“What is a Blockchain?” and Other Questions You’re Too Shy to Ask

A Non-technical Primer on Blockchain for the Mortgage Industry

While it isn’t necessary to understand the intricacies of blockchain in order to use DART, Portfolio Manager, or any other applications built by Figure on Provenance Blockchain, we’re often asked basic questions about blockchain during pitch meetings.

This blog post should help get any non-technical reader familiar with the basics of blockchain.

What is a blockchain?

There are many explanations of blockchains. Here’s how I like to explain it in simple terms:

• A blockchain is a type of database, where instead of having a single central data repository, there are multiple copies of the database distributed across a number of different computers. This is called a distributed ledger.
• Blockchains use special protocols in order for the computers to agree on the database entries and to ensure the accuracy of the data. This is called consensus mechanisms.
• Data are chunked out into blocks, which are created (or “cut”) on a periodic basis. These blocks represent transactions to append to the blockchain. Provenance Blockchain blocks are cut every 6 seconds.
• For each block of data and transactions, a hashing algorithm (i.e. math) is used to add up all the data and determine a resulting number or hash (a unique series of letters and numbers assigned to a block).

When determining the hash to assign to a given block, the unique number of the previous block is included in the calculation — thus the block-chain.

• Some blockchains allow for programs called “smart contracts.” Smart contracts are code written on top of a blockchain that are like if/then statements. You provide an input, and if the parameters are satisfied, it will perform something based on the if/then statement.

The result is a record of transactions (such as creation of, ownership of, or value paid for an asset) that is permanent or “immutable.” You can only add data to the blockchain…you can’t go back and alter the past (because of that hash that is attached to each block).

These features allow you to trade digital assets instantaneously (without intermediaries). So, for example, if you have a mortgage as a digital asset on a blockchain, through a smart contract, you can simultaneously transmit funds and change ownership of a mortgage in a bilateral transaction.

How does this have anything to do with the mortgage industry?

Blockchain is simply a technology (like a sophisticated database) that, in itself, doesn’t directly have to do with the mortgage industry. But there are a number of tech companies that are building applications on top of blockchains to make it easy to leverage the technology as a source of truth and to facilitate bilateral transactions, thereby eliminating intermediaries that take cuts of every transaction.

The ultimate beneficiary from the adoption of blockchain technology by the mortgage industry will be the borrower, who will see reduced costs as all the stakeholders in the system are able to eliminate frictions and pass on savings to the consumer.

If you’d like to go a bit deeper:

What is an example of a distributed ledger?

A blockchain is a type of distributed database, meaning that copies of a ledger are maintained and updated by various entities.

Example: Imagine 100 people across the US have the same excel spreadsheet saved on their laptop. The database could be considered secure because it would be very difficult to hack every single laptop to alter the data. But how would the computers ensure that they are in sync? They would need a means of ensuring agreement (i.e., a consensus mechanism).

What are consensus mechanisms?

In the above example, the entities that participate in the maintenance of the database follow certain processes by which they agree on the transactions and order of transactions. This is called “consensus.” Those 100 laptops have to have a manner to communicate, agree, and kick out anyone who tries to break the rules.

Proof of work and Proof of stake are two common consensus mechanisms.

What is Proof of Work (PoW)?

PoW is the oldest consensus mechanism and is used by Bitcoin. In PoW, the distributed entities (called “miners”) must perform complex mathematical problems to verify transactions to add to the blockchain. These math problems are extremely sophisticated and require significant electricity and computing power to perform the “work” necessary to solve the puzzle.

PoW is criticized for being wasteful of electricity, but it has proven the test of time with Bitcoin.

What is Proof of Stake (PoS)?

PoS is the second most widely used consensus mechanism and is considered highly energy efficient. In PoS, the distributed entities (called “validators”) must put up money (like collateral, called “stake”) in order to be able to validate transactions. Provenance Blockchain uses PoS.

In PoS, validators get rewarded for good behavior or can lose their money for bad behavior. The money that validators stake is generally the same type of digital currency that’s native to the blockchain. For Provenance Blockchain, this is called the Hash token.

Ethereum shifted from PoW to PoS in September 2022. This was called “The Merge.”

Who are the validators on a PoS blockchain?

For a Proof-of-stake blockchain, a validator can be any entity who is interested in participating in the process of verifying transactions.

For Provenance Blockchain, validators provide the service of running a copy of the blockchain and for voting on transactions, smart contracts, and the rules of the system. To be a validator on Provenance Blockchain, all you need is sufficient resources to buy enough Hash and a computer with the ability to run the software.

What does this have to do with cryptography?

Blockchain, in the chain aspect, leverages cryptography as part of the hash function. These cryptographic hashes are mathematical computations that link together various blocks of transaction data. By linking each set of data to the last set, you can verify the data hasn’t been altered. This is the quality of “immutability.”

The most commonly used hashing algorithms were developed by the NSA, and many corporations and systems use hashing algorithms when transmitting data.

The mortgage industry already uses hashes and in some cases calls this a “tamperseal.”

What is a token?

Tokens are uniquely-identified digital units that can be encoded with data and registered to (or owned by) a user on a blockchain. Some tokens, like cryptocurrency, are interchangeable; some tokens, like NFTs are not, due to the uniqueness of the token’s encoded data.

What is cryptocurrency?

Cryptocurrency is simply a form of value on a blockchain system. It can be exchanged between parties without needing an intermediary like a bank. Bitcoin is a very famous form of cryptocurrency.

What are Non-Fungible-Tokens (NFTs)?

NFTs are unique digital assets that can be transferred on a blockchain. They are not “fungible” in that they are unique (as opposed to something that is “fungible” like a dollar bill that is equal to any other dollar bill, or 1 Bitcoin is equivalent to any other 1 Bitcoin).

An example of a use case for NFTs is mortgage assets, which can be uniquely identified and transferred on chain. If you own the token, then you have enforceable ownership of the asset.

While it is easy to become overwhelmed with the technical lingo, the real value in blockchain is in the actual use cases that leverage the blockchain as the underlying infrastructure.

The good news is that companies like Figure Technologies have already built applications on top of blockchain so that you and your teams are not required to become experts. You can learn more about these applications at figure.com. And provenance.io contains a wealth of information about the blockchain itself.

LEAH PRICE

Leah Price is Vice President of DART / Lending Ecosystem at Figure. Previously, Leah worked at Fannie Mae in the Digital Products division, on Day 1 Certainty and other pilots.