A blockchain is a very specific distributed ledger technology. The blockchain was first introduced by Bitcoin and ensures that it is a decentralized network that is censorship-resistant and offers a new form of money that cannot be counterfeited, confiscated or otherwise controlled. It is only ruled by the protocol and every transaction in the network requires consensus that is only reached if the participants adhere to the rules of the aforementioned protocol.
This had a significant impact not only on the way that we think about money but also on very different sectors in the economy other than banking and payments. There are many possible use cases for blockchain technology. Some of them have already been explored, while others are still under development. Most notable cases are digital signatures and certificates to improve supply chain management and automated payments between autonomous machines.
But what is blockchain technology and how does it work? In today’s article, we are going to explore the technology, use cases and more.
What is a Blockchain?
A blockchain is a decentralized database that can either allow private or public access to its ledger. Private blockchains are more common with companies that are using them for internal use or provide paid access to their customers. Public blockchains are accessible by anybody and their software clients are often open-source and free of charge. Bitcoin is the most notable example of such an open and public blockchain.
Each participant represents a node in the network and each node keeps a copy of the database. Which is not only helps the network to decentralize the database further but also enables each node to verify past transactions using its own copy. Each blockchain has its own protocol which sets the rules within the network and how the nodes reach consensus about each new and all past entries in the database. One of the major advantages is that the participants don’t have to trust each other, but they’re rather putting their trust in the protocol.
In effect, each node that receives or sends a new transaction can rest reassured that no manipulation is possible. Another side effect is that data on a blockchain cannot be corrupted, because it is part of an ongoing verification process that requires present transactions to be in alignment with past transactions in order to be verified and reach consensus.
How does Blockchain work?
A blockchain is literally a chain of blocks. In the Bitcoin network, each block contains transactions. Once a new block is verified it is connected through a cryptographic hash to the block before. This way all blocks form one chain. If the hash of a single block in that chain is changed the whole blockchain is corrupted, because each hash depends on the correct information of its predecessor.
To ensure that those hashes cannot be easily produced miners have to solve a cryptographic puzzle in order to find the right hash that is fitting in the chain. This is called proof of work. Only if miners calculate those hashes, new blocks come into existence. In return, a miner is rewarded for his important role in the network, if he produces a new block. In return, he is going to gain a block reward with freshly minted BTC and the transaction fees that have been spent by the sending parties.
Mining makes sure that nobody can simply create new blocks out of thin air, but instead has to spend significant resources to do so. It also establishes an equilibrium between miners, because they are competing. In effect, this competition makes sure that it is always more profitable to follow the protocol and be an honest miner. A malicious miner would have to spend his resources and has to go against the rest of the network without a guaranteed reward. While at the same time his honest competitors are getting rewarded accordingly without any hassle, but the competition itself.
Proof of Work and Proof of Stake
The example of Bitcoin shows that miners are required. While it is true that the first blockchain ever invented is based on mining, there are also other mentionable consensus models. The most important right after proof of work is proof of stake.
Instead of mining, each new block is verified by stakeholders who vouch with their own stake for the correctness of the information that is verified. The stake is often a certain amount of the cryptocurrency in question. There are also different variants of the proof of stake model. Among them are delegated proof of stake (DPoS) and liquid proof of stake (LPoS).
Proof of stake is especially important when it comes down to use cases outside of payments and cryptocurrencies. Depending on the use case it makes absolutely no sense to waste resources on mining and electricity. This is especially true for private blockchain. They are often part of a company network that is owned by a single entity.
Such a single entity is not interested in a blockchain that gives power to the people. These companies have other use cases for the technology and often chose a different consensus model that is more fitting to their needs. Decentralization is important for them for a different reason. They don’t want their data to be corrupted and also sufficiently stored throughout a network of computers.
They also want transactions to be verified through their private blockchain because it eradicates certain errors that could happen if these transactions would happen in a more regular environment. One possible error is human failure. Even if a blockchain is private, it will follow the protocol strictly and provide immutable results.
Let’s say a company is producing screws that are used to build cars. The whole process from the beginning when a single screw is produced up to the moment when it is used to mount a certain part of a car in production can be tracked with blockchain technology. This includes, but is not limited to the transport of every single screw or batch of screws that have been produced. This is especially useful to improve supply chain management for the car manufacturer, but can also be used for different aspects.
Another purpose is quality insurance. Because everything can be reliable tracked all errors can be reduced to their sources. In a regular industrial environment, not every single detail can be tracked reliably. With blockchain technology, robotics, AI and machine learning these things will certainly change in the future. Combined they are going to change the quality of all industry products and will bring cost-effectiveness to a new level.
Blockchain security – Can we trust Blockchains?
To answer this question in short: Yes, you can trust blockchain technology. This statement also comes with a caveat, because you can only trust a certain blockchain if you are capable of understanding the underlying protocol.
There is of course an information asymmetry. Most people cannot read code and are relying on the work of others. Generally speaking, open and public blockchains offer the highest security if they are actively developed and audited by an open-source community. Once it is ensured that the code and new proposals are under constant review, the technology is very secure. Every transaction is executed according to protocol and is irreversible.
If we stick to the example with Bitcoin, all Bitcoin transactions are final and immutable. It's good if you can verify the code by yourself, but on the other hand, Bitcoin is so well audited and reviewed that you can simply rely on the judgement of other people more competent in this field. Still, it is always possible that they simply fail to find an issue or a bug before new code is released to the network. To make sure that no change can simply bust everything, each new proposal is carefully reviewed and then slowly implemented. Those implementations that could deeply impact the network also need consensus among the nodes and cannot simply be edited or enforced by any developer.
This requires a lot of off-chain and on-chain governance. It is recommended to judge new cryptocurrencies according to the governance in their respective communities. To reassure that everything is designed with safety and security in mind, projects should at least:
- Disclose the whole code open-source
- Should actively and publicly communicate their development decisions
- Allow free speech on their respective platforms
- Offer anybody the opportunity to contribute
Are there any alternatives to Blockchain Technology?
Blockchain technologies are only one part of distributed ledger technology. There are a couple of other technologies that competing. Notable examples are IOTAs Tangle, which is a directed acyclic graph or hash graphs from Hedera.
They are designed to reach consensus in a network as well, but simply use a different approach to make sure that the rules of the protocol are enforced and come into effect. It remains to be seen which technology will be more successful or if they are going to continue to coexist. Blockchain technology will always be a part of Bitcoin, but it is not necessary for other use cases. Especially private networks that seek out a distributed ledger solution might be happy with a less decentralized solution that offers more speed and is not trying to build hard money.