Breaking down blockchain and cryptocurrencies

Maybe you’ve already invested in Bitcoin or another currency, and depending on when it was, you might be showing some handsome rewards or, more likely, given what’s happened recently in the crypto space, you might be suffering from buyer’s remorse.

Or maybe you’ve been more conservative and either viewed with envy some of the incredible returns your friends have reported or, more recently, their disbelief at the rapid return to earth of some of the stratospheric gains they’d had – more likely that they didn’t hear about the (paper) losses suffered by newcomers to the crypto brigade.

We will look at a number of aspects of cryptocurrencies and so-called “platforms” in part two and then more specific elements such as their granddaddy, Bitcoin, as well as other names you may be familiar with, from Ethereum to Binance and the recent “fall-from- grace” example of FTX, in part three.

But where to start? There are two basic concepts or trends that in combination led to the rise of cryptocurrencies.

Number one: the fact is that it is now a digitized world! If that doesn’t make sense to you, let’s put it more simply: there are “lists”, kept as sets of data on computers, somewhere, for just about everything.

Examples are a barcode and a price, for supermarkets (and other retailers), or your name, date of birth and IRD number or mobile number for many things such as insurance policies, bank accounts and other groups you belong to, so that when you call them on an 0800- number, they immediately know who you are! In the words of Gilbert and Sullivan: “I’ve got them on the list… .” (forget the next line!)

Number two is the concept of trust. When you do your online banking – and who doesn’t these days? – or use your credit card, with or without the added protection of a PIN (personal identification number), you believe that the accounts you deal with will be debited (or credited) immediately with the correct amount.

That “faith” is a strong form of trust. You believe or trust that the person you are dealing with will not allow transactions that you have not created on your accounts.

Banks in particular, but also other financial institutions, must always be one step ahead of hackers and fraudsters.

You may even have received a call from your bank’s fraud department regarding a particular transaction that they consider “suspicious” (for example, being in a different country than your usual transactions).

So it is our trust in the systems that has made it possible for all of us to adopt and use digital transactions as part of our everyday lives: far better and easier than standing in bank queues.

Do you know, or need to know, how much capital your bank has to be able to operate efficiently? Do you know how the processes work to ensure that credits and debits across all accounts are matched and balanced at the end of each day (if not at multiple times throughout the day)?

Or how are transfers made between different banks? Almost certainly not! Why? Because you trust the bank, the systems and the regulators who are responsible for overseeing and checking these things.

Now, without some of the extra reporting and controls, how could or would you ensure that transactions between two parties are correctly matched and that the sum of credits and debits, across all users of an unregulated entity, balances at all times, as that the users have the same degree of trust as they have in the banks?

Enter the concept of blockchain. This is a security solution process, actually independent of cryptocurrency (although you could be forgiven for thinking they are somehow one and the same thing, given the way the two words are mostly used together – as cryptocurrencies actually depend on blockchain- methodology for the essential ingredient of trust).

Surprise! Blockchain is nothing more than a network of computers with identical ledgers (lists of account numbers, balances and transactions), referred to as a “distributed database”.

A typical number of computers, called “nodes”, would be eight, and for added security they should be in different geographical locations.

They are all connected through what is now possible with networks and (almost instantaneous) data transfer via either cable or the Internet. As in many situations, it may be possible for hackers to get past some defense mechanism (“firewall”) at one of the locations – but getting to all eight at the same time will be (almost) impossible.

Constant, regular checking that all eight have exactly the same information means that any deviations can be detected almost immediately and to determine which of the eight is “wrong”, find the gap and check which transactions caused the problem and rerun them ( if it turns out to be correct, so that they reflect on all the ledgers) or return the erroneous to the “correct” balances without the suspicious transactions (until they are verified).

Another important feature of blockchain is that all transactions are time-stamped, so that all transactions that should have occurred with a time stamp earlier than the last check between ledgers will be classified as “suspicious”.

Transactions are also linked (giving rise to the concept of “chain”) to another transaction or “block”: reference, time and details.

All this indicates that whoever was responsible for the following headline, pulled from the internet, was hyping a standard security procedure: “Binance recovers stolen, disguised crypto-exchange from megahack” – whatever “disguised crypto-exchange” might be!

— Liston Meintjes is an independent consultant and analyst in business, economics and markets, with many years of experience in the investment industry.