What Are Blockchains And How Do They Work
In this current day and age, where every innovation demonstrates unprecedented potential, I still can’t help but be astonished by Blockchain technology’s incredible potential. As both a development platform and a cryptocurrency system, the possibilities are just as limited as the human spirit of innovation. Unfortunately, the knowledge we have about Blockchain technology tends to be scattered, incoherent, or just plain obsolete. I’ve written this post to help you understand the theory of Blockchain as well as fundamental protocols.
First, in Section 1, I’ll describe the background of value storage systems and outline what’s wrong with banks serving as the central authority for maintaining value transactions. In Section 2 we’ll take a look at Blockchain philosophy as a cryptocurrency system, as well as a development platform. Finally, Section 3 sheds some light on the main element principles of Blockchain technology, the working process, and the current developmental phases.
1. Background
These days, with easy access to WIFI and smartphones at our fingertips, it’s easy to consider the internet for granted. But before you can understand the incredible technology of Blockchain, it’s important to grasp a few basic concepts. The internet is a network of information through which data moves in one node to another. A node is a connection point that can receive, store, or send data, and each node reproduces and stores data infinitely.
Information on the internet spreads quickly and in a non-unique fashion. Some information shared commercially is not free, but value-driven. For instance, a publisher might sell copies of the book but keep the master copy. In this example, information is transmitted through reproduction. But what happens when you’re transmitting value? If you have 100 British pounds (£100), you cannot sell copies in the same manner as a book’s publisher, because it would be valueless. Therefore, value must be transported through a “move” format and not really a “copy” format to avoid duplication. For decades experts have prevented double spending by maintaining ordered ledgers of transactions.
We don’t often take the time to consider that financial transactions generally contain a date, time, sender, a receiver and an amount. Each person’s stake is determined by adding incoming amounts and subtracting outgoing amounts. Hence, both significant ways of keeping track of value transfers are cash notes (physically passing money in one hand to another) and ledgers. However, printing notes and securing against reproduction is quite challenging and involves a comparatively great amount of value. Plus, if you tear a note in half it’s suddenly worth nothing.
Which leaves us with ledgers. When carefully protected, ledgers will keep track of value in a very resilient fashion. However, they require careful attention to detail and plenty of trust. All parties involved in the transaction need to be certain that the person updating the records is both efficient and reliable. This implies that the security of a ledger has its very own costs and risks. With the digital revolution, the days of tracking long columns of information yourself are gone. The main method of tracking value, a digitized ledger, involves the same unique transaction details (dates, amount, sender, and receiver) as a physical ledger. For instance, when you open a new bank account, you’re assigned a merchant account number. This identifies your transactions on a digital ledger. Every bank in the world maintains a unique, synchronous ledger which means that your value is tracked across exclusive storage locations.
Unfortunately, the banking system itself is inherently risky. The system relies on a set of centralized databases that store worldwide financial transactions. Rather than trusting the folks in charge of updating physical ledgers, individuals are forced to trust the banks themselves for consistency, integrity and transactional security.
2. The Problem with Banks
Giving banks full control of global financial ledgers creates huge economic risks. As financial rule makers, banks are susceptible to toe the line and also twist reality. They often create value out of “thin air”, counting on the fact that they’re seen as being “trustworthy”.
Let’s consider this scenario: a bank lends money to Customer A. The transaction is added to their ledger: “Amount X has been put into Customer A, and after a certain amount of time Amount X, plus Amount Y (interest) is expected from Customer A”. This seems fairly straightforward in the abstract, but in reality, Amount X might not exist before the transaction is documented. How is it possible for banks to make value from thin air? Through debt! Legally, banks can lend more money than they own, provided they’ve safeguarded their risks. Because of this, a lender pays non-payment insurance in addition to interest rates. This makes sure that rates of interest are proportional to the risks taken by banks.
The problem with this system? When people take benefit of limitless money power but cannot repay their loans, it leads to global disaster. In the fall of 2008, the collapse of the financial sector resulted in the bankruptcy of countless organisations.
3. Blockchain Philosophy
In the fall of November 2008, an author with the pseudonym “Sakoshi Nakamoto” suggested the necessity for a new kind of money system - Bitcoin. Nakamoto proposed Bitcoin to create and store value in a totally different digital form - fully decentralized. Recall that in conventional banking systems, value is stored in centralized ledgers and maintained solely by banks. However in a decentralized ledger system, everyone linked to the system can initiate new transactions and form a consensus to validate transactions. This advancement was the response to decades of expert research. Suddenly, the task of decentralizing value transactions on a massive scale seemed truly possible. Bitcoin successfully recreated a decentralized digital money system and inspired new ideas of other generic value mediums, including insurance policies, certificates of ownership and so many more. By creating more cases of value decentralization, the “internet of value” was born.
3.1 Blockchain Real World Applications
Though the Bitcoin platform is typically the most popular application of Blockchain technology, the potential of a Blockchain extends far beyond financial transactions. We are able to apply currency tracking concepts to other real-world applications, such as property title ownership. Let’s look at it this way: when Person A sells his/her property to Person B, Person B sends the value of the house in currency to Person A. In addition, Person A sends the ownership title or certificate to Person B. Such ownership titles can be registered with a central authority, where in fact the record of the transaction is stored in an electronic ledger.
Let’s consider another example. When you operate a movie theatre, you can keep a strict record of all the tickets you generate. You can decide the worthiness of every movie ticket and track the creation, movement and destruction of those tickets in a ledger. In the Blockchain world, this process is called tokenization. It gives you to track value above and beyond just currency. To understand this further, I will describe the idea of transactions in section 3.2.
3.2 The Concept of Transactions
Transactions consist of four basic elements: origin, destination, value, and state. Consider Figure 1, which demonstrates the logic for a basic transaction. If the sender’s balance at the date of the transaction is greater than the transaction value, then the sender’s balance is decreased by the transaction value, and the receiver’s balance is increased by the same amount. Quite simply, you can only give up to the amount which you have.
On the Bitcoin platform, the basic logic is the same for many transactions in the ledger. These programs can be personalized by adding new variables, functions, and even more advanced constructs such as loops to allow the execution of various transaction types on a Blockchain. Moreover, structures like mortgage repayment plans, insurance contracts, movie tickets, lottery tickets and energy tokens can be modelled. In the world of Blockchain, these are called smart contracts.
Smart Contracts
Smart contracts are programs stored on a Blockchain. The functions of the programs are executed through transactions. Smart contracts include things of value such as copyrights for artists, contract for lawyers, laws in Congress, votes in polls, invoices for an accountant, bets in a lottery game, maintenance functions in a factory, procedures in a supply chain, shares in an organization and many more. The transaction sizes may vary in conditions of memory and computer processing power.
4. What is a Blockchain?
A Blockchain is a digital record of valuable transactions beyond your control of a central authority. It uses codes that run directly on the computing devices of all individuals active in the transaction. Of course, in a Blockchain free-world, a trusted party needs to care for all the centralized transactions Blockchain and keep maintaining consistent and authentic ledgers.
There are three layers to every Blockchain concept:
1. Design goals: the properties a Blockchain software possesses such as distribution, decentralization, immutability, and peer-to-peer.
2. Implementation: A Blockchain’s developer can implement some or all these properties. Bitcoin and Ethereum are examples of Blockchain implementations.
3. Instances: different networks working on different datasets permit you to build a different version of reality. For example, the Ethereum implementation has at least four public cases of its protocol: Rinkeby, Robsten, Kovan and the primary Ethereum network. You’re also able to create private instances for development purposes using platforms such as Remix and TestRPC.
Distributed and Centralized System: In this case, all nodes in the network store “read only‟ copies of the info, but modification happens at one centralized node. Consider Napster’s peer-to-peer file sharing system. Files were distributed across networks, allowing users to download content, however the list of the files, their locations and business logic, were centralized.
Distributed and Decentralized System: When data can be distributed and decentralized concurrently, it’s impossible to corrupt or hack the network. However, the task of implementing a distributed and decentralized data system lies in maintaining consistency. Blockchain manages this consistency issue through a concept known as the consensus algorithm. Relying on innovative research, Blockchain uses cryptoeconomics and game theory to get this to possible.
The Bitcoin Implementation
Bitcoin, Ethereum and Hyper Ledger fabric are cases of the implementation of Blockchain. Like flavours of ice cream, they share the same base but appeal to different audiences. Bitcoin is implemented in a completely non-trusting environment. It is a specialized Blockchain because it is primarily created for one application: an electronic digital cash system. The essential element that transactions track is called unspent transaction output.
The Ethereum Implementation
Ethereum is a Blockchain implementation that relies on the same principles as Bitcoin with extra features that help it to to use in a slightly different way. For example, with Ethereum there are no unspent transaction outputs because the Blockchain has a stored state and can store the total amount of each account after each block. Because of the different implementation strategy of the consensus algorithm, the time used to generate new “blocks‟ in Bitcoin is ten minutes while Ethereum is only 7 seconds.
Ethereum clients or nodes connect to peers through a protocol referred to as DEVp2p. In DEVp2p the client performs functions such as receiving data, validating data, and writing data to the neighborhood database (LevelDB) and sends data to any requesting peers. Your client also receives transactions and propagates them to the network, which executes the smart contract functions. Decentralized applications (also called Dapps (e.g. wallets and Explorers)) hook up to the Ethereum network by way of an Ethereum node or client. A JavaScript console can be attached to a running node for invoking web3 APIs. The key advantage of this technology? Speed! These transactions boast unprecedented efficiency.