A Primer on Blockchain, Bitcoin and the Cryptocurrency Craze | Capital Group

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A Primer on Blockchain, Bitcoin and the Cryptocurrency Craze

From bitcoin to ethereum, ripple and dash, so-called cryptocurrencies have transfixed speculative investors around the world in recent months. Aside from their drastic contortions in price, these highly volatile instruments have also trained a spotlight on the blockchain technology underpinning them. But what exactly are cryptocurrencies, how does blockchain actually work, and why have they stirred such a frenzy?

Part of the answer lies in the fledgling currencies themselves and the possibility of an alternative to the centuries-old global payment system. The rest of the answer comes from the enthusiasm for blockchain, which may have far-reaching applications regardless of the fate of digital money.

Essentially, blockchain is a digital recordkeeping system intended to speed up transactions, lower costs and improve security. It’s designed to facilitate peer-to-peer transactions, thus eliminating the need for intermediaries such as banks or credit-card processors.

Dispensing with middlemen could bolster efficiency and slash layers of costs for industries ranging from finance to medicine. On a broader societal level, blockchain could streamline everyday activities. Imagine, for example, ordering a ride share on a smartphone without going through an Uber-like service. Instead, drivers and passengers would communicate directly, and the entire transaction would take place via a blockchain.

Of course, blockchain development has a long way to go, and many questions must be resolved for a mainstream rollout to be possible. Capital Group’s emerging-technology team is studying these technologies extensively to assess their long-range prospects. “We’re just starting to imagine what we can do with this technology,” says Rohan Hall, a Capital Group emergingtechnology researcher. “We’re still in version 1.0. We won’t see meaningful adoption for at least several years.”

Bitcoin sparked the cryptocurrency mania.

Depending on one’s point of view, cryptocurrencies are either a quixotic investment fad or a genuine advance. The digital fervor began with the launch of bitcoin in the aftermath of the 2008 financial crisis. Bitcoin was designed to allow fast, cheap and anonymous transactions outside the purview of banks and governments. Created by a cryptography expert, or group of experts, toiling under a pseudonym, bitcoin caught on among enthusiasts enticed by the idea of a decentralized currency impervious to banking crises and free of government interference.

Each “coin” is created through an elaborate “mining” process in which highly torqued computers race to solve complex mathematical equations, with the winner granted a small number of coins. These computers essentially oversee the system, processing and cross-checking every transaction. Bitcoin holders keep their coins in digital wallets that are accessible through passwords known as private keys. If a private key is lost or stolen, access to the wallet is gone forever. (The bitcoins still exist, but it’s as though they’re locked in a safe that can’t be cracked.) Holders also have public keys that are akin to account numbers.

Among the many question marks surrounding bitcoin is whether it’s used much as a currency. A growing number of stores and restaurants accept it, and securities exchanges have introduced bitcoin-related futures contracts. But mainstream acceptance has been slow. Worries about fraud, for example, have prompted Google and Facebook to ban cryptocurrency ads. At least for the moment, bitcoin may be functioning more as a vehicle for financial speculation than as a practical transaction mechanism.

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Such uncertainty has caused fitful price swings. Bitcoin has attracted interest from prominent corners of the financial world, but it also faces daunting regulatory and logistical obstacles, and is tarred by a lingering image as the payment of choice among drug dealers and online renegades. After zooming from roughly $1,000 in early 2017 to nearly $20,000 toward year-end, a brutish sell-off pushed it below $7,000.

Bitcoin is popular now, but blockchain may turn out to be the real breakthrough.

At their core, financial transactions are simply entries in a ledger. Financial institutions typically maintain these ledgers themselves — recording, for example, a debit in the account of an apartment dweller writing a rent check and a credit in the account of the landlord cashing it. Blockchain, by contrast, consists of public ledgers maintained by a network of computers, known as nodes. Nodes process “blocks” of transactions, with each block mathematically affixed to the group preceding it, thus forming a chain. An account holder’s public key is visible to the nodes, but both the private key unlocking a wallet and the user’s identity are not.

Blockchain could prove to be more electronically secure than the banks and retailers keeping customers’ financial data. In-house ledgers require hackers to breach only one entry point to gain illicit access. If a hacker were to infiltrate one node of a blockchain, however, an attempt to pilfer funds would be rejected because the transaction would conflict with the history recorded on other nodes.

“It’s a very different model from what exists today,” says Ninou Sarwono, a Capital Group emerging-technology lead.

Eventually, other types of data could be stored on blockchains. Personal health records could be accessed quickly if someone fell ill on vacation. Property sales could be faster and less cumbersome if files were readily available. Ditto for voter registration, census data and intellectual property records. One day, each step in a process could be memorialized and verified on blockchains. To ensure that a restaurant’s seafood is truly organic, for example, a blockchain could track a fish from the moment it’s caught to its arrival on your plate.

Though these uses are unlikely in the near future, they are well within the realm of possibility.

“Blockchain is a very large boulder that’s moving slowly, and its impact will be gradual,” says Basit Sheikh, vice president of Capital Group’s emerging-technology group. “But when it comes, it’ll be massive and long-lasting, which is why we’re keeping such a close eye on it.”

Pictured above: Members of Capital Group’s emerging-technology team studying blockchain (from left to right): Rohan Hall, Basit Sheikh and Ninou Sarwono

The above article originally appeared in the Spring 2018 issue of Quarterly Insights magazine.