This paper provides a non-technical introduction to blockchain technology using cryptocurrencies as an illustrative example. We describe the mechanics of blockchain and outline some risks associated with the existing cryptocurrencies.
Recent years have witnessed substantial innovation in the financial services sector with a wide range of new technologies coming to market. Highlighted by the 2016 World Economic Forum as one of the seven most world-changing technologies, blockchain is a technological innovation with the potential for broad applicability in finance.1 Consequently, many financial experts have noted the potential implications of such a technology. At the Consensus 2016 event, former US Treasury Secretary Larry Summers stated:
“I’m reasonably confident…that the blockchain will change a great deal of financial practice and exchange.”
Blockchain is a type of distributed ledger: a database that exists across several locations, usually referred to as participants, nodes, or computing devices. The most important feature of distributed ledgers is that they are not maintained by any central authority, and all updates are made after consensus among participants has been reached; the latest, agreed-upon version of a ledger is saved separately by each participant. The absence of a trusted third party is perceived by many as a way to reduce the costs of maintaining the ledger and to make the ledger more secure. Distributed ledgers can have a variety of forms, and blockchain is a particular form in which all transactions are organized in blocks that are linked to one another and secured using cryptography. Its append-only structure makes it practically impossible to alter or delete previously entered data. Thus, blockchain technology is well-suited for recording events and managing records.
At present, cryptocurrencies are one of the most quickly developing applications of blockchain technology. Cryptocurrencies employ blockchain as a digital ledger on which all transactions are securely stored. While the ideas behind blockchain trace back to a series of papers by Haber and Stornetta published in the early 1990s, recent advances in computer science have used cryptography and clever incentive engineering to make a conceptual breakthrough: a pseudo-anonymous, fully decentralized blockchain.
This paper is organized as follows. Section 2 provides a non-technical introduction to blockchain technology using cryptocurrencies as an example. In Section 3 we list some of the flaws in the existing crytpocurrencies. Section 4 concludes.