Demystifying the Blockchain Technology

We've come a long way from trading sea shells. Currencies have existed since civilization itself with new methods of payment regularly replacing the old. Today we're experiencing the rise of digital currencies, and the question is: Is virtual money for real? And what do mysterious terms like "blockchain" and "bitcoin" mean, anyway?

We've come a long way from trading sea shells. Currencies have existed since civilization itself with new methods of payment regularly replacing the old. Today we're experiencing the rise of digital currencies, and the question is: Is virtual money for real? And what do mysterious terms like "blockchain" and "bitcoin" mean, anyway?

Building Blocks

With traditional methods of payment, transactions and account balances are verified, processed and recorded by a central authority, like a bank - the ledger is centralized. Whereas, cryptocurrencies, such as Bitcoin, are based on blockchain technology, which is a decentralized, distributed ledger that keeps track of transactions but is not a currency itself. Blockchain is maintained by a community who deal directly with one another when making transactions, versus a centralized ledger, such as a traditional bank.

Say Andrew wants to pay this month's rent to Kate electronically. The transaction, also known as a "block", is announced to the community, who each allocate portions of their computers to hold and maintain a complete copy of the ledger containing all past transactions. Each computer consults the ledger to verify that Andrew has the money and hasn't already spent it elsewhere. Once the community network has verified the transaction, a new block (essentially, a timestamped ledger entry) is added tot he existing "chain" of blocks. There is now a permanent and transparent record of the transaction. Kate receives the payment from Andrew.

A history of all past transactions is accessible to the entire community in real time, which helps keep the ledger accurate. Further, transactions between members and their account balances are encrypted for personal privacy. Each member has a public key, allowing them to transact on the blockchain, and a private key, which gives them access to the individual account and allows them to make complete transactions.

Once the encrypted transactions - blocks - have been added to the chain, they are theoretically secure and can never be altered. As a result, blockchain technology has potential uses in other situations that require accuracy and prevention of double entries, such as election vote counts, health-care records, and supply chain management. It isn't limited to transferring funds using digital currency.

Putting the "crypto" into "currency"

If blockchain is synonymous with a bank's ledger, cryptocurrency is money and Bitcoin is a dollar. Many confuse blockchain with cryptocurrency, but blockchain is the technology, while cryptocurrency is one way the technology can be used. Like regular currencies, cryptocurrencies are units of exchange. The "crypto" in cryptocurrency stems from the use of cryptography to encode and secure transactions.

There are thousands of cryptocurrencies, the most popular being Bitcoin. While regular currencies are issued by governments and administered by central authorities, cryptocurrencies are issued by the rules of the community and collectively administered using blockchain technology. Unlike currencies, cryptocurrencies do not have legal tender status, meaning that they are not required to be accepted as a form of payment.

Approaching with caution

As useful as cryptocurrencies appear, they are currently less an accepted method of payment then speculative investment, as you can see by the intense volatility in cryptocurrency exchange values such as Bitcoin. While blockchain technology appears to have a bright future, cryptocurrencies remain in question and are still considered extremely speculative investments.

As such, we would not recommend cryptocurrencies as part of a sound investment strategy at this stage of the game.

Mathieu's column, Your Financial Corner, will appear in each edition of Chamber Vision magazine, published by The Chamber of Commerce for Greater Moncton.

About the Author

Mathieu LeBlanc, CPA, CA, CIM

Associate Portfolio Manager, The Cormier Group of RBC Dominion Securities
Mathieu LeBlanc is a Chartered Professional Accountant and Associate Portfolio Manager with The Cormier Group of RBC Dominion Securities.