Over the past decade, blockchain has become integrated into everyday language. For good reason – thanks to Bitcoin, blockchain technology has been implemented across a number of industries.
Having proven itself with Bitcoin, blockchain is likely to become the key technology behind many central bank digital currencies (CBDCs). The question then is, what is so innovative about blockchain technology?
What problems does Blockchain solve?
At a basic level, blockchain is nothing more than a type of database. Every time you log into an online account, such as Twitter, Google or Facebook, you connect to a database. As the word suggests, each database is a set of information, which is organized in a logical order.
Databases make it easier to manage and update sets of information. What sets blockchain apart as a database technology?
- Blockchain is a distributed database. Computers in a network — nodes — run identical copies. Therefore, if one copy on a node is compromised in any way, the blockchain network’s redundancy ensures that it will continue to run.
- Nodes are synchronized to update the database. If any nodes provide an erroneous record that does not match the rest of the nodes (51%), the record is rejected.
- Blockchain forms the database in chronological order. Because each block of data is time-stamped, it creates a chain. This has the effect of creating immutability. If a particular block of data was tampered with, a new chain would branch, effectively creating a fake database that is rejected by the network.
- Added data blocks are encrypted individually through the hashing method. Simply put, hashing transforms one value into a fixed-length string of characters. Using the same formula that produces the hash, any data of arbitrary size is then transformed into a fixed-size dataset. Therefore, hashing is not only useful for validating data, but for storing it in such a way that it does not reveal the original input.
Beginners Guide to Crypto in 2022
Given these key features, blockchain is a decentralized, distributed, immutable and secure database, also commonly called DLT – distributed ledger technology. Depending on how such a ledger is distributed, we have different blockchains that serve different purposes.
How is a blockchain network secured?
The best starting point would be to consider how cloud computing works. Specifically, one of the most popular workspace environments is Google Doc/Sheet. When such a document is created, the author grants sharing rights to users.
In turn, they can modify the document, with each change visible to anyone granted sharing rights. Therefore, the work of Google Doc/Sheet is to access and change a distributed data chain. In Bitcoin’s blockchain, which generates the most popular cryptocurrency that once reached a market value of $1T, the originator is Satoshi Nakamoto as the pseudonymous creator.
Instead of giving sharing rights to individual users, Satoshi Nakamoto, Bitcoin’s creator, made the network public and open source. Using the Script programming language, Bitcoin is nothing more than a smart contract that records whether the BTC token is spent or purchased.
What is stopping someone from adapting the smart contract so that spent tokens can be recycled? This problem is known as double spending, and all blockchain features fall into place to solve it. Going back to the analogy above, a Google Doc user can simply manipulate the datasets. The data chain will then be updated to all other users, presenting false data as true. Needless to say, it would be impossible to create a viable cryptocurrency with such a loose system.
Blockchain tackles this monumental problem in a revolutionary way:
- Each block of data in the chain consists of the three elements: the transaction data itself, a 32-bit nonce number that is randomly generated when the block is created, and the aforementioned hash.
- Once a block of data is timestamped, it is signed with the generated nonce number, linked, and transformed into a cryptographic hash.
- The network participants who hold blockchain copies create these blocks, in a process called mining. Because each block is unstamped with hash, as well as referencing the previous block in the chain, mining becomes a complex task.
The power of mining
Mining was intentionally designed to create a barrier to tampering. In particular, miners use specialized software that solves mathematical problems so that they can find a nonce that generates a hash that is accepted as the next block in the chain.
The nonce itself is a 32-bit randomly generated number, while the encryption hash is a 256-bit function. This translates to a whopping 4B potential non-hash combinations to be mined before the right block is found. When one is not found, it is added to the chain as a confirmed block when consensus is reached from the majority of nodes.
For all this work, the miner receives a reward in the form of the network’s native cryptocurrency. In the case of Bitcoin, this will be BTC. Such a reward system represents the cornerstone of decentralization because network participants are inherently incentivized to participate.
In short, the computational power needed to carry out this mining process creates such a barrier that it is virtually impossible to manipulate the blockchain network. After all, this is why Bitcoin makes headlines for its power consumption, usually compared to a country. According to Digiconomist, the Bitcoin network currently consumes 204 TWh of annual consumption, which is comparable to a country the size of Thailand.
However, such energy consumption only applies to Proof-of-Work (PoW) blockchains where work is translated into electricity use needed to solve cryptographic mathematics, represented as the miner’s hash power contributing to the network’s total hash rate (TH/s).
In contrast, Proof-of-Stake (PoS) blockchains use financial stakes of native tokens to achieve the same goal. For this reason, miners are called validators in PoS networks.
For example, when Ethereum transitions from PoW to PoS, energy usage is poised to drop by 99.95%, according to the Ethereum Foundation.
Types of blockchains
The primary point of divergence for blockchains is whether they are permissionless or permissioned, which should not be confused with private vs. public. This difference is closely related to the number of nodes verifying the blockchain network. They have fewer nodes because there is a permission barrier that prohibits access to approved blockchains. Consequently, such blockchains are highly centralized. On the upside, they are generally faster because fewer nodes confirm data blocks. That said, permissioned blockchains can also be public.
One such public/permissioned hybrid blockchain is Ripple. In Ripple (XRP), network participants (nodes) are granted permission to maintain the network by Ripple, Coil and the XRP Ledger Foundation. Together, they create unique node lists (UNLs), based on the node’s trust level. The latter mainly concerns the node’s past performance and provable identity.
Currently, the Ripple blockchain network runs on 35 trusted nodes. In comparison, the top two cryptocurrencies, Bitcoin (BTC) and Ethereum (ETH) run on significantly more decentralized networks, at 15,539 and 6,089 nodes respectively.
Altogether, based on the primary permission/permissionless criteria, blockchains can be public, private, hybrid, and federated (consortium controlled).
Can any data be recorded on a blockchain?
Bitcoin (BTC) popularized blockchain technology with its use as a peer-to-peer (P2P) digital money. Because Bitcoin was designed to have a limited supply of 21 million coins, it is not subject to inflationary forces. Likewise, because it is run on such a decentralized network, no central bank will ever be able to tamper with the money supply the way the Federal Reserve does with the dollar.
However, all data can benefit from blockchain’s immutability, security and decentralization. The dollar itself can be tokenized in the form of stablecoins. These types of cryptocurrencies remove volatility from the equation while providing global payment networks comparable to the likes of Visa, but even faster and cheaper.
The most prominent blockchain payment networks that emphasize stablecoins are Terra and Tron. There are a number of ways that stablecoins maintain their peg to the dollar. Some give them security with 1:1 cash reserves, such as USD Coin (USDC). Terra’s UST stablecoin uses an algorithmic security system, where the original LUNA cryptocurrency is burned (removed from circulation) to buy UST when the pointer goes above the 1:1 ratio.
Vice versa, UST tokens are burned to buy LUNA when the pin goes below the 1:1 dollar pin. Whether regular or algorithmic, stablecoins represent frictionless 24/7 payment systems. Central Bank Digital Currencies (CBDCs) are trying to catch up, but central banks will control them completely, removing financial privacy in the process.
Provenance of assets
Outside of payment systems, blockchain networks can be used to verify the origin of assets. For example, an artwork can be tokenized with a smart contract as an NFT – non-fungible token. The same goes for audio, e-books, video and even real estate. For example, CityDAO uses blockchain to tokenize real-world plots of land in Wyoming to manage land development and ownership.
Similarly, blockchain networks can establish provenance in the supply chain. For example, Walmart uses Hyperledger Fabric, a permissioned blockchain, to establish the traceability of consumer products. Therefore, if a food item goes bad, it can be traced back to its source, along with all the handlers along the way.
The biggest blockchain use comes from the embedded smart contracts. These are executed agreements that are triggered when conditions are met, stored on a blockchain. Although all blockchain networks use smart contracts, it took Ethereum to make it easy to deploy them as dApps – decentralized applications.
When dApps are combined with the blockchain’s immutability/security, an entire financial infrastructure can be recreated in a decentralized way:
- Markets without market makers – Uniswap, Sushiswap, Balancer
- Banking without banks – Anchor, Aave, Compound, Curve
- Auction houses without auctioneers – OpenSea, Rarible, SuperRare
Currently, there is over $200B worth of crypto assets locked across smart contract platforms. They provide services from decentralized exchanges (DEXs) and lending to NFT marketplaces and insurance, such as Nexus Mutual.
Finally, even voting itself can be symbolized. Perhaps this will be the most robust way to secure elections. If a person’s identity is linked to their wallet address, which is already verified through KYC/AML rules, it would be a simple matter for that person to cast votes that cannot be tampered with.
Of course, this would be best done on public and highly decentralized networks like Ethereum. Vote registrations can then be anonymised, transparent, immutable, traceable and auditable. Effectively, just as Bitcoin proved that it solved the problem of double spending, the same can be done with double voting. After all, they are both accounting entities.
Should Blockchain replace all databases?
In conclusion, what is a blockchain good for? Should organizations use it as a standard computing solution? To answer that, we need to keep in mind that blockchain’s key feature is data redundancy that stems from decentralization. Once we understand that, we can measure the balance between long-term record keeping and cost effectiveness.
In the case of blockchain smart contracts, if the gatekeeper/intermediary in the traditional setup is either inefficient or too expensive, it is time to replace it with a smart contract platform. For example, tourism company TUI Group implemented blockchain smart contracts to connect customers directly with hotel suppliers, effectively replacing the booking system.
Finally, if it is important for the record to contain all historical data, there is no better way than to create a time-stamped and redundant data chain, the blockchain.