Advances in cryptography, combined with the potential for data transmission and storage, have led to the emergence of so-called distributed ledger technologies (DLT) .1 These are databases of which there are multiple identical copies distributed among the participants in the network, which are updated in a synchronized and consensual manner. The great attraction of DLTs is that they allow you to manage and securely share data and save all the information without it being altered. The best-known type of DLT is the blockchain, which organizes information by blocks and is often compared to a book that cannot be erased.
Blockchain technology is based on three fundamental ingredients:
Thanks to cryptography, each block of information is uniquely identified. Network participants must approve and validate all information that enters the network. The registry is unalterable and immutable and therefore extremely difficult to hack or modify.
Blockchain technology facilitates the emergence of cryptocurrencies, since, by creating a shared record of all transactions and establishing a decentralized validation method, it facilitates the digital exchange of money between users directly (traditional payment infrastructures have an intermediary central, be it the central bank, a digital payments company, a mobile platform …). The best-known application of blockchain in the financial world is the settlement of payments (in international transfers, cryptocurrencies can play a valuable role as bridge currency), as illustrated in the first figure.
1. Distributed ledger technologies.
How blockchain technology works
Blockchain, a rapidly evolving technology that may end up facilitating the development of applications for mass use
One of the areas in which more work is being done is improving the scalability of payment systems with blockchain as one of their fundamental ingredients. The first initiatives to emerge were fully decentralized and public networks. In these cases, as all participants must validate the transactions, the number of transactions that can be processed is considerably slowed down (a clear example is that of Bitcoin, which processes seven transactions per second compared to 65,000 for Visa), and the expenses of energy are very high. One of the solutions being explored is the use of permissioned networks, in which an administrator controls the network and decides who can participate in it. Their advantage is that they are more scalable and validate transactions much faster, although they are more vulnerable to tampering and hacking attempts.
Beyond the blockchain
It is important to clarify that technological advances in the financial sector go far beyond cryptocurrencies and DLTs and have made it possible to improve the agility and operation of existing payment systems. A good example of this is the spectacular advances in mobile payments. As we have seen, blockchain technology has a lot of potentials, although it would be possible to issue a digital currency without the need to resort to it. An authority with powers of centralization of processes such as a central bank could consider this by developing an infrastructure based on the payment systems that already work today.
But the bottom line is this: The open-source nature of blockchain technology, the excitement it has generated, and the growing value of associated currencies have inspired a global community of smart, passionate and financially motivated computer scientists to work on overcoming these limitations. It is reasonable to assume that they will keep technology improving steadily. As with internet software, open and extensible protocols can become powerful platforms for innovation. Blockchain technology is advancing too fast for us to know which future versions will improve our present, whether through the cryptocurrency-based protocol of Bitcoin, on Ethereum’s smart contract-centric blockchain, or on some platform that we have yet to discover.
Like the dot-com bubble, the crypto bubble is creating the infrastructure that will allow future technologies to be built. But there is a key difference. This time, the money raised is not ensuring a physical infrastructure but a social infrastructure. It is creating incentives to form global networks of collaborating developers, a joint intelligence whose supply of interactive and iterative ideas is encoded in open-source software lines. This free access code will allow you to test countless ideas that even hours were unimaginable. It is the foundation on which the decentralized economy of the future will be built.
Very few people would have predicted the birth of companies like Google, Facebook and Uber in the mid-1990s. Today, we cannot guess which blockchain-based applications will emerge from the remnants of this bubble to master the decentralized future. This is what happens with extendable platforms. Whether it’s the open protocols of the internet or the core components of the blockchain algorithm and distributed record-keeping, its power lies in providing an entirely new conceptual framework for innovators who are ready to dream up and deploy world-changing applications. . In this case, those applications, whatever their form, will be aimed at disrupting many of the institutions of control that currently dominate our centralized economy.
The main areas in which the use of cryptocurrencies can be beneficial are the following:
International financial transactions. Although blockchain technology is not the only alternative being studied in this area, it is a clear candidate to improve the efficiency of international payments due to the reduction in costs that it can entail and a greater speed of transactions compared to systems with a high operational centralization. Reduction of the black economy. Even though one of the main properties of cryptocurrencies is the anonymity of transactions, mechanisms could be designed to identify illegal activities. For example, that payments in certain areas or of a certain amount were not anonymous. They can promote financial inclusion in underdeveloped or emerging countries, where a significant part of the population is unbanked (but you could store cryptocurrencies in a digital wallet linked to your mobile phone).
Not all cryptocurrencies are the same
According to the definition of the BIS, two cryptocurrencies are distinguished because they are electronic and allow exchange between pairs without a third party acting as an intermediary. But there are many types of cryptocurrencies. The so-called “money flower” helps us to classify the different currencies, and also the cryptocurrencies, based on their properties in the most relevant areas: the type of issuer of the currency (central bank or other), its accessibility (universal or restricted), its form (electronic or physical) and its transfer mechanism (peer-to-peer or centralized).