Understanding Bitcoin, Ether, cryptocurrencies, blockchain and "distributed ledger"

Here is a PSA for anyone confused by Bitcoin this, Bitcoin that, "cryptocurrencies", "blockchain" and all that.

First of all, you do not need to understand what "blockchain" is any more than you need to understand how your iPhone identifies you by your fingerprint. It is underlying technology serving a purpose.

Second, you do not need to understand anything about currencies. Later, you may but to understand the fundamental concepts involved which you can explain to a 12 year old, you don't.

So in order to avoid that let's start with something that is not money at all. Imagine that there was a ledger (a book with records) in which ownership of every piece of land was recorded. Each parcel of land is uniquely identified and it says next to it who owns it. There is such a ledger - it is called "land registry" or "cadastral system" and just about every country has them. Many of you have bought and sold property and are familiar with the process of transfer of land ownership.

Let's say that XYZ wants to transfer her ownership of a parcel of land to ABC. They go to the land registry office (via their lawyers carrying notarized pieces of paper with signatures) and the transaction is recorded in the registry and anyone who wants to know who owns a particular piece of land can go to the land registry office and look that up (and in many places you can look it up online).

Now imagine that instead of one book (physical or electronic) existing in one place (City Hall land registry or another place) there were 100 of such books kept in different places by trusted parties such as government entities, banks, insurance companies and any number of non-profits who just want to perform a useful service. And each of those 100 books gets updates instantaneously with any transaction taking place anywhere.

So XYZ and ABC now don't have to send their lawyers with a 3 page notarized document to the Land Registry office but they record their transaction in a much simpler way by accessing one of the registry books. With procedures in place to make sure that ABC was not holding a gun to XYZ's head when they both made their transfer of ownership entry.

And there you go - what I just described is called a "distributed ledger" - a record of transactions kept synchronized in many different locations. The process of adding one transaction is adding of a "block" to "blockchain". All with levels of security and redundancy that do not change the fundamental principle. If 100 identical books is not enough you can have 500 or 5,000. Whatever is deemed sufficient and secure from tampering. And there is a process for ABC to go and later say "hey, there was a gun to my head so that transfer should be voided".

What I just described for transfer of ownership of land, applies to any other transaction between two parties. It can be for a corporation to purchase a tanker for $343 Million by wiring that money to the seller or can be for me to buy a burger or give my friend $17 for the share of dinner he paid for and we did not ask for separate bills (Venmo).

And in the example that I gave for land transfer just think how much money would be saved? For legal fees, for notaries, for in some places like the US "title insurance". Massive amount of efficiency squeezing out costs just like that. No wonder people are excited about it.

So why then all the controversy and hot air expended making most regular people confused as to whether it is "real" or "not real"?

Because when originally conceived in 2008, Bitcoin started "from the wrong end". Instead of first being put in place for large transactions, not involving money and occuring relatively infrequently, it was invented to enable payments among people online in very small amounts. It was a system to allow somebody to pay somebody else $17 without having to go to the bank to make a wire transfer, which the bank charges $20 for and to make a payment to somebody in Ecuador by somebody in Belarus who can't give each other cash.

So instead of starting with large, infrequent transactions, it started with micro-transactions which there was a lot of. And as the success of the model built because it makes so much sense not to have to pay a bank $20 just to transfer your own money to somebody else, it ran into problems of scale. There were a lot of transactions people were doing and because each transaction has to be instantaneously duplicated in every location where the ledger is kept, it became a big problem of computing. Just not enough capacity to quickly process all the transactions people wanted to make. And since that is fundamental to the functioning of the system, that is a big issue.

In addition, because the concept is so powerful and yet simple, if one set of people could organize Bitcoin system of distributed ledgers, another group can organize Ether and there are now dozens of different varieties out there. And they all want to make money so they will all try to convince everyone else that they are the best alternative (as I would) and that is where you get a lot of noise, competing claims and so on.

The final problem was that because this was just a group of people wanting to trade things online, they could not from Ecuador send their currency to Belarus and for that to be useful to the guy in Belarus. So they had to invent their own currency and called it Bitcoin. It was only worth something within the confines of their system but as that system grew, if somebody was willing to do 6 hours of computer programming for you for the amount of Bitcoin that was enough to buy some physical goods others were willing to sell for Bitcoin in return, the "porous membrane" emerged where you could exchange Bitcoin into actual currencies and other things of value.

And a further problem emerged because of the fact that these transactions could be made completely anonymously so you could use them to buy drugs, weapons or a contract hit in parts of the Internet where such things are traded. Nobody in the entire system had any interest in anyone knowing who they are and even the person who allegedly invented the whole system has never been conclusively identified. There are all sorts of reasons why you would not want people to know your name and address, not the least of which being that if you make a profit, you will be asked to pay taxes on it and that people online generally do not like. (Some of you are too young to know but when Amazon started, it was allowed to sell goods without charging a sales tax that any regular book store would have to charge it's customers).

So that is all that you need to know about it. And the conclusion is "distributed ledger" as the principle of keeping track of transactions makes a lot of sense and "blockchain" as a technology through which you keep those transactions secure, moving along fast and costless works. None of it though "requires" any new currency and in not too distant future we will have distributed ledger systems in place where money in existing world currencies will be tracked this way. At first, large amounts among big banks around the world and eventually when you pay $3.48 for a Big Mac.


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