Anyone active in the stock market has certainly heard about it many times: blockchain is going to change our daily lives. Thanks to this technology, business and administrative processes can be completely rethought and, above all, considerably accelerated.
Many people automatically associate the term blockchain with cryptocurrencies such as bitcoin. But what is blockchain? How does it work? And above all, is the principle really secure enough to transfer large sums of money in the form of cryptocurrencies?
The name already reveals that a blockchain is essentially a chain or chain of blocks. In the language of the computer world, the term “block” refers to a piece of information. The most catchy translation of blockchain would therefore be information chain.
Each block is also assigned a specific code or fingerprint that uniquely identifies it. In the field of information technology, the fingerprint of a block is called a hash. The hash represents the checksum derived from the information contained in the block. Each block therefore has its own hash. At the same time, each block contains the hash of the block preceding it in the chain. Hashes function like links. They link information in a fixed order.
What’s special is that the information contained in the blockchain cannot simply be changed, as otherwise the assigned hash, i.e. the individual verification code, would also have to be modified. This means that the various links in the chain no longer fit together coherently. If a block were to be modified anyway, the associated hash would also have to be recalculated – and thus all subsequent blocks and hashes in the chain would have to be adjusted. The principle of verification codes makes this technology particularly secure.
To understand the architecture of a blockchain, it’s useful to take a look at well-known communication platforms such as Facebook or Whatsapp: A Whatsapp message, unlike an SMS, doesn’t reach the recipient(s) directly, but first arrives at a central server, which is usually managed and controlled by a third-party provider (Facebook). It is from this central server that the message finally reaches the recipient. The central server, which manages incoming messages, is only sometimes also a central element of attack for hackers. In blockchain, there are no central servers for data processing.
The information chain is managed via a decentralized network that is distributed among all users and end devices such as PCs or tablets participating in the blockchain. As in a Whatsapp group, every end device participating in the blockchain, and therefore every user, receives the same information at the same time. Every member of a blockchain therefore has exactly the same copy of the information chain – another reason why this technology is considered particularly secure. If, for example, a piece of information is changed in the chain, this change is verified by the computers of all participating members due to the decentralized management structure. Only after everyone has verified the change does it become valid. Because of the “everyone controls everyone” principle, there is no need for a central trust authority, as the blockchain is controlled by the members themselves.
This is particularly important for money transfers
In classic payment transactions by credit card or bank transfer, the seller of the item does not receive the amount directly from the buyer, but (as in the case of Facebook’s central message server) via a third-party provider. In the case of payment transactions, this is a credit card company or bank. This principle presupposes trust in the third-party provider, which is not necessary in blockchain. Here too, a transaction is only fully completed or valid when it is visible to all blockchain participants, i.e. when it has been stored as information in a block of the chain and verified by all other members.
In short, a blockchain is nothing more than a decentralized database for a specific group of participants, who all receive the same information and monitor each other. This architecture is ideal for transactions with cryptocurrencies such as Bitcoin, Ripple and Co – it’s even the basic requirement for trading with the digital currency. For this, you need virtual wallets. Each wallet has two cryptographic keys. The keys are nothing more than long strings of characters. The user receives a private key and a public key. The public key also represents the user’s name, as you don’t appear on the blockchain with your real first and last names. Transactions are carried out under the pseudonym of a character string (cryptographic key), so to speak. The public key is a kind of account number that can be used to receive amounts, currencies or other values. For subsequent access to the received values, the private key is then required in turn.
The key to crypto trading
Currently, this technology is mainly used for crypto trading, as it offers significant advantages such as system security and offers its users a high degree of anonymity. What’s more, cryptocurrency trading has so far been subject to little or no regulation. Well-known companies such as Paypal are also aware of these advantages and are banking on the option of paying with cryptocurrencies. The recent IPO of online platform Coinbase, which enables the purchase, administration and sale of digital currencies, was celebrated with gusto by investors (but only briefly, as the euphoria has since subsided).
Even investors who don’t yet own a digital wallet can participate in cryptocurrency trading. A selection of ETCs and ETPs (Exchange Traded Cryptos or Products) is shown in the table. They track the price of the underlying digital currencies identically. Beginners are advised to invest only small amounts, as price fluctuations are extreme and cryptocurrencies are currently in a phase of severe correction after the sharp rise at the start of the year.
This concerns the classic Bitcoin, Ether, Binance Coin and Ripple, as well as Stellar Lumens, a project in which IT giant IBM is involved to process cross-border payments in real time. The company’s seriousness doesn’t change the fact that, often, all crypto-currencies move in the same direction, with second- and third-tier ones naturally fluctuating even more than the heavyweights.
But cryptocurrencies aren’t the only ones that can be stored and traded on the blockchain. They represent just one of many possible applications. Companies’ entire supply chain data can also be stored on blockchain – including all flows of goods and payments.
Decentralized digital recording of patient data would be another conceivable application. Even the real estate sector could be digitized one day. This could make the appointment of a notary superfluous if both parties verify the sales contract electronically. Land registers could also be held digitally on a blockchain, and the transfer of ownership would no longer take weeks, but could take place in real time as soon as the seller has confirmed receipt of the money. It will certainly be some time before the notary system and land registry offices are converted.
Token: It’s best to just test it out
Blockchain technology is also the basis for “tokenization”. Here, a financial product is digitized and anchored or stored in a link of the blockchain. This means that a security is considered securitized, but only digitally.
Token is the English term for token. Similar to cryptocurrencies, virtual coins are intended. The advantage: securities such as bonds can be broken down into several parts. For example, if a real estate bond worth 1,000 euros is digitized using the blockchain, it can be tokenized into numerous small tranches worth one, ten or 20 euros. Each of these small individual bonds corresponds to a token.
With digital securitization, ownership (e.g., the number of shares or bonds attributable to a person) and rights (e.g., fixed interest or distribution) are proven via the token in the blockchain.
The principle is similar to that of a conventional securities account, except that the form of securitization is realized via character codes and bits. A custodian bank is not required to hold tokens, only a digital wallet.
Not like the Wild West
Token-based securities are regulated in Germany by the Federal Financial Supervisory Authority (Bafin).
However, legal protection in the event of loss or fraud is not regulated, or at least not entirely. Deposit insurance in the event of loss, as is the case for bank deposits, is not generally available either.
The advantages of tokens are that they enable almost all investors to access an investment thanks to their fragmentation – even with the smallest amounts. What’s more, tokens are considered low-administration, meaning that only low costs are incurred for structuring and issuance. This in turn can lead issuers, i.e. issuers of financial products, to make higher distributions to investors than with traditional securities. Like listed securities, tokens can be traded at any time, but only via the blockchain.
In technological terms, a token is made up of bits and bytes, i.e. a sequence of ones and zeros, and enables its holder to access a specific digital resource on the blockchain. According to the legal system, a token represents a person’s ownership of a certain thing – for example, ownership of a real estate bond worth 500 euros.
However, as is often the case, there are some black sheep who want to get rich quick with the new fad. When choosing a token investment provider, investors should therefore always be cautious; thorough research beforehand should be the minimum requirement for interested parties.
