Much is being said and written about blockchain technology recently. Although initially used to manage cryptocurrencies, according to some people, blockchain could potentially revolutionize how things are done and change many industries that have been supported and driven by countless IT solutions in recent decades.

From supply chain management to secure data storage solutions, not to mention the management of digital medical files… our imagination seems to be the only limitation to the possible applications for this technology, which seems to be turning into a “digital panacea”.

To help you navigate in these very turbulent waters without feeling overwhelmed, we’ll be publishing a series of three articles on the subject. The underlying concepts for blockchain technology are explained in sufficiently general terms in this first article, so that you can understand how blockchain can be used to prevent cryptocurrency fraud, the subject of the second article. The third article will explain how blockchain can generally be used in areas where it does not seem natural to resort to this technology.

Blockchain in a nutshell

Heralded as the next revolution, coming in the wake of the changes brought about by the arrival of the Internet, blockchain technology provides an environment where transactions can be carried out securely between strangers, with no need for an intermediary.

How does it work?

To do this, blockchain technology leaves an indelible and unalterable trace of all transactions in a ledger. This ledger is, in fact, a system composed of blocks comprising all previous transactions and connected to a constantly growing chain (hence the name blockchain).

Before each transaction is executed, the system validates that the party actually owns the related assets, as claimed. The system will scan the entire chain to ensure transaction integrity. Once the transaction has been validated, a new block containing an indeterminate number of transactions is created and added to the chain. The system is totally decentralized and composed of a series of computers that are part of a network. So far, so good? Let’s continue.

The hardest thing to understand is how fraud can be prevented and how it can be ensured that the information in the ledger is absolutely true. Since the system is decentralized, each node (i.e. each computer connected to the network) must include a copy of the ledger that has to be updated as transactions are executed. But how can a malicious individual be prevented from taking advantage of the system by introducing false transactions? This is where a very important factor comes in: Blockchain uses the same mathematical theories and concepts as seen in cryptography, i.e. the ones that are used to ensure the security of your banking transactions and online purchases.

In order for a transaction to take place, there must be trust between the parties (who do not know one another). This is achieved through the exchange of public cipher keys and the use of private deciphering keys to confirm the participants’ identity. These concepts are largely beyond the scope of this article and do not need to be discussed to provide a good understanding of blockchain technology. However, you should know that the Bitcoin system uses a 256-bit key. In other words, cracking this key would mean finding a random number of 2 to the power of 256, which is mathematically impossible. To learn more about this, read this article online (in French only).

Blocks are authenticated before being added to the chain, and therefore are linked to one another via hash codes, i.e. encrypted information that is already stored in the existing blocks. This means that the network would quickly detect and reject any attempt to modify even the tiniest bit of information already in the chain.

What are the impacts?

With blockchain technology, it’s possible for strangers to carry out secure transactions without the need for a central authority to manage them. This is precisely how blockchain technology is currently upending a wide array of transaction models traditionally based on the concept of confidence in established bodies which, over time, have built their reputations to earn people’s trust.

However, recent history has shown that, this trust has been eroded, particularly during the financial crisis, with the major problems experienced by several central banks that were supposed to guarantee and safeguard asset value in their monetary systems. What makes blockchain interesting is that it is now possible to imagine specific property and broader data management systems with no need for controls by central third parties.

Traceability

Yet another important feature of blockchain technology is worth highlighting as well: transaction traceability. Blockchain ledgers always include all transactions that were accepted by network participants. It is highly unlikely that one person will be able to change the recorded data. Blockchain technology therefore makes it possible to develop monitoring tools that can reliably trace any transaction executed in the system. This will be discussed further in a future article, together with some practical examples.

For more information, note that Raymond Chabot Grant Thornton announced the creation of a Montréal-based blockchain centre of expertise in July 2017. The centre’s objective is to provide companies with the expertise they need to make the transition to this new digital platform. Please go to catallaxy.com.

26 Sep 2017  |  Written by :

Manager, Tax, Raymond Chabot Grant Thornton

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