Opinion: Dave Hrycyszyn, director of strategy at Head London, takes a technical and practical look at blockchain tech in FS.
Unless you’re an accountant, you probably don’t think about double-entry accounting very much. But it’s the basis of pretty much all financial systems in the world today: bank cards, credit cards, bank accounts, money transfers and currency markets all use it.
Most of the security, auditing, and other controls that we associate with banks and payment providers exist to protect the integrity and accuracy of the ledger.
Online digital currencies like BitCoin, use triple-entry accounting. As well as credit and debit in a ledger, they introduce a cryptographic signature secret key, which is cryptographically tied to transactions.
This makes it possible to eliminate most of the security we traditionally associate with banks and other financial institutions. The ledger’s integrity is protected by cryptography, not by security guards or system administrators.
BitCoin is the most well-known of the crypto-currencies and has proved its transaction security. Starting with nothing but their keyboards, a tiny group of hackers bootstrapped an economy of about USD$3.4Bn into existence, in half a decade.
As a distributed transaction processing system, not centrally controlled by any single trusted person or organisation, is amazing. But its distributed nature introduces different problems: scalability and energy consumption.
Computers in the BitCoin network continually solve hard mathematical problems. Requiring a huge amount of processing power, and result in the production of a "block" of cryptographically signed information. Each block is added to a chain of existing blocks (thus, "blockchain"). The blockchain gets distributed to all other computers in the network, using peer-to-peer file transfers.
The time it takes for blockchain propagation across the network is a major limit on scalability. The system can only process about ten transactions each second, and there’s a lag time, typically about ten minutes, for the network to acknowledge a transaction. This is fine for some uses, but not in retail, for example. I get annoyed by three-second waits for card payments at the supermarket checkout.
Bitcoin has been criticised for of its profligate energy use. The system prevents anyone taking over and re-writing the distributed ledger by spending a monstrous amount of CPU time on solving equations. The thesis is that it’s impossible for dishonest people to command enough CPU resources in the distributed system to write bad blocks into the blockchain and subvert the currency.
BitCoin’s security requires massive electricity use. It’s estimated that the system uses enough energy in one BitCoin transaction to power an American household for a day.
Other digital currencies are attempting to solve these problems. PermaCoin, from the University of Maryland and Microsoft Research, asks: why should we guarantee distributed cryptographic security by doing a huge amount of useless work? Why not do something socially useful, like archiving the internet, instead? However, this doesn’t solve the scalability problem.