Blockchain will soon power stock markets, music sales, and even prevent child labor — how?

The blockchain was conceived by the mysterious creator of Bitcoin, a digital currency with a mixed following: privacy-minded libertarians, activists and some criminals.

Now, the idea of ​​blockchain has captured the attention of big Wall Street institutions.

Its backers think it can change the world. Big banks are interested because it will make contracts more enforceable and speed up the settlement of stock trades. But some think it can go further, helping to combat sex trafficking, music piracy and child labour.

The key to capturing the attention of these different groups of people is something that, on the surface, sounds pretty mundane: a digital ledger, like the kind you use in your checkbook.

“Blockchain is really a remarkable technology that does something really mundane,” said Paul Brody, global blockchain leader at Ernst & Young.

Despite its promise, some big questions remain: Who will pay for it, and is it as safe as its backers say?

What is blockchain?

Without blockchain, we kept separate records of transactions. You sent a check to your friend, you checked it in your checkbook, and your friend kept his own record when he deposited the money. Mistakes were inevitable, and they might forget to record it in time. Even if a person had enough money in their account to pay off their debts, the bank had no way of knowing immediately.

With blockchain, instead of having two separate checkbooks to record debits and credits, you can share the same transaction ledger. It is private (encrypted, computer-readable) and decentralized, and neither of you has control over the ledger.

This "distributed ledger" works in unison and is visible to both parties. Transactions are put into separate blocks. If both parties agree that the block is valid and correct, it is added to a chain. This chain is protected by complex cryptography: no one can change the chain afterwards.

Now imagine this in a more complex form, and you’ll understand why finance and technology people are excited.

You say you want to buy a stock. Right now, your bank, your broker, the stock exchange, and the company you're buying from all have separate private records of your transaction, and none of them can see each other's ledgers or verify that everything involved is accurate.

With blockchain, all of this is recorded word for word on the same page.

The bank can verify that you have enough money in your account to transfer to the broker. The transfer is added to the ledger for everyone to see. Then, the broker buys 100 shares for you, and this is also added to the blockchain, and everyone involved verifies its legitimacy.

The exchange receives the order, adds it, and verifies it. Eventually, the company's shares appear in your account. The purchase and sale of the shares will be permanently recorded and visible. If you decide to sell the shares later, this action will also be added to the blockchain.

Because it is a consensus model, a transaction is confirmed by all parties, so in a blockchain, "the more people join, the more secure it is," Brody said. "Once the transaction is completed, everyone gets a copy of the transaction."

This is the purest form of blockchain. However, in reality, different companies are experimenting with different forms. Blockchains used in financial services may be private, or a hybrid model between a decentralized view and the traditional centralized model (which bankers are more used to). For example, regulators could hold the key to blockchain, and some companies are considering how to retain dealers.

Mysterious Beginnings

No one knows who invented blockchain. The idea came from a paper published online eight years ago that unveiled the digital currency Bitcoin. The author, Satoshi Nakamoto, is thought to have used a pseudonym. The author's true identity remains a mystery. Whether blockchain was created by an individual or a group is hotly debated.

At first, Bitcoin got everyone's attention. The idea of ​​a secure, private currency that was independent of a specific government captured the imagination of technologists, libertarians, and people who were intimidated by the power of big banks and governments. Bitcoin transactions occur peer-to-peer, with no government or third party involved.

Today, bitcoin and blockchain still attract the privacy advocates and anti-government crowd. But it’s also increasingly attracting people like Grainne McNamara. She spent years building such technology at banks like Morgan Stanley and Goldman Sachs. Now she’s PwC’s leader for financial services blockchain and spends a lot of time attending and hosting blockchain conferences.

At one conference, a speaker showed a picture of a shed. McNamara remembers him joking, “Kill the banker behind the shed.” He had no idea who was in his audience.

McNamara's seatmate, a former economist, found the whole thing amusing.

Despite the unfriendly metaphor of the shed, "it's a peaceful symbiotic relationship," McNamara told Business Insider. "What people really appreciate is the disruptive element that sets off innovation."

A contract with the brain

One idea that has proponents excited is “smart contracts” on the blockchain: While most banking agreements are still paper documents (even in 2016, banks were still full of paper), a smart contract is a computer program that helps ensure everyone fulfills their responsibilities.

Let's say you have a company that designs and sells video game consoles, and you work with suppliers and shippers and have a bunch of important things to worry about. You have to make sure the consoles are delivered on time and to the right quality, that there's no child labor involved, and that everyone gets paid on time.

In the past, this might have involved a large number of contracts, each party having to keep its own copy.

Smart contracts enable automated accountability.

Because in a blockchain, every participant sees the same contract; no one can make changes without the permission of the majority of others.

Here’s an example: When a truck packs finished video game consoles at a factory in China, the shipping company scans each box. These actions are added to the blockchain, triggering the video game company to release the money. Neither party has to issue an invoice or chase for payment.

“You can combine delivery and payment,” Brody said.

It can do more than just payments. Every worker on the assembly line can scan their ID, which is then verified by multiple parties (such as government agencies and third-party auditors) to ensure that the worker is not underage and is not overworked. This is a blockchain, so no one can change the record afterwards.

Some people are discussing whether blockchain could be used to prevent sex trafficking and other harms. Maybe it has other uses that will profoundly change our lives in the future.

Health Insurance

Smart contracts in medical insurance can perform such operations. For example, when a patient undergoes a CT scan, the smart contract will trigger insurance payment.

Blockchain can also securely store electronic medical records.

It will record in detail all communications between doctors and patients, disease and treatment information, vaccination records, medical expenses, etc. Even if they are not in the same city and country, every visit or treatment will be added to the blockchain, creating a complete patient health history.

In this case, the blockchain is private and only certain specific participants hold the encryption keys to view the records.

Music and Media

At the turn of the century, Napster disrupted music sales through file sharing, and if blockchain had existed at the time, it would have benefited musicians.

Now, some are considering using blockchain to combat piracy and boost sales. Artists publish their work directly on the ledger, and smart contracts ensure that the right people get paid, and only those who have permission can play the tracks.

A similar model could help news outlets and other media organizations.

Property records

Some companies employ people full-time to keep track of property records. Blockchain could eliminate that job.

If the property deed is embedded in the blockchain, other participants validating the transaction (acting as “network nodes”) can be real estate agents, financing banks and land registries.

Once the transaction is verified, it will be added to the blockchain, and the updated state of the blockchain will be broadcast to participants in real time. Since the blockchain retains the history of all transactions, the history of the property and its owners will appear on the blockchain.

Trade and Banking

The Australian Securities Exchange (ASX) plans to decide in mid-2017 whether to replace its existing post-trade clearing system with blockchain. This will be a turning point in the development of blockchain and may lead to widespread use of blockchain in the future.

Central bankers are also getting in on the action. The Bank of England and the People’s Bank of China are in discussions to issue their own currencies, the British pound and the Chinese yuan, respectively, on a blockchain. If successful, the technology would make currencies more traceable, allowing banks to track their movement through the financial system in real time.

Right now, this use of blockchain is limited to discussions and research papers, but if implemented, other central banks may follow suit. The Federal Reserve is also closely watching blockchain developments, with Lael Brainard at the Fed overseeing the technology.

There are rumors that other items (such as diamonds, art, and food) could also be put on the blockchain so that the goods' past can be traced.

Rumors vs. Truth

Today, there are more than 120 blockchain projects across a wide range of industries, and in 2016, the annual budget invested in blockchain was estimated at $1 billion.

In financial services, big names like Goldman Sachs, JPMorgan Chase and Bank of America have partnered with R3, a startup trying to apply blockchain to the financial industry.

If blockchain is to be adopted, an industry standard must be established. It may be a risky and expensive investment for the first bank to adopt this digital system and overhaul the existing infrastructure for it, and the bank must get the cooperation of other banks in sync. No bank wants to be the first crab eater.

This is why blockchain is one of the few cutting-edge technologies that has generated a lot of discussion. Today’s banks are just dipping their toes in the water, attending conferences, working with R3, but no one bank is at the forefront of moving this concept from paper to actual practice.

“To get real value, you need network effects,” said Graham Warner, head of product development for Deutsche Bank’s Americas global transaction bank. “The more people and companies use blockchain, the more valuable the technology becomes.”

Other Challenges

Despite the promise of blockchain, several major barriers, including regulation, cost, and security issues, prevent its widespread adoption.

Implementing and standardizing blockchain will likely cost billions of dollars, meaning people will have to change habits, overhaul legacy systems, and rethink things. The technology works today, and replacing it with something unproven is a costly venture.

Blockchain technology could also mean a lot of job losses, especially in intermediary and back-office jobs. Banks will have to adapt the remaining staff to the new technology, and using it will be a process of trial and error at first.

Security and Privacy Issues

In August, hackers stole $72 million worth of bitcoin from accounts at the Hong Kong-based cryptocurrency exchange Bitfinex. In June, hackers stole $55 million worth of ether, a bitcoin competitor. The Ethereum Foundation, the nonprofit that runs ether, just got back on-chain as if the hack had never happened, and business is back as usual. But purists are still worried.

The Ethereum hack, and the response to it, prompted Accenture to create an “editable blockchain model” to “address human error, accommodate legal and regulatory requirements, and avoid harm and other issues,” according to a news release.

Blockchain enthusiasts say this threatens the essence of blockchain technology, one of its defining benefits is its immutability: The blockchain is a “golden record” of transactions that is complete and technically impossible to interfere with or undo.

But “there’s not one blockchain to rule them all,” Warner said. “It’s going to be an evolution, a Darwinian process of elimination,” where only the blockchain versions that fit the use case are created.

What's next?

When McNamara learned about blockchain, she said she was “a little skeptical, but it turns out I didn’t have to.”

She said the ecosystem is evolving, with players — whether activists or bankers — coming together to discuss “shared values ​​and pain points.”

While some large operators like the ASX could be using some form of blockchain as early as next year, some questions remain.

Different versions of blockchain are being developed, and there is disagreement over which is the best or purest version. Dozens of startups are developing their own blockchains. Innovation is happening, but the idea of ​​competition is keeping big companies from making any commitments.

But most supporters believe that everything will work out in due time. In the next few years, blockchain and its smart contracts will improve our lives, even if it just runs quietly in the background, invisible to most people.