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Decentralized trust

Decentralized trust

30-04-2021 | Graph of the week
Bitcoin, the largest and most important cryptocurrency, recently broke through the momentous barrier of USD 1 trillion in market value. Whipped up by Elon Musk’s embrace of the cryptocurrency space and the growing options for using bitcoin as a means of payment or investment object, its value doubled in the first four months of this year.
  • Steef  Bergakker
    Steef
    Bergakker
    Senior Portfolio Manager
Source: CoinMarketCap

There are few topics in the financial world that divide opinions quite so sharply as the subject of cryptocurrency. Some see crypto as the inevitable future for modern payment methods. Others see these digital currencies as reprehensible, energy-guzzling instruments for facilitating criminal activity and satisfying gambling appetites.

Whatever you think about it all, the fact is that the protocol on which cryptocurrencies work – a decentralized validation technology better known as ‘blockchain’ – is being seen by more and more parties as an attractive and potentially extremely disruptive technology.

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Overview

So how does blockchain technology work?

Without going into too much technical detail, it boils down to the following: a transaction between two parties is digitally recorded, together with other transactions, in a public register or ‘block’. The transactions in the block are then validated by solving mathematical puzzles with the help of computers. Puzzle solvers are called ‘miners’.

The miner who solves the puzzle first receives a certain amount of cryptocurrency as a reward. If more than half of the computing power used by the number of connected parties on the blockchain network considers the transactions to be legitimate, they are adopted by every connected party. This is a simple majority vote. The block is then added to the chain of previously validated blocks. This creates a blockchain.

Whoever wants to change the blockchain has to enlist more than half the computing power available in the network to do so. In practice, this is almost impossible, especially when networks are large and global. The bigger the network, the safer it is. The transactions stored in the blockchain are verifiable by everyone in the network and practically unchangeable and are therefore secure and credible.

Disintermediation

Blockchain technology therefore eliminates the need for a central, widely trusted intermediary to validate transactions between parties who do not know each other enough to trust each other. Trust intermediaries such as notaries, custodian banks or other financial institutions should fear for their economic lives if this technology gains more ground.

Decentralized registration and validation not only offer enormous potential for cost savings by eliminating intermediaries, but also for innovative new services and products. Financial services in particular take on a completely different character if this technology is applied on a large scale in combination with so-called smart contracts, contracts that are automatically executed without outside interference. Possibilities include a decentralized peer-to-peer network for lending and borrowing or insurance.

Non-fungible tokens

Non-fungible tokens (NFTs) are perhaps the most intriguing application of decentralized registration and validation technology. These NFTs are non-exchangeable digital proofs of authenticity. This allows property rights, authorship or even your own identity to be conclusively established and, if necessary, traded.

Beeple, a digital artist, recently sold the NFT of his work ‘Everydays: The First 5000 Days’ for USD 69 million at Christie’s. The irrepressible Elon Musk then made headlines by offering a tweet as an NFT for which he reportedly received a bid of USD 1 million (he decided not to take up the offer, by the way).

Cryptocurrencies have so far been the main use case for distributed ledger technology such as blockchain, but they may represent only the tip of the iceberg when it comes to the potential disruptive impact of this technology. Regardless of your opinion on cryptocurrencies, it is recommended that you keep a close eye on developments in this area.

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