Why the Block Chain Could Be Bigger than Bitcoin

During TechCrunch Disrupt New York, Fred Wilson of Union Square Ventures said he’s “really excited” about the opportunities presented by block chain based architectures (like the one Bitcoin is based on):

The block chain could be a much bigger opportunity than Bitcoin….The whole thing about block chain based architectures is that they allow trustless transactional activity…There is no third party, there is no clearinghouse of identity information.

Fred Wilson talks Bitcoin at #TCDisrupt NY

Removing the Middle Man

What he meant is that the block chain architecture removes the need for an intermediary—the middle man. The role of the middle man in transactions to provide the element of trust.

In a financial context, we know that when we make a transfer via an intermediary, we can trust that our money will go from A to B. We pay for that peace of mind (and that’s how intermediaries make money).

But imagine the efficiency gains (and windfall for those of us engaged in financial transactions) we could achieve if we could remove the middle man, but still make transactions safely?

Solving the Byzantine Generals Problem

What the block chain and Bitcoin solve is what computer scientists call the Byzantine Generals Problem. As Marc Andreessen of Andreessen Horowitz explained in The New York Times:

Bitcoin is the first practical solution to a longstanding problem in computer science called the Byzantine Generals Problem. To quote from the original paper defining the B.G.P.: “[Imagine] a group of generals of the Byzantine army camped with their troops around an enemy city. Communicating only by messenger, the generals must agree upon a common battle plan. However, one or more of them may be traitors who will try to confuse the others. The problem is to find an algorithm to ensure that the loyal generals will reach agreement.”

The fundamental question of the Byzantine Generals Problem is how to establish trust between otherwise unrelated parties over an untrusted network like the internet. Andreessen further explained:

The practical consequence of solving this problem is that Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate.

(emphasis added)

But How Does the Block Chain Work?

Practically speaking, you might be wondering how exactly Bitcoin, and its block chain architecture, go about solving the problem of establishing digital trust. While it’s a complex process involving cryptography and large amounts of computing power, The Economist has provided a simplified explanation:

Bitcoins also don’t move around when they are transferred. They are best understood as entries in a giant ledger, the “blockchain”, which contains the transaction history for every Bitcoin in circulation. It is kept up to date with the help of cryptography and copious computing power, provided by a global network of tens of thousands of computers. Again, openness helps the system remain secure: the blockchain is public so every participant can check whether a transfer comes from the rightful owner.

(You can also check out the explanation provided in the video in this Torque article on Bitcoin and WooCommerce).

Who Cares? Economists and Investors

While there is so much more we could say about Bitcoin and the block chain—such as why the exchange rate of Bitcoin doesn’t matter when it’s used as a medium of exchange—the potential for trustless transactional activity online has got some investors and economists pretty excited.

As Susan Athey, A Professor of Economics at Stanford University, explains:

As we think about the next set of people coming online, we’ve got people from poorer countries, from developing countries, people without banking, and without good ways to get paid. We’ve got middlemen in there. We’ve got market power by banks… So I’m very excited about these new types of currencies as a way to both put pressure on existing systems to lower their fees and to become more efficient….

The ability to securely say “I’m sending something to you, it’s in a public ledger and that transaction has occurred,  and it’s confirmed now,” is really, really quite powerful.

Image credits: TechCrunch and Shutterstock

What possibility excites you most about trustless online transactions?