A while ago, back in 2018, I covered some tech talks that were part of the first edition of Pint of Science México. Two of them were particularly interesting for me, and this was one of them: “How to Explain Blockchain to Your Grandma in 20 Minutes”. Below I am leaving the English translation I made of my post, where you will find blockchain explained for non-techies.
During the second night of Pint of Science México’s first edition, at the Peter Brown bar, the director of Technology Development of Mifiel and Volabit, Genaro Madrid, talked about the greatly-famous-controversial-and-little-understood technology called blockchain. Pint of Science is an international festival of science communication that takes researchers and specialists out of their ivory towers to take them to bars, where they can engage in a dialogue with the general public.
The housing bubble bursts
Between 2006 and 2007, the American real estate market was at its peak: everyone gave loans to buy houses. The problem was that these credits did not have money to support them and were granted to practically anyone, without verifying if they had the money to pay them. The hope was that those who did pay would cover what others had yet to pay. And then came the 2008 economic crisis, precisely because the banks gave loans with money they did not have.
Do you know Satoshi Nakamoto?
In those years, someone with the alias of Satoshi Nakamoto proposed a mechanism by which this kind of thing could no longer happen, a system that does not allow the printing of paper money without having a real value to support it, and guarantees it to be easy to track. This is how the cryptocurrency called bitcoin was born — Genaro warns: there are other cryptocurrencies, but this is the one around which blockchain emerged. And the “chain of blocks” arises to satisfy specific needs of that mechanism. So, to understand blockchain, we first need to understand cryptocurrencies.
A bitcoin is a digital currency… But what is a currency?!
Every day we use coins (pieces of metal) and bills (paper or plastic cuttings) that, even without having any physical or real value, we exchange for other things that do have value. Centuries ago, the method used was barter: exchange of products… and done! But what if I want what you sell but you do not want what I sell? How would we make the exchange?
That substitute in the transaction was required to be:
- Scarce: if, for example, sand were used, any type of product or service could be bought simply by going to the beach and accumulating large amounts of sand.
- Unforgeable: something easy to identify, that cannot be substituted for something else without the receiving seller realizing that it is not genuine.
- Divisible: practical in order to make small transactions, regardless of whether the monetary unit has a very high value.
- Transportable: not annoying or impractical when it is necessary to transport yourself to another community to buy something.
- Durable: not perishable.
- Expendable: gives the possibility of exchanging products, meaning you can exchange them and retain the same value.
In Greece little shells were used, in Mesopotamia cocoa beans were adopted, in Europe salt was chosen — hence the word salary. Later, this type of currency, called commodity money — it has a value and can be exchanged for other things that also have value — would be replaced by gold, which would become the main medium of exchange. Nowadays, the currency represents work: if you have something you want to sell, the price you give it depends on the work you have invested in it; this is elementary to understand how bitcoins work.
Representative money emerged many years later in China when an emperor came up with the idea that he could keep people’s money and, in return, he would give them vouchers (tokens); when his subjects demanded their money back, they could claim it through the vouchers. In Italy this same service began to be offered, merchants used to do their business on the benches (banche, in Italian) in public squares. Thus banking was born. The document/voucher specified how much money the customer had saved and the exchange rate.
Eventually, since these vouchers represented money, people realized that they could exchange them for goods and services, although those documents were not essentially money. The problem came when you wanted to exchange your documents with a different merchant than the one who had issued them to you: the other merchant had no proof that what was written in your documents was true and, therefore, it was of no use to him. To solve this, the Government created a central bank, and it was the only one that could issue the documents and keep the money.
The world is priced in dollars… and then in fiats
After World War II, when world finances were going through difficult times after six years of armed conflict, almost all countries chose to adopt the dollar as the representation of their money, since the United States (US) did have the funds that they did not. Years later, when countries decided that it was time to get their money back in dollars, another global economic crisis occurred.
Instead of representing money it no longer had, the solution the US came up with was: “Let the price of my currency determine the market.” Fiat or fiat money enters the scene: money is no longer backed by any kind of thing. Following the example of the US, the trend of separating gold from money was emulated in other countries around the world. Those were also the years of the appearance of debit cards.
The 2008 economic crisis and money’s “loss of identity”
Now that we have an idea of its origin and the problems money can have, let’s go back to the crisis of 2008. By the time money reached this point in its history, it had already lost two of its essential characteristics:
- It is no longer scarce: banks are free to print as many bills as they want, and thus control the price of money.
- Now it is falsifiable: you do not know if the bank is giving you real money, nor if it is really backed by a tangible good.
Faced with this problem, Satoshi Nakamoto poses the challenge of returning money to all its essential qualities, which are what make it work, and without it ceasing to be electronic like the one we currently use (90% of the money in circulation does not physically exist):
- Divisible: it is a computer, it is something digital, it can be divided n times.
- Transportable: thanks to the internet, it is.
- Durable: it is a computer, it is digital, it can be kept for as many years as desired.
- Unforgeable: how do you beat copying?… How about a database?
- Scarce: again, how do you beat copying?… How about we slow down the creation speed?
As “simple” as a public database
Instead of an image or something virtual (like a PDF), a database is created where transactions are recorded: each bitcoin is tracked and, at the end of the day, it is known how much the gain of each person is. So far, nothing out of the ordinary… Wait, this just gets better: it is a public database. But like, why make it public?… Well, so that all the people involved (and any individual who wants to) can access the database; this way, under public scrutiny, no one can sell/buy a bitcoin that does not exist. Get it?… Through this decentralized system, money regains its unforgeable quality.
Let’s give money a break from the accelerated postmodern pace
Aha… and how do we slow down? By implementing a proof-of-work (PoW) system, the foundation of bitcoin: making money represent work once again. “If you want a bitcoin, you have to work for it”; this process is known as mining. Such proofs of work, carried out by a specialized algorithm (or a combination of them), produce a new block of information every 10 minutes: you run a process that takes 10 minutes and, when you send it to someone else, this person runs the program and it takes another 10 minutes, thus validating that it also took you 10 minutes to run that program. And finally, money becomes scarce again, thanks to the time/labour it takes to produce each block.
How to send/receive bitcoins?
Let’s go back to the decentralized and public database where all transactions are recorded. A wants to send a bitcoin to B, but they do not trust each other. Bitcoin essential issue. The only way to exchange goods when the other is not trusted is through a third party, to validate the transaction. C, the third, is a miner. The miner earns a commission from each transaction whose data he/she validates. The miner provides sense to the system because without he/she you would have to save the database on your server, therefore destroying the qualities of being a public and decentralized system.
The miner takes a set of transactions — the ones paying him/her the best, obviously, because there lays the gain for this third party — and saves them in a block. A block is a series of listed transactions and points to the previous block, the one that the miner used as the basis for validating that the transactions in question have a history. So, when you want to buy a bitcoin, you will have the certainty that whoever is selling it to you actually received it before selling it to you.
The immutability of bitcoin
The system is designed in such a way that it is more profitable to join it than it is to hack it. You cannot modify what is already validated, you can only add things to the new link in the chain of blocks that you are producing based on the block immediately before yours, but you will not be able to remove things or modify them in its history. When executing the algorithm you are running, it points to the previous block, and this is what makes it a chain. And, of course, everyone wants to build on the most recent block to start working from there (because it takes less time and less work).
If, in addition to the above, we take into account the period of 10 minutes that each block in the chain requires to be validated, the result is that, with the currently available technology, it is impossible for someone to modify a block because, to achieve this, they would have to run the PoW in less than 10 minutes and process more than one block at a time (the most recent and the previous ones, starting at the point where he/she wanted to insert a modification). And, it is not monetarily viable either: the person would have to own 51% of the computers participating in the mining process. Only this way would it be possible to modify history.
The offer of bitcoins is limited
Satoshi Nakamoto designed this system to ensure control of the currency, thinking of saving it from falling into the dreaded inflation of business cycles. How is that achieved? In 2009, for validating 8 blocks, a miner earned a reward of 50 bitcoins, a reward that is divided in half every 4 years; so, in 2012 the sum dropped to 25 bitcoins and since 2016 it is at 12.5 bitcoins; then, by the year 2140, the bitcoins will be produced no more. Thus, bitcoin is not an inflationary currency. And, as they are being produced less and less, the value of the bitcoins that exist increases.
And what does this have to do with the blockchain? Well, it takes on meaning because, as it is a monetary system, that is, the miners who are working do it for money, and since the reward they earn is based on bitcoins, they are interested in bitcoins keeping their high cost. If bitcoins have no value, then your work is not worth it, and the whole mechanism of this system breaks down. Hence, the miners themselves are a key element in the conservation of the system’s mechanism.
In conclusion, blockchain is a public ledger, it is decentralized; and no one can control it, unless the whole history changes — currently not one country has the necessary power… neither one country nor anyone else ; immutable, nobody can modify it, which not only has benefits for bitcoin, it also has benefits for everyone.
To record transactions, and a lot of other things, it is super useful. And it is a financial system: without a monetary value, it simply does not work. You cannot have a local blockchain system working in your company, it does not work; you would just have an extremely difficult and slow to manage database… And that’s it.
It is cryptographically validated:… is not like you have to believe anyone, you run the algorithm and that’s it. And you don’t have to run it with their system, you can validate that it’s true with any [PoW] system.
And it’s virtually impossible to hack.
Director of Technology Development
Mifiel | Volabit
What is out there for blockchain beyond bitcoin?
Keeping a record of transactions, not only of money but of any asset, like a group of all the assets and rights with monetary value owned by a company, institution or individual. For example, in Mifiel, blockchain is used for documents such as checks or promissory notes. In general, for anything that requires permanent and unchangeable registration. If you do not want it to be immutable, if you do not want it to be public: do not use blockchain.
This technology has barely been around for 10 years, we are still in a phase where all the possibilities that this economic innovation could bring with it are being analyzed: registration of legal documents, monitoring of stock market assets, property registration (houses, cars …), voting … Even fiat money, the Mexican peso, can be digitized to bring back the five essential properties of money. Blockchain was designed to provide solutions to needs for which a mere database is insufficient. The detection of these problems and the approach of their respective solutions through blockchain is just beginning.