Understanding Decentralization and Blockchain Technologies

Now that bitcoins are trading at more than US$500 again, there has been renewed interest among speculators and cryptocurrency users slightly higher up the left side of the adoption curve.

This piece is for those people.

There seems to be a growing understanding that the more important innovation in Bitcoin isn’t the currency, but the blockchain itself.

So, if you bought in earlier this year at US$380 and think you can cash out at US$600, great. But there is a big, big forest cropping up if you look beyond those trees. Blockchain technology is very likely to revolutionize the way we transact money, data and assets in the coming years.

Here are a few projects that rely on blockchain technologies that look beyond currency as an application. These are the technologies that can facilitate smart contracts, the decentralized issuing of stock and the transfer of assets.

We won’t get into those specific applications yet; that’s a topic for other posts. For now, we will just take a look at the technologies themselves and try to explain them through metaphors and examples.

Colored Coins

Meni Rosenfeld laid out the theory behind colored coins back in late 2012. Colored coins are simply a layer on top of Bitcoin that marks a token (say 0.00001 BTC) as representing an asset, perhaps a house or a share in a company.

Here is an easy metaphor that will be familiar to golfers. Sometimes, you have to pick up your golf ball and mark its position. Many golfers use a coin as a marker. In this particular case, the value of the coin doesn’t matter, only that everyone understands the coin represents a golf ball.

In the golf example, everyone playing that hole can see your coin and probably remembers which coin belongs to whom. But suppose, for some reason, a dispute over who had which marker arose. That’s where the blockchain ledger would come in because it would provide cryptographic, publicly verifiable proof as to who owned the coin.

“Colored” here is also a metaphor: The coins are no redder or bluer than the bitcoins not jingling in your pocket. Rather, a unique value is attached to the token(s) to distinguish it/them from others. Coins of a single color, or assigned value, represent a single asset.

To learn more about colored coins, read our piece from from May 21.

Alternate blockchains

As Rosenfeld noted, “[t]he inclusion of the extra burden of colored coin transactions

can supposedly bloat the blockchain, increasing the cost of running a node.” That means adding those color values on top of any number of the 12.8 million bitcoins currently in circulation can make the blockchain exponentially cumbersome.

Thus, one alternative is to create a separate blockchain for a particular asset. Just as Litecoin and Dogecoin have their own blockchains, smart contracts and time shares in Maui could have their own blockchains, too.

The downside here is barrier to entry. If everyone is already using Bitcoin, for example, then everyone can just piggyback off that existing infrastructure. Or, back to the golf metaphor, if you and your friends are playing Torrey Pines and paid greens fees in dollars, it’s unlikely your ball marker would be a Danish krone, unless you just happened to keep one around for such occasions.

Open Transactions

Open Transactions is a decentralized financial software toolkit intended for currency and other financial instruments. As Kyle Torpey wrote in early 2014:

One of the main aims of the Open Transactions project is to decentralize the entire financial landscape by allowing anyone to issue currencies and various financial assets that are secured with cryptography. Anyone will be able to create digital tokens that represent real value on Open Transactions, but one of the most innovative features of this system is that the people who issue the digital tokens will not be able to alter the ledger for their currency or stock.

Rosenfeld described the weakness of Open Transactions as follows: “Its intuitions are different than those of Bitcoin, which means it will likely be more slowly adopted by the Bitcoin

community (who is the primary target market for the features we are espousing) than a Bitcoin-based system.”

To learn more about Open Transactions, visit the project’s Wiki.

Other Technologies

A few other technologies worth exploring include Ripple, a payments protocol that has developed as an alternative to Bitcoin; Ethereum, a platform and language on which to build decentralized applications; and MaidSafe, an eight-year-old project that just might reimagine the internet — and specifically data security — as we know it today.

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