Demystifying the Blockchain

From Bitcoin to Litecoin to Ethereum, we explain how cryptocurrency transactions work.

This is bonkers.

A new so-called blockchain company is selling virtual real estate online with prices as high as $120,000 for a 10-meter by 10-meter piece of virtual land.

You can buy a plot of virtual land in a virtual city, with certain neighborhoods costing more than others, like in a real city.

Except that it isn’t a real city. It is all virtual.

Follow? Me neither.

Somehow this company, Decentraland, managed to raise $26 million in 30 seconds from investors last year. That money isn’t “virtual” — it is real.

Welcome to the world of blockchain, the latest technological revolution to those in-the-know — and what seems like the latest get-rich-quick gibberish to the average person.

You’ve probably heard that the blockchain is a technology that is going to change the world — it is the backbone of Bitcoin, the now infamous cryptocurrency. You might even have heard someone trying to explain blockchain by describing it as a “trusted distributed ledger.”

If you’re like most people, that’s when you stopped understanding — or even trying to understand — what this whole blockchain thing is all about. (Stick with me for a moment and I promise you’ll understand it very soon.)

It all feels a bit like 1999, circa the dot-com bubble. In Cannes, France, just last week, at an annual gathering of advertisers, there was a “blockchain yacht” and a “blockchain villa.” In Davos, Switzerland, earlier this year, there was a “blockchain lounge.”

[Read more: Confused about blockchains? Here’s what you need to know.]

Meanwhile, Fortune 500 companies are investing billions in the blockchain. IBM has a whole division focused on blockchain, as do the consultancies Accenture and PwC. Jamie Dimon, JPMorgan Chase’s chief executive, has dismissed Bitcoin, but says “the blockchain is real.”

Silicon Valley venture capitalists have already sunk more than $1.3 billion into blockchain technology just this year. And just this week, Andreessen Horowitz, one of the most prominent technology firms founded, in part, by Marc Andreessen — who is credited with inventing the modern Web browser — announced a $300 million “crypto” fund to exclusively invest in blockchain technologies.

“For those of us who have been involved in software for a long time, it feels like the early days of the internet, web 2.0, or smartphones all over again,” Mr. Andreessen and his colleagues said when introducing the fund.

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Baffled by Bitcoin? How Cryptocurrency Works

From Bitcoin to Litecoin to Ethereum, we explain how cryptocurrency transactions work.

There’s Bitcoin. There’s Litecoin. There’s Ethereum. So just what is cryptocurrency, and how does it work? Essentially, it’s digital money that’s bought and sold online. There’s no bills or coins. It’s not based on another asset like gold. And it doesn’t go through traditional financial institutions like banks. Instead, these currencies operate in a completely decentralized system that uses so-called blockchain technology to track transactions. To see how this works, let’s look at how you’d buy something with cryptocurrency. Say that Alice wants to buy a bike from Dan using Bitcoin, her cryptocurrency of choice. Alice begins by logging into her Bitcoin wallet with a private key, a unique combination of letters and numbers. With a traditional financial transaction, the exchanges get sent to banks on each side who record the money being subtracted from one account and added to another. But remember, in this scenario, there are no banks or middlemen. Instead, Alice’s transaction is shared with everyone in the Bitcoin network. These networked computers add Alice’s transaction to a shared list of recent transactions, known as a block. Every 10 minutes, the newest block of transactions is added on, or chained, to all the previous blocks. That’s how you get a blockchain. To ensure that each block of transactions on the chain is verified, a subset of Bitcoin’s network joins a race to solve a difficult math puzzle. And if they solve it first, their record of the block of transactions becomes the official record. They’re rewarded with Bitcoins of their own, and the network gets a new block on the chain. This entire process is known as mining. But instead of chipping away at rock, you’re solving complex puzzles. The fact that many computers are competing to verify a block ensures that no single computer can monopolize the Bitcoin market. To ensure the competition stays fair and evenly timed, the puzzle becomes harder when more computers join in. The Bitcoin protocol says mining will continue until there are 21 million Bitcoins in existence. That’s set to happen around 2140 — if Bitcoin lasts that long.

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From Bitcoin to Litecoin to Ethereum, we explain how cryptocurrency transactions work.

That explanation of where this new technology sits within history feels right: While prognosticators love to talk about crypto and blockchain as a bubble, it is likely just very early days. And while 1999 marked what seemed like a high point for the internet before a precipitous fall, it proved to only be the first stage of the internet’s ascendance. Yes, there were implosions like Pets.com, but there was also Amazon.

And what was arguably considered wild overspending in the late 1990s on internet infrastructure and an assortment of experimental companies, ultimately set the foundation for the modern era we live in today.

Think about blockchain like this: There will be huge failures and misspent money — and yes, scams (the Securities and Exchange Commission can hardly keep up with the number of fraudulent players out there), but a decade from now, when you look back at 2018, it’s more likely than not that blockchain will be embedded in our day-to-day lives in ways that, today, we can’t even imagine.

“New models of computing have tended to emerge every 10 to 15 years: mainframes in the 60s, PCs in the late 70s, the internet in the early 90s, and smartphones in the late 2000s,” Mr. Andreessen said. And now blockchain.

The easiest and most basic way to think about the underlying technology is to think about a technology that keeps a master list of everyone who has ever interacted with it. It’s a bit of an oversimplification, but if you’ve ever used Google Docs and allowed others to share the document so they can make changes, the programs keep a list of all the changes that are made to the document and by whom. Blockchain does that but in an even more secure way so that every person who ever touches the document is trusted and everyone gets a copy of all the changes made so there is never a question about what happened along the way. There aren’t multiple copies of a document and different versions — there is only one trusted document and you can keep track of everything that’s ever happened to it.

The blockchain is, of course, being used to create all sorts of cryptocurrencies, led by Bitcoin and Ethereum.

But more important, it is touching all different industries.

The advertising industry plans to use it to track its ads all over the internet; the music industry is planning to use it to track songs; banks and mortgage companies want to use it to track the deeds of homes and the complicated process of tracking all the documentation; shipping companies are investing in blockchain technology to track bills of lading, the pharmaceutical industry wants to use the technology to verify the drug supply chain.

If it is successful, blockchain technology will bring a new level of enhanced trust to business and will also cut out the middlemen that have historically tracked — and profited — from the complexity of so many different systems trying to communicate with each other. That could lower prices for goods and services.

At the same time, for all the promise of blockchain, there are real questions about whether it may be applied to solve problems that don’t exist. Databases already exist and, in certain cases, a centralized database might actually be preferable to the blockchain.

The blockchain is ultimately about solving society’s ultimate challenge: trust. Or rather, lack of trust. Blockchain is about using technology to create a shared sense of trust by a group of disparate participants.

The biggest question is whether the hundreds of projects like Decentraland, where individuals are using real money to buy virtual property, will end well or badly — and whether that experience will ultimately instill or undermine trust in this emerging technology.

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