The Bank of England's recent report on payment technologies and digital currencies regarded the blockchain technology that allows digital currencies a'genuine technological innovation'which may have far reaching implications for the financial industry.blockchain technology
So what's the block chain and why are y'all getting excited?
The block chain is an on the web decentralised public ledger of all digital transactions which have taken place. It's digital currency's exact carbon copy of a high street bank's ledger that records transactions between two parties. In the same way our modern banking system couldn't function with no way to record the exchanges of fiat currency between individuals, so too could an electronic network not function with no trust that comes from the capacity to accurately record the exchange of digital currency between parties.
It's decentralised in the sense that, unlike a conventional bank which is the sole holder of an electronic master ledger of its account holder's savings the block chain ledger is shared among all members of the network and is not susceptible to the terms and conditions of any particular financial institution or country.
So what? Why is this preferable to the current banking system?
A decentralised monetary network ensures that, by sitting outside the evermore connected current financial infrastructure one can mitigate the risks to be element of it when things go wrong. The 3 main risks of a centralised monetary system that have been highlighted as a result of the 2008 financial crisis are credit, liquidity and operational failure. In the US alone since 2008 there were 504 bank failures as a result of insolvency, there being 157 in 2010 alone. Typically such a collapse doesn't jeopardize account holder's savings as a result of federal/national backing and insurance for the initial few hundred thousand dollars/pounds, the banks assets usually being absorbed by another financial institution nevertheless the impact of the collapse could cause uncertainty and short-term difficulties with accessing funds. Since a decentralised system like the Bitcoin network is not dependent on a bank to facilitate the transfer of funds between 2 parties but rather depends on its countless amounts of users to authorise transactions it's more resilient to such failures, it having as much backups as you can find members of the network to make certain transactions remain authorised in case of one member of the network'collapsing'(see below).blockchainsoftware
A bank will not need to fail however to affect savers, operational I.T. failures such as for instance those who recently stopped RBS and Lloyds'customers accessing their accounts for weeks can affect one's capability to withdraw savings, these being a consequence of a 30-40 year old legacy I.T. infrastructure that is groaning under the stress of keeping up with the growth of customer spending and deficiencies in investment in general. A decentralised system is not reliant on this type of infrastructure, it instead being based on the combined processing power of its countless amounts of users which ensures the capacity to scale up as necessary, a mistake in just about any the main system not inducing the network to grind to a halt.
Liquidity is your final real risk of centralised systems, in 2001 Argentine banks froze accounts and introduced capital controls as a result of the debt crisis, Spanish banks in 2012 changed their small print allowing them to block withdrawals over a specific amount and Cypriot banks briefly froze customer accounts and used up to 10% of individual's savings to greatly help pay off the National Debt.
As Jacob Kirkegaard, an economist at the Peterson Institute for International Economics told the New York Times on the Cyrpiot example, "What the deal reflects is that becoming an unsecured as well as secured depositor in euro area banks is much less safe because it used to be." In a decentralised system payment happens with no bank facilitating and authorising the transaction, payments only being validated by the network where you can find sufficient funds, there being no 3rd party to stop a transaction, misappropriate it or devalue the quantity one holds.
OK. You create a point. So, how does the block chain work?