The fundamentals of blockchain, explained by an expert.
Blockchain has moved from whiteboards to reality, and is gaining momentum in a number of industries. To get a better understanding of what the implications of this are to all of us, ESRA spoke with Daniel Rice, co-founder and CTO of Bootstrap Legal. The topics ranged from the basics of blockchain to its relationship with Bitcoin and smart contracts.
The conversation started with the simplest question: “What is Bitcoin?”
“The beginning of it was around 2008, 2009,” Rice replied. “The ideas was to create a form of digital cash. In my mind, the concept of digital cash wasn’t possible then, because it’s based on not being able to copy certain data. If it’s just a file on your computer, then can’t you just copy the file and double your money?”
He continued: “So Bitcoin was a way to say, ‘Here’s a way to have digital assets that can’t be copied. And the first asset we’ll put out is a form of money called Bitcoin.’ It’s cash you can send to someone else, but there’s no party in between.
“When we look at how we send funds today, you go into your bank’s portal, you send it to someone with an account at another bank. It’s really a transaction between the banks. But what Bitcoin does is take the banks out of the equation.”
So why Bitcoin, instead of the money you already have?
“That’s a fundamental question everyone asked when Bitcoin was first launched online by its anonymous creator. There was a big question about whether it had any value and if anyone could use it. Typically, currency has to be backed by something, but what if I create a new type of currency and put it on the Internet? Will it be worth anything?
“The first big moment for Bitcoin was when it stopped being worth zero and was worth anything, because suddenly you had this make-up currency that suddenly had value. So we became aware that it was possible to bootstrap a currency.
“So why would you use it? The founder of Bitcoin said in a forum post, ‘What if you could instantaneously give money to someone anywhere? Would that have value?’ People said it did, because they could send it to someone anywhere in the world.
“The second reason why it’s appealing is because it’s what I would call more sound money. There will only be 21 million Bitcoins ever created, so you run into this supply and demand issue where as people use it, it becomes more scarce, and therefore more valuable. In the first transaction on the Bitcoin blockchain, the creator had published a headline from a UK newspaper talking about the bank bailouts from the real estate crash, so the idea was that printing money had gotten out of control.”
How many Bitcoins have been created so far and how do they get created in the first place?
“I think we’re somewhere around 15 million Bitcoins right now. I’ve been working in this space for about four years, and when I started, it was around 13 million. The way they’re created is a process called mining, which is the fundamental breakthrough in the network. There’s this thing called the ‘Byzantine General’s Problem,’ which says that if you have multiple parties who want to talk online and some of them may have sporadic connections, you don’t have any way of knowing how much time has passed on the network and if the information you’re receiving is accurate.
“So the idea of mining came from something called ‘proof of work.’ The idea is that you ask computers to solve a math puzzle, one that can only be solved by brute force, which means that you can’t teach your computer to solve it. So every computer that’s mining on the network is trying to brute force guess the answer to the problem, and whichever computer solves it first gets to mine that block. And you get a mining reward, which right now is 12.5 Bitcoins, every time somebody on average finds a solution to that puzzle. In today’s money, that’s worth almost $100,000.”
How do you see how many Bitcoins you have, and how do you send them to someone?
“The model is very different from a bank. Since there is no bank involved, you are the bank, essentially, on the network. You can think about yourself that way because you’re responsible for your own Bitcoins, because if you lose your private keys, you lose your Bitcoins. The assumption is that quite a few Bitcoins have been lost that way. There are stories of people getting rid of their hard drives and realizing that they had keys to Bitcoins on them.
“You have to have a wallet, which is software on your computer that can compare what you have with what’s on the blockchain ledger on the network. Each computer has a full record of every transaction that’s ever happened on the network, so the data takes up many gigabytes. So if you have that full record, you can see how many Bitcoins are in that account and can use your wallet to send other people coins.
“When you send someone coins, a request is written that uses the private key to create a digital signature on that record so the network can validate the transaction and finalize it.”
What is Bitcoin’s relationship to blockchain?
“There were things similar to blockchain before Bitcoin’s existence, but Bitcoin is what made blockchain mainstream. It was the first cryptocurrency to use blockchain technology, which is what underlies Bitcoin. On the Bitcoin network, a bit is created every 10 minutes, and a block is like an Excel spreadsheet that shows the transactions and where the balances went.
“And there’s something called a Merkle tree, which uses a hash function to create a short string of digits that identifies a larger bunch of data. So you can verify that the short string of digits is correct strong, if you have the data, but if you don’t have the data, you cannot reproduce it using the short strong. It’s a verification process around these larger blocks.
“These hashes are created and every new block that comes in is hashed, so they become a string of hashes that can also be hashed, so you can have a tree of hashes. From there, a single string of digits can identify a lot of data going back over a long period of time. And that’s what a blockchain is.”
What’s the relationship between Bitcoin, blockchain, and smart contracts?
“Bitcoin has a scripting language built into it. Early on, it was pretty complicated and had a lot of functionality,. As Bitcoin became more mature, a decision was made that Bitcoin was trying to focus on being really good at digital cash, so some of these advanced scripting features could be security issues. If there are any flaws in the scripting engine that can cause the system to crash, that could destroy confidence in the network.
“The decision was made to permanently turn off some of the scripting features in Bitcoin. Maybe they’ll be turned back on eventually, but for now, smart contracts were somewhat handicapped on the blockchain, so that’s when a lot of smart contract technology started moving toward other networks, like Ripple and Ethereum, which is the most popular smart contract blockchain out there right now, in terms of value.
“A lot of people call Ethereum ‘Bitcoin 2.0’ because basically they took the foundation that was there and added some additional things, like a complete programming language, so anything can run decentralized on the blockchain network. And you have a state engine, like a normal computer would have, that Bitcoin doesn’t have. Bitcoin has smart contracts, but they’re fairly limited, so that’s why other platforms have taken that on, since it’s more complicated and needs more functionality.
“Smart contracts are self-executing code. When we talk about them today, we’re talking about them on a decentralized blockchain network. An early example of a smart contract is a limit order in your stock account, where you have a price that you’re willing to sell at. You put the order in, and if the stock reaches that target price, the selling may happen automatically, and you don’t need to be there for that.
“The difference in the example I have is that you have a brokerage account, such as with Charles Schwab, which could decide they don’t want that code to execute. But with Ethereum or another decentralized blockchain, no one can stop it. There are exceptions to that, but in general, it means that no one can stop the smart contract when it starts. So we’re moving toward trustless computing, where you don’t need to trust a person or company to make something happen.”
What are some examples of smart contracts being used right now, in the late fall of 2017?
“I’ve heard a lot of skepticism around whether they’re actually being used. Earlier this year, some of the Ethereum developers and programmers came out and said that it was still experimental and shouldn’t be trusted with large transactions. They’re in their infancy. But when we look at Ethereum right now, we see something called ICOs happening on the Ethereum blockchain, and they’re using smart contracts.
“An ICO is an initial coin offering. It’s probably the most-used smart contract today. It has opened up a new realm of funding for start-ups. The idea behind it is kind of like Chuck E Cheese, where you have to put coins in games to play them. The idea was established that it’s not just about the currency. What if you had a company and made your own currency? Even Starbucks, where you, for example, couldn’t buy anything there without Starbucks tokens on the Ethereum network.
“A lot of people are doing it. Some of it is scammy, where people say they want to build a project and are accepting tokens for it. Or some people are just giving away tokens. For example, if you look at the way a rewards program works at a store or restaurant, you could separate reward points from a company and verify them any way you want. You could verify that the company hasn’t deleted any of your reward points or tampered with them, for example.”
What is the perceived benefit for a person or company using a smart contract?
“There are valid concerns around that. It’s a ‘You were so worried about whether you could, you didn’t think about whether you should’ kind of thing. There are definitely concerns about them being used in illicit ways, and first of all, it’s important to remember that blockchain technology can exist as a public thing but also in a federated way, between companies. For example, you could have a bunch of banks that get together and say that for a settlement, they don’t need to use SWIFT or something like that. They could create a closed network and use blockchain to audit all the records and come to a consensus about what actually took place.
“One thing people haven’t talked about a lot is the idea of consensus because everyone has a copy of the database, so there’s no dispute about what actually took place. So that’s important when you’re talking about bank transaction settlements, for example. All the banks on the network can agree where money was sent.
“Getting back to the legality question, the example I use is that if a judge or a jury decides you have to give up your Bitcoin, a judge can’t compel the blockchain to do that. With bank accounts, the US government can freeze assets in various ways, even if you don’t agree to it. But with Bitcoin, it’s a bearer asset where you can only own it by having a password, so no one can force you to give up Bitcoins without insisting you have to give up your password.
“I can consider situations where that could be a bad thing, so it does come down to a question about people’s philosophical stances on that. One of my mentors says that ‘Demand is all that matters,’ so we’re in a world where blockchain is taking off, regardless of what anyone thinks about it. The important thing is to understand it. The morality behind it has yet to be seen.”
How is security maintained and what are some of the things that could go wrong?
“A few days ago (ed note: at the time of the discussion, which occurred in January 2018), there was a situation that occurred on the Ethereum network where $150 million of assets had been frozen on the network because of a coding bug and someone interfering, seemingly on accident, But it’s a Wild West network where no one is in control of it, so this is a major shift in how you think about your assets.
“If there’s a virus on your computer and you have Bitcoin, and the virus is aware of Bitcoin, which a lot of viruses are aware of now, it could grab your passkeys and send them to the virus creator, who could liquidate all your accounts. And if you accidentally give your private key to someone or print it out, or even if a camera spotted it on a piece of paper, you could lose all your money that way too.
“As a user of the network, there is major education needed. One of my fundamental focuses as an engineer has been on usability, and in that context, w have a long way to go with blockchain. Digital signatures are something I compare to blockchain – they’ve been around for a long time and yet people still ask me to sign things by hand on paper. So I think it will take a long time to pass that education gap and for it to become mainstream and take over, especially with the huge risks involved, especially for people who aren’t tech savvy.
“The second part of it is that if you’re using any type of Bitcoin or Ethereum, you’re probably running software that could cause problems with your money. Your wallet software could have a bug in it that could cause you to lose money. You probably want to use something that’s been around for a while. Ethereum has a company in that space, called Parity, and they created a state-of-the-art wallet, which is supposed to be the most secure because it has multi-signature, where you need multiple passwords. You can take several people you know and say, ‘Here’s the password to my funds. If I need help, I may come to you.’
“But there was a flaw in the wallet, and everyone who used it after July 20, all their money was frozen. As it looks now, it could be lost forever, The only hope is that the entire Ethereum network will have its code altered in an exception to bring the money back, but everyone has to agree to it.
“It’s all about education and being careful about what they’re doing. There’s a risk that some people are getting involved without understanding what they’re doing. Even one of Ethereum’s founders said this is experimental and shouldn’t be used for anything important.”