Descrambled: What You Need To Know About Blockchain Basics

Welcome to our new series dubbed Descrambled: a non-technical overview of cutting-edge technologies, intended to give your entire C-suite a shared mental model of the latest innovations and their potential business impacts. Let’s launch right into it with Descrambled: What You Need To Know About Blockchain Basics.

Since this is neither the first nor last guidance you’ll likely read on blockchain basics, we want to meet you where you are. So, if you’re in need of a full-on analogy to build your working knowledge of blockchain, by all means skip the graphic below and return to it later. If you just need a memory jog as to how the tech works, our graphic should help. Either way, you’re in good shape to grasp this blockchain basis article.

Okay, now that we’re all in the right place: let’s examine the simple transactional act of getting a coffee at Starbucks. You walk into the store, you place an order, and you pay in cash. What happens next? You get your coffee, right?

Not so fast – you overlooked a few crucial steps.

What you actually purchase at Starbucks is trust: an expectation that after you’ve handed over your money, you’ll get coffee in return. But what if the barista walks away, and no one else behind the counter acknowledges that you paid? Well, that’s why you have a receipt; proof that your side of the transaction occurred. But what if the store doesn’t agree with your claim? After all, your receipt doesn’t prove that you didn’t get your coffee… and it’s not as if you can call on some higher authority here. The Starbucks store is the authority, and if they think you already got your coffee or never paid, you don’t have much recourse unless you plan on hiring a $5,000 lawyer to recoup your $5 iced mocha.

Consider some of the factors at play here, and you’ll see why there’s significant opportunity to innovate on the ways people conduct transactions with each other:

Trust

To make this transaction occur, one party had to first extend trust to the other, therefore exposing themselves to risk. If this were a more significant purchase, the two parties would likely have agreed to place the valued items in escrow – a ludicrous level of operational overhead for something as cheap as a cup of coffee. Blockchain is, in part, an affordable and automated escrow service attempting to solve this problem.

Visibility

A few problems have arisen in this busted coffee transaction. First, because you paid with cash, any evidence that you possessed that cash has now disappeared into the register. Had you used a credit card, you’d have visible evidence of your payment – but that is yet another level of operational overhead, and bloats the cost of the transaction for both parties (credit card fees, the store’s expenses to accept credit cards, etc). In contrast, each block – a single transaction on the blockchain – contains unique identifiers by design, so you don’t need to stand up a dozen middlemen industries just to prove where your money went.

Second, the only people involved in the transaction were you and the barista. Much as another employee or customer might want to help resolve the dispute, they had no visibility to the transaction, so they have no say. That’s why we created receipts, which of course add even more operational overhead just to identify and prove the uniqueness of a transaction. On the blockchain, however, those unique transactions (blocks) contain cryptographic strings known as hashes, and are visible to everyone… so in a way, everyone has your receipt. This is an analogy you may have heard before, as a public digital “ledger.” The chain in blockchain is this public ledger of all the transaction blocks over time, and everyone gets to see it. The hash is a unique identifier representing your coffee – not just “a” coffee, but “your” coffee.

Authority

When you combine these trust and visibility factors, the power dynamic between you and Starbucks becomes obvious: in a conventional trust-based transaction, it’s just your word against theirs. Even with a receipt, you’re still placing trust into some other central authority who will have to adjudicate on the he-said-she-said. And whether that central authority is Starbucks, your bank, or the local courts, we yet again have to acknowledge the operating expenses society collectively pays to allow for such trust disputes to be resolved. Makes you wonder how much of your coffee’s cost is coffee, and how much of the cost is trust.

Imagine instead, that every person in Starbucks was a node on a blockchain – a participant with visibility into the ongoing ledger (chain) of transactions (blocks). Those nodes could vote to validate your coffee transaction, effectively democratizing and decentralizing the authority.

This decentralized operation is made feasible by the fact that your unique transaction identifier (hash) isn’t just some random number – it’s an encrypted string which also contains the transaction prior to yours on the chain. Your receipt for an iced mocha also contains Andrea’s receipt for a Unicorn Frappuccino; Andrea’s receipt also contains Darren’s receipt for a cortado, and so forth.

If Starbucks wants to prove to 51% of the voters (nodes) that your iced mocha receipt is invalid, Starbucks effectively needs to go back and overwrite the receipts of everyone else who shopped before you. Not gonna happen, especially when everyone else has been looking at the public ledger this whole time. That cryptographic proof of work is primarily what makes blockchain programs able to operate as decentralized, autonomous organizations (DAO); nobody is the ultimate authority, because everyone is.

In short, this means that the decentralization of transactions isn’t really some dramatic courtroom trial of fellow Starbucks customers showing up to defend your side of the story. Rather, it’s just a built-in feature of shopping at Starbucks, where the extension of trust from one party to another is no longer part of the transaction at all.

As far as a single cup of coffee is concerned, this model may seem like overkill. But in large part, that’s because Starbucks has established trust with you and millions of others over time – your expectations are reasonable and your exposure is chump change, so your risk is realistically low even if it does exist theoretically, and even if a lot of your cost is squandered on overhead.

Can you say the same for a one-time purchase of perishable goods from overseas? What about entering into a long-term services contract with a new vendor? Or paying a hacker’s ransom after a breach to get your data back? Are these the types of transactions where you’d be comfortable extending trust and relying on whatever central authorities may exist in the event of a dispute? Even if you were Starbucks in this scenario, isn’t there something to be said for the massive overhead you absorb just to manage transactional trust? All of this is what blockchain attempts to address.

Our follow-up article will help explain how businesses across multiple industries have been putting blockchain to work, and what innovative projects are worth keeping an eye on.