[explainer] What Blockchain and Distributed Ledgers are For

I always kind of suppose that everyone in the tech field knows what distributed ledgers are, how that ties into cryptocurrencies like Bitcoin, and so on. But I have lots of non-tech friends who keep asking for a simple explanation.

I’m not sure there is one, but here we go.

In the early days, before computers were a thing, all national currencies used what was called a distributed ledger. A ledger is how you keep track of who has which bits of money; in the early 1900s, it was simple: whatever was in your pocket, or stuffed in your mattress, was yours. In other words, we didn’t have a ledger. You had what was yours, and you could prove it by pulling out a big ol’ gangster wad of it and waving it around.

Banks changed that. With a bank, we took our money into a building and they kept our money, but it was still our money. We weren’t “giving it to the bank;” they were keeping it “in trust” for us. And so banks had to create ledgers, which was a big ‘ol book that listed how much of your money the bank had. In today’s terms, this would be called a central register.

Now, as far as that went, things still aren’t too complex. You trusted one bank. If you needed some money, you went in and withdrew it, and they updated the ledger.

Things got a bit more complex when we started writing checks. When Bob writes a check against his First National Bank of Boston account, and he gives that to Mary, who deposits it in her First National Bank of Connecticut account, a whole process has to kick into place. Originally, the Connecticut bank had to literally carry the check to the Boston bank, present it, and ask for the cash. They’d then haul that cash back to Connecticut, put it in Mary’s account, and update their ledger.

This was obviously a PITA.

Very quickly, the emerging national banks – as opposed to the local banks who merely used the word “national” in their name – started establishing clearing houses. The idea here is that Mary’s Connecticut bank could take Bob’s check to a local, Connecticut-based clearing house. The clearing house would direct their Boston branch to walk over to Bob’s bank in Boston and retrieve the cash. Once they did, the Connecticut clearing house would release the same amount of cash to Mary’s bank. Telegraph lines were used for these communications, but it could still take a few days for the check to “clear.” But you can see how the ledger-ing got more complex, right? We’ve got a lot more banks we have to trust now, and they have to coordinate their activities pretty precisely.

With the advent of computers and fast communications lines, banks created an Automated Clearing House, or ACH. This clearing house works exactly like the old ones, except that it talks directly to the computers at both Bob and Mary’s banks, “clearing” checks in seconds (despite banks still liking to put multi-day holds on the funds). If you get your paycheck direct deposited, you can thank the ACH for that. The ledgers might have become computerized, but they’re still very much in play, and in operation they don’t work much differently than they did a hundred years ago.

Today, with Venmo and PayPal and God knows what else, we rely on the ACH system tremendously to direct deposit and direct debit funds. In fact, the concept of money as a physical, tangible thing is getting a little vague. You can have money, spend money, and receive money, without ever seeing any actual cash. The entire financial system relies on those carefully controlled, computerized ledgers that the banks all keep.

This annoyed the creator of Bitcoin.

He (probably the right pronoun, but nobody can prove it) wanted to let us continue to use digital currency, for all of its instant-ness and convenience, but didn’t want to have to rely on banks’ centralized ledgers to do so. Instead, he wanted a kind of digital-only currency that worked like physical cash did: if you have it, then it’s yours. You don’t need a central ledger to prove your money is yours, because you have it in your physical possession.

And that’s what cryptocurrency is. Using the most Godawful math you can possibly imagine (and then some), a single Bitcoin is basically a data file that lives on a computer, can be carried around on a USB key, etc. Typically, the file is maintained by a “wallet” app that keeps track of all the things. Yeah, Bitcoin is the digital equivalent of having a zillion pennies in your pocket.

Each Bitcoin (well, technically each fraction of a Bitcoin, as you can spend them fractionally) has a record of everyone who’s ever owned it. If you own one Bitcoin, and spend half of it, then the half you spent gets split off, given its own transaction history that starts with the original Bitcoin you own, and sent on its way. Because each bit of currency “knows” its own history, this is called a distributed ledger. The ledger – the blockchain, if I can oversimplify the concept for the purposes of clarity – is encrypted fifty ways to Sunday to ensure anyone can validate it, and that it can’t be modified without breaking it. Try to turn your 1 Bitcoin into 100 Bitcoins by messing with the file, and you’ll end up with 0 Bitcoins.

Having invented this idea, distributed ledger and blockchain can apply to lost of things aside from cryptocurrencies. Some banks, for example, are exploring using distributed ledgers instead of their old-school centralized ledgers. A distributed ledger can be faster to clear transactions, for example, and it’s more resilient than a single, central ledger.

Blockchain could play a part in anything we own. For example, rather than having property titles recorded in a central ledger with your county, the property itself could “know” who owns it, and who has owned it. This removed the government from the loop, something a lot of folks like the idea of. This hasn’t happened, and it might not ever happen (governments do like their paperwork filing fees), but it’s the vision some folks have for blockchain technologies.

More practically, imagine bills of lading for goods using something like blockchain. An inspector at a port of entry could know exactly where a piece of cargo has been, and who has owned it, in a way that can’t be easily forged or faked. That could clear up port operations, and it’s one of the uses being explored for blockchain.

So there you have it. I don’t know how you turn that into a 90-second Schoolhouse Rock cartoon, but it shows how everything old becomes new again: from the time when money was cash, to now, when money might become cash again. Sorta.