From the course: Finance Foundations

Blockchain: Introduction

From the course: Finance Foundations

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Blockchain: Introduction

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- [Instructor] A blockchain is a distributed data storage system in which data are stored simultaneously on many network computers in time-stamped groups, or blocks, that are linked, or chained, to previously-stored blocks of data. Imagine a network of five people who pay money to and collect money from one another on a regular basis. Rather than having these transactions go through a traditional bank, the five people decide to take care of the transaction processing, recording, and verification themselves. The record of each transaction is put into a computer program that creates a code identifier, a hash for the transaction. That hash along with the hash of the immediately preceding transaction is saved along with the transaction data and sent out to the five people in the network as a block of data. A collection of blocks of data with each block linked to the preceding block by containing that preceding block's hash, that's called a blockchain. These hashes are generated by publicly available cryptographic or code programs. This process systematically generates a messy stream of characters and numbers, such as by using certain digits in the square roots and cube roots of prime numbers, that's scary. Now, if you give me a hash, can I work backward to get to the original data? Well, yes, but that process basically involves systematically trying every possible initial input to see which one gets transformed into that hash. For a detailed record of a financial transaction, working backward through each possibility would require a trillion years or more. Here's my favorite description of hashing, unhashing and that process. Yes, the process of hashing a cow into ground beef is publicly known and fairly straightforward, but unhashing that process to turn the ground beef back into a cow is not doable in a finite amount of time. If an outsider, an evil hacker, gets into one of the computers in the blockchain network and changes a number or character in the transaction data and one of the blocks in the middle of the chain, the hash identifier for that transaction immediately changes. Remember that in the network, there are other copies of the original blockchain. If the network runs a consensus program, the fact that one copy of the blockchain is corrupted would be quickly revealed. In fact, to successfully change any transaction data in the blockchain, a hacker would have to change the data and fix all the hashes in a majority of the computers in the network. That is a lot of work. This is how data security is maintained in a blockchain system. Let's consider how a blockchain system is different from a traditional bank account information system. With a traditional bank, the processing and storage of data is centralized. Data security is assured through firewalls, encrypted data, careful email policies to keep out hacking attempts on the bank's system, virus and fraud protection software, education of employees and customers and so on. Banks basically adopt this policy, put all your eggs in one basket and then carefully protect that basket. With a blockchain system, data security is assured through distributed storage and frequent comparison of the verified blocks among the different computers in the network. Now, the question is this, when is a blockchain system better than a traditional centralized database system? In the United States, for example, large banks have traditionally proved to be reliable in maintaining accurate financial records for depositors, borrowers, and the transactions with each. So continued use of centralized databases by large, trustworthy banks probably makes sense. But in a developing economy or in an economy where there has just been a major financial meltdown, a blockchain system makes more sense because responsibility for maintaining the database is shared among the network of users. Blockchain technology is sometimes described as the solution to all of our data problems. While that's true in many cases, but in settings in which the central organization, such as the bank, is trusted and has reliable redundancies in terms of data storage and backup facilities, there's still room for centralized data systems.

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