Bitcoin, Blockchain, Initial Coin Offerings – A short primer

[column width=”1/1″ last=”true” title=”” title_type=”single” animation=”none” implicit=”true”]

I was talking with a few high level business types, doctors and lawyers from an aviation community I belong to and the subject of bitcoin came up. It seems there is a lot of conjecture out there and myths being perpetuated, so I thought I’d put together a short primer for those who are not technical. If you have questions, please ask!

First, let’s explain some basics.

Bitcoin is a cryptocurrency that is based on a distributed ledger system called Blockchain. Blockchain is the underlying technology that allows Bitcoin to exist. Blockchain can be used as a distributed ledger for any kind of asset class, physical or virtual.

Blockchain – A distributed ledger

A block in the Blockchain represents a ledger entry that shows a key for the underlying asset (virtual or physical), the public identifier for who owns it and the public identifiers showing the chain of ownership since the block was created. When I say public identifiers, that doesn’t mean we know the real entity, we just know the public string of letters and numbers that serve as a proxy for who owns that block or what it represents. Each identifier also has a mathematically derived component that can only be matched if the public identifier and the owners private key are combined in a prescribed way. When someone trades something of value using a Blockchain, they trade a block or series of blocks representing value in exchange for something else of value. It’s also not just one centrally controlled ledger. They key to making this work is there are multiples of this mutual ledger spread all over they place to the extent that no hacker could ever take control of all of the copies of the ledger at one time. Bitcoin has millions of copies of the ledger across the planet. The airlines are considering using a distributed ledger to control messaging from sensors in various airplanes. Every airplane, every airline and multiple countries would have a copy of the ledger. More on why that is important in a minute.

Blockchain is a brilliant system of trading assets; like Bitcoin; because everyone and their brother has a copy of the ledger, and you can’t steal the title of a block by hacking the ledger.

ok, let’s peel back a layer and look a little deeper.

Bitcoin – A ton of math on top of a Blockchain ledger

Bitcoin is mined by a computer acting as a clearing house for current bitcoin transactions. A single Bitcoin is composed of multiple blocks on the Blockchain. Bitcoin is traded on the Blockchain system described earlier in this article. Bitcoin is created by a miner running a mathematical signature on the whole ledger to date. It then takes that signature and runs a complex mathematical equation to create a new Bitcoin block.

When Bitcoin first came into being, a computer could take care of the very few ledger transactions, do the math calc on the short ledger and create the next block (bitcoin fraction). That block address would be published to all miner’s ledgers and the owner would be the miner’s public key. The miner could then sell the block to someone else for an arbitrary value. Think of this process as exchanging the title to a deed in real estate. I give you some form of value and you give me ownership of the title. Initially, the process was very energy/compute freindly, and you could mine a whole bitcoin for not much real money spent in electricity/compute resources. Think pennies on the dollar.

Several years later, today, the ledger parsing/cryptography math computation to create the next block has become very electricity/compute intensive. I doubt it takes $3800 in electricity and compute resources, but it’s certainly more than a few hundred.

Here’s why:

In order to mine the next block, a miner has to perform a clearing house function on the current transactions (and keep the ledger whole) in order to get the math to calculate the next block. As we approach 21 million bitcoins, you will no longer be able to generate another block and the machines that process bitcoins will charge a fee to cover the electricity/compute to clear the transactions. It’s predicted that the last Bitcoin will be minted in the year 2140. The last 5% will create a conundrum for the folks who manage the ledgers in cost benefit to mine the last coins, or just charge a fee to cover keeping the ledgers synchronized.

Now, since miners are located all around the world, that means everyone has a copy of the ledger. Your friends, your enemies, people who don’t give a rats a$$. So, you can’t game the ledger because all the other ledgers will disagree and call you out. You’d have to game the entire ledger system, and that is impossible. (Now you can think back to the airline example I gave earlier. Make sense?)

I have the following thoughts on Bitcoin:

Pros:

• Takes banks out of the value chain. No more overdraft fees, you either have money or you don’t. This is the same concept as Amazon taking over retail. They got rid of the middleman. (Blockchain WILL disrupt real-estate and other business models.)
• More secure than cash. You need a secure code. You can literally hide it in your virtual mattress and no one can steal it if you’ve taken care to protect your private key. Why would I ever carry cash around? Maybe just a little cash in case I get mugged.
• Not subject to runaway inflation like government currency is. It’s borderless. While fiat currencies may become completely worthless due to wars, corruption, etc, Bitcoin should theoretically hold it’s value as long as the whole world is not crashing into the sun.

Cons:

• Someone could steal your private key. If you have a digital wallet and have given someone like Mt. Gox your public and private keys, someone could hack the system, like was done, and steal your blocks. The community learned a lesson and this should not be as major a threat in the future as it was in the past.
• If a thermonuclear EMP (or just plain old EMP) occurs and wipes out electricity, it’s all over until infrastructure is restored. (And we all now how well our infrastructure is taken care of! Not!) You would still hold the private key, and you’d still own the blocks, but without computing resources to trade, you’d be dead in the water. Of course, in our current banking society, you have the same problem. You’d still need some kind of hard physical currency with a trusted value.
• If there is one agreed to currency, then it has value. What happens if there are competing currencies? Ethereum? Dogecoin? Litecoin? Can they all co-exist and have value? Maybe… Only if everyone understands the system, and more importantly, trusts that the correct value has been assigned. Otherwise, if people don’t understand well enough to not trust it, it all evaporates into thin air.

Initial Coin Offerings – Disrupting the IPO market

Initial Coin Offerings (ICO) are based on Blockchain, but they should not be thought of as a currency, necessarily. What you are buying is a block of ownership of that particular company that is offering the ICO. As that company builds equity, the value of the block of that company should increase, and should have value that could be translated into Bitcoin, Ethereum, USD or perhaps a real-estate trade where the real-estate is held in a Blockchain-based system. It’s just a disruption and a bypassing of the IPO market. You are essentially paying the company with the ICO real money. In exchange, they give you blocks in their Blockchain that represent the value of their company. They save a ton of money on banking and legal fees, which should help them get profitable sooner. However, be warned that if the company folds, your ICO is worthless.

Times are a changin’!

I bought a quarter of a bitcoin a few years ago for $85. Last I checked it was $999.89. I’ll just hold it in my Coinbase wallet. I’m not buying any more right now. The risk was much less a few years ago. Right now there feels like too much risk. I would certainly accept Bitcoin as payment for my services, but I would immediately translate it to USD.

I think Bitcoin, digital currencies and especially Blockchain are here to stay.

Clients rely on me to transform their technology from a growth inhibitor into a growth accelerator.

© Mark Travis – All Rights Reserved   http://www.travis-company.com

[/column]