording each bitcoin transaction is also very unique.  A financial institution or bank maintains a ledger of all their client’s transaction records, likely stored on a centralized computer server.  However, every single bitcoin transaction is stored publicly on a massive, decentralized, and continuously updating digital ledger – collectively known as the “blockchain.”  After each encrypted transaction is authenticated (in the “mining” process), the record of that transaction is added to a “block” – which is comprised of other authenticated transactions bundled together.  That “block” is then added to the end of the existing “chain.”

As the “blockchain” continues building upon itself, you can’t go back and edit blocks in the chain to alter previous transactions.[4]  Tampering with the blockchain is nearly impossible.  To alter the target transaction, you’d have to change every single transaction that followed as well.  

There are certainly some problems bitcoin’s facing (discussed in The Downside of Bitcoin), but regardless of its success or failure, “blockchain” technology has immense potential (discussed in The Future of Blockchain).

[1] Bitcoin Whitepaper, https://bitcoin.org/bitcoin.pdf

[2] https://qz.com/1159188/bitcoin-price-approaches-20000-making-satoshi-nakamoto-worth-19-4-billion/

[3] https://www.coindesk.com/information/what-is-bitcoin/

[4] https://www.cnet.com/news/blockchain-explained-builds-trust-when-you-need-it-most/