Corporate Finance, DeFi, Blockchain, Web3 News
Corporate Finance, DeFi, Blockchain News

How I Explained Blockchain to My Grandmother

My grandmother likes to stay informed and recently told me: << I read on the magazine a few days ago about something called “blockchain”.

Enrico Camerinelli
Enrico Camerinelli
Everybody seems to have fallen in love with it so it must be something imoprtant. Unfortunately the article was full of technical jargon and I could not understand a thing. Do you know what it is? >>. << Yes, of course. >> was my prompt answer. << Good. Could you explain it to me? >>. She must have seen my face because she generously added: << Of course if you have time now. >> At that point I was caught between reluctance to give an explanation that could have only increased her confusion, and self-pride that told me I could do it. The latter won. So I took courage and started what would have turned into a lesson for life.

<< Assume all you have is a $100 bill to buy goods in a shopping mall. At the checkout you say that you will send an email promising to pay $100, with the email representing a promise to pay (i.e., an “electronic I.O.U.”). The merchant happily accepts the email and goes to the bank. The bank also accepts the email and credits $100 to the merchant’s account.

Sounds odd? Certainly for one reason: assuming just for one second that all happens as described, what is it of your $100 bill? It’s still in your wallet. So does that mean you can buy goods for more than you have by simply sending emails? Too good to be true. However, believe it or not, the transaction can happen (and indeed it does in the real world- just have some patience and we’ll get there).

To understand how this could ever be possible let’s add a group of customers in the mall. Now, when you say that you will send the email I.O.U. the people will ask to receive the same email. There are some “special” customers in the crowd that will compete to be the first to validate the email (e.g., the sender, the receiver, the exchanged amount, the real possession of the claimed amount). Once they validate it, the content becomes “true” for all. But wait a minute: Since all “special” customers in the mall will want their validation to become “the” version of the truth, which one should you follow?

All special participants follow a rule (that is, a “protocol”): The first to solve an electronic puzzle, say a Sudoku, wins the race. As we all know a Sudoku is quite a hard nut to crack, but the solution is easy to check. The winner is compensated for the hard work to solve the Sudoku. There is an incentive for the contenders to win the next time.[1] After checking that the puzzle is properly solved, contenders scrap their version and accept the winner’s validated email as the “version of the truth”. The email is then sent to all the people in the mall, which now all have the same copy, acknowledged as valid and immutable. With the version of the truth publicly accepted, everyone in the mall will know that you owe $100 to the shop and that the $100 bill in your hands is worth nothing. [2].

You now move to the next store in the mall and try to buy other goods worth $100. You make again the promise to pay via email. This time your offer will be refused. Why is that? Well, did I say that also the merchant received the email? This means that he perfectly knows that you don’t have any money left. Before I forget again, both your bank and the merchant’s bank are also in the loop. So the system is self-controlled and there’s no need for any intermediary (e.g., a clearing house or the Central Bank) to tell parties how much each owns and if the transaction is acceptable.

What if instead you make the promise to pay to a clerk who has just been told that he was made redundant and that it’s his last day of work? The clerk may want to retaliate. Why not give a lesson to his boss and accept a fake email payment from a stranger? In other words, what if he who receives your promise to pay has the intention to act maliciously and accepts an irregular transaction? Well, in this case the customers in the store (exactly those who received the first valid email) will raise a red flag (yes, we are in a world where people speak out). As long as 51% of customers say this (after all they all have the same copy of the “truth”), you will be refused to buy the goods. If the malicious clerk wants stubbornly to cheat the system, he will have to convince at least 51% of attendees who have no particular reason, nor vested interest, to buy his story. Hence the effort and energy to turn the system to his favour will be overwhelming and economically unfeasible. The system once again is self-controlling without the need of a central ruling authority.

To add even more “esoteric” elements to this already intricate scenario, when the merchant that received the valid I.O.U. will use it (or a portion of it) with some other party in the mall, the entire population in the mall will be informed exactly of what is happening. The history of the I.O.U. will never be lost and, at any time in the future, someone will be able- if duly authorized- to trace the transactions backwards and know that on that certain day at that certain time you passed your “electronic I.O.U.” to buy goods for $100. It’s as if the full history of the transaction was written in stone and will remain immutable thereafter.

This history repeats for all transactions between all parties in the mall. On a regular schedule the miners run the Sudoku and disseminate the validated I.O.U. emails. To recap, every participant in the mall (banks included) receive a copy of all the valid transactions since they entered the mall. If someone goes out and then returns later, they can still get the list of the transactions (only the valid ones, of course) during their absence. So at any time anyone in the mall has the latest updated list of all valid transactions (i.e., the “truth”) from the beginning of time.

This simple (and rather silly- I apologize) story is to exemplify the features of the blockchain. In blockchain jargon, the “electronic I.O.U” is called “bitcoin”. When you promise to pay $100 it’s as if you are writing on a ledger that the title to redeem a value worth $100 is transferred from your account to the seller’s account. If you try to spend it again (that is, to “double spend”) someone will shout out loud that you are cheating. That’s why the bank will accept the email I.O.U., because they know it belongs to a valid transaction.

You, the stores in the mall, the crowd of customers, the “special” participants that control the validity of all transactions, the banks that convert the I.O.U. into solid cash—and even the unfaithful clerks—all constitute the blockchain infrastructure. There is no centralized control; every party can transact with any other (that is, peer-to-peer) and it’s the system itself that controls the validity of the exchanges. The “special” participants are called “miners”, as their role is to “mine” and validate/ reject transactions following a schedule. Miners exist in the so called “Bitcoin” blockchain (also known as the “Satoshi” blockchain as a tribute to the inventor of bitcoins), while other forms of blockchain (e.g., Ripple) assign different roles to the validators of transactions. Miners collect valid transactions in a “block” [3]. Anyone can track back the history of a transaction because the blocks are connected (i.e., “chained”). So, in a nutshell, blockchain is a chain of bocks, each with a recorded ledger of validated electronic I.O.U.’s. All network members have a copy of the blockchain which represents the agreed version of the truth. >>

I then looked at my grandmother who had remained completely silent during the rather long explanation, asking if everything was clear. <<You make difficult things look so simple. There is one thing, though, I need to ask. You said that I could pay using an email. >>. <<Yes, exactly. You just send an email and the payment is done. >> I answered, already proud of my performance. << So what is that you wanted to know? >> And she, with a smile: << What is an email? >>

[1] Some other malls in town may decide to use a different puzzle and different protocol (e.g., nobody gets paid), but the basic rule is that the version of truth descends from some evident activity performed by the claiming party.
[2] This part of the story is a bit stretched but use your imagination (I know I am abusing quite much of it) to pretend the bill will magically disappear.
[3] In the Satoshi blockchain the collection schedule is every 10 minutes

Enrico Camerinelli is a senior analyst at Aite Group specializing in wholesale banking, cash and trade finance, and payments.
Based in Milan, he brings a strong European focus to Aite Group’s Wholesale Banking practice.
Mr. Camerinelli has been widely quoted by publications ranging from American Banker to Financial Times.
He has contributed editorial content to publications such as Supply Chain Europe, Finyear, and serves as a consulting editor with gtnews.
He has spoken at leading trade shows and conferences in Europe, including Sibos and EuroFinance.

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Mercredi 23 Mars 2016