Digital Asset Growth: Exploring bitcoin, Ether, and blockchains
Welcome to my first post on Medium.
My name is Adrian Jonklaas, and I am an entrepreneur and angel investor based out of Vancouver, BC. This post is about a particular technology which also piqued my interest as a business and financial advisor.
Question: what asset appreciated the most in 2016?
The answer is not the Dow Jones, the S&P 500, emerging markets, gold, or any of the other traditional asset classes. It is the digital asset called bitcoin(which uses the three-letter identifier, “BTC”).
Did you know bitcoin is classified as a commodity by the Commodity Futures Trading Commission? The following chart shows the performance of commodities in 2016.
For reference, the Dow Jones was up ~15% in 2016 and Russia’s RTS index — the best-performing equity index globally — rose 52% in 2016.
Around Christmas 2016, Boris Mann and I — who are doing a deep dive into blockchain technology as part of a broader exploration of frontier and emerging technologies that are going to shape industries and define businesses over the next ten years — discussed this incredible appreciation in bitcoin.
We also came to the conclusion that this seemed like an ideal entry point into the Ether market. Ether (which uses the three-letter identifier, “ETH”), like its big brother, bitcoin, is a digital asset. Both bitcoin and Ether are cryptographic tokens that “fuel” the Bitcoin and Ethereum platforms respectively.
Given a number of initiatives slated for Ethereum in 2017 (Metropolis, Mist, Swarm, broader programming language development and support) Boris noted the network effects as adoption amongst developers of decentralized applications (“dapps”) on the Ethereum platform increased — hence boosting demand for ETH with end users, since ETH are required to run the dapps, and therefore conceivably increasing the value of ETH.
“Woah! What was that?!” I hear some of you saying.
Hang in there! I know I may have thrown out a lot of unfamiliar words and concepts in the preceding paragraphs. Just follow along as best you can, and I promise to explain everything, if not today, then over the next few posts. This is exactly why I am blogging about blockchain technology: so I can educate myself as I endeavour to break it down for you.
So after my chat with Boris, I spent about 5 minutes looking into the onboarding process — answering for myself: how do I buy ETH?
For a slightly neurotic person like me — especially when it comes to participating in something new — the onboarding process seemed intimidating or at least like something that would take an hour or more. I would have to research wallets (where to securely store bitcoins and Ether), download and potentially configure software, figure out how to transfer fiat currency to the wallet and/or an exchange; most of all, I would have to allay the (irrational?) fear that I would be turning money into electrons that would flit away down a wire, potentially forever lost.
The last point, in particular, was not something I was ready to deal with. Believe it or not, it took me months before I made my first online purchase in the Year 2000.
In any case, at the time, I was busy editing my Sci-Fi novella (“2030 ET: Tribulation”), so I gave buying ETH a pass thinking I would invest in ETH later in Q1 2017 when I had a bit more time to look into the technology and dispel any doubts I had.
The chart below shows Ether price appreciation from Christmas 2016 through February 20, 2017.
Needless to say, I am kicking myself for not making a significant investment into ETH over Christmas! Over this period, Ether rose from USD 7.50 per ETH to USD 12.75.
“Snooze, you lose.”
I missed a 70% bump over 2 months.
For an angel investor, whose target (as determined by the average returns to angel investors in the seminal study by Rob Wiltbank and Warren Boeker) is 27% IRR over an average holding period of 3.5 years, that’s a big miss.
And guess what? It turns out, with just a credit card and an app — Coinbase — it is super simple to buy ETH, even without understanding anything about Ethereum or blockchain.
What is blockchain?
So what exactly are bitcoin and Ether? And why did they appreciate so significantly to make them the best performing (digital) assets? Are they money? A store of value? And /or do they have inherent utility in of themselves?
This is the first of many blog posts on Bitcoin and Ethereum (the platforms that are “fuelled” by bitcoin and Ether respectively) and the underlying technology, blockchain, that both are built on. Over the course of the next few weeks and potentially months (blockchain is a huge topic; the rabbit hole runs deep!) I hope to research and answer the above questions as well as many more.
To start with, for today’s post, I endeavour to provide a simple answer to the question: What is blockchain?
There are people far smarter than me who have written extensively on the topic. As such, at the end of this section I will point you to several resources I found useful in understanding blockchain which you can dig into.
For now, here is a short summary in layman’s terms:
“Blockchain is a decentralized database where blocks of data are chained together immutably.”
Let’s parse the above.
Blockchain is a decentralized database.
Unlike data in a cloud, which is controlled (monitored/censored/etc.) by an entity (e.g. Amazon, Google, Microsoft, a Government), the data in the blockchain database is available to everybody. The fact that every single node — a software application running the blockchain, which can be downloaded and installed by anybody (for a public blockchain at least) — contains a full copy of the database prevents the most egregious misuses of data: censorship and falsification of data.
Think about it: data cannot be censored if it is everywhere (no cloud servers to shut down). You can falsify the data within your database (and the ones you control); but nobody else will accept it as true if it does not match the data in the 1,000s of copies of the database outside your control.
“Old security models focus on locking people out. [Blockchain’s] model focuses on letting everyone in.”
Blockchain is blocks of data.
In the Bitcoin application of blockchain, each block stores a “ledger” with changes in balances to bitcoin accounts (transactions).
There is no (good) reason that the blocks could not store other data within; for example, you could record non-monetary transactions such as titles to land or even a record of weddings, births, and deaths.
“Namecoin,” which was the first “fork” (copy and modification) of the Bitcoin blockchain, contains blocks which register and record ownership of .bit domain names creating the first censor proof DNS.
Blocks in different implementations of blockchain can store other types of data e.g. blocks in the Ethereum implementation store either “ledger” data or small computer programs (smart contracts) which run on an operating system called the Ethereum Virtual Machine.
Each block also has information about itself in a header: how big is the block (in bytes), a hash (a cryptographic fingerprint) of all the data (transactions) in a block and a timestamp amongst other meta-data.
There is one additional very important piece of information the block header contains: a unique identifier to the previous block (the hash of the previous block’s header).
Which leads us to…
Blockchain is blocks chained together.
Imagine three blocks. Block 3 contains a hash of the header of Block 2 (a unique fingerprint that identifies Block 2). Block 2 contains a hash of the header of Block 1.
If we change information contained in Block 1, for example, divert a transaction of bitcoins to an address we control, then the hash of the header of Block 1 would change (since the header itself contains a hash of the contents of the block).
Note: with cryptographic hash functions, the change of a single bit of content creates a totally different fingerprint.
That one change creates a cascade of changes. The hash of the header of Block 2 will change because it contains a hash of the header of Block 1. The hash of the header of Block 3 will also change because it contains the hash of the header of Block 2.
Generalized, a change to the contents or header of any block changes all the blocks that come after it in the blockchain.
Mind you, making changes to the content of a block is not easy since the block has to be cryptographically signed (with a hash). By design, it requires significant computing power to solve the cryptographic problem involved with the hashing. This process is called mining.
Currently, it would take hundreds of years for a top-spec desktop PC and graphics card to mine a block. However, statistically, given all the computing power devoted to mining around the world, it takes on average 10 minutes to mine a block. Again, this is by design, with the difficulty of the cryptographic problem increased according to the hashing power added to the Bitcoin mining network.
In practical terms, a mischief maker who wants to divert bitcoins to his own account, would be in a race to change all the three blocks and add a fourth block, Block 4, before other miners add Block 4 to the chain (an act which confirms the previous history of transactions contained in the chain).
The longest chain rule is part of the consensus mechanism built into the Bitcoin blockchain where nodes are required to build on the longest chain and ignore shorter chains. The probability of mining all three blocks and adding a fourth before other miners add the fourth would be analogous to winning the Powerball lottery four times in a row, so is “zero” for all intents and purposes, meaning it would be impossible for the mischief maker to win the race. The only possibility of abuse is if 51% of the miner network is controlled.
To me, this is the first truly magical property of blockchain; its immutability.
This linking of blocks goes back (in time) to the first block mined by Satoshi Nakamoto, the (anonymous) person who proposed and launched the first blockchain, Bitcoin.
In my next post I will examine, the second magical property and key innovation of Satoshi Nakamoto, discussed in his (her?) famous 2008 whitepaper, which is the consensus mechanism that allows Bitcoin to function in a “trustless” manner (where it doesn’t matter what the intentions of the people who use the blockchain; they simply cannot steal or cheat without extreme effort).
That discussion will be part of an examination of different types of blockchains (public and private) and applications of each.
Now, here are the links I promised:
A history of blockchain in the context of the evolution of centralized databases that blockchain is designed to replace; this explains the rationale as to why blockchain exists:
While “gentle,” this guide does go into more depth than my introduction to blockchain above:
This is an excellent video by Anders Brownworth that explains some of the key technical concepts of blockchain (hashes, blocks, blockchains, distributed peer-to-peer network): https://anders.com/blockchain/
Eyeing the Markets
As a CFA charterholder, I always have one eye on the markets. Markets post the global financial crisis of 2007–2008 have truly scared me because I have failed to understand them. So much fiat money has been (effectively) printed (in Western economies primarily) through quantitative easing; while the world has not seen price inflation in consumer goods the world has seen price inflation in financial assets (e.g. the second longest equity bull market in US history) in part fuelled by this loose monetary policy.
Naturally, to see bitcoin and Ether as top performing assets intrigued me as a financial analyst. But more significantly, my deep dive into the underlying technology has opened my eyes to the potential of decentralized money; where its “supply” and “worth” are not controlled or influenced by central authorities.
A final thought: bitcoin was v1 of a decentralized form of money and of blockchain; Ether is v2 (by virtue of introducing “smart contracts” to blockchain on top which decentralized applications can be built). Both are wonderful, and both have their flaws. In my next posts, I hope to shed some light on these topics including what I think is required of a v3 digital currency.
Thanks for reading my first blog post on Medium. Feel free to comment!