A Brief History of Blockchain Technology
The concept of a “blockchain” was introduced in 2008 by Satoshi Nakamoto as part of the protocol behind the digital currency Bitcoin. Nakamoto published a technical paper to an email list that was popular amongst cryptography enthusiasts that laid out the basic principles behind both Bitcoin, a digital currency, and the blockchain, the underlying technology behind that currency.
Shortly thereafter, in 2009, the first blockchain was put into implementation when the first Bitcoin was mined by Nakamoto and put into circulation. Today, Bitcoin has achieved global renown and is accepted as a valid currency by increasingly more vendors. You can buy everything from airline tickets to online courses using Bitcoin; even Burger King has started to accept it!
Over the past decade, many other digital currencies often called “cryptocurrencies,” have emerged utilizing blockchain technology to manage transactions. It is important to keep in mind that the implications of blockchain technology reach far beyond the realm of digital currencies.
While cryptocurrencies, and specifically Bitcoin, were the first applications to use blockchains, many industries are beginning to explore blockchain tech as a way to handle a wide range of procedures, including smart contracts, data storage, and resource management. Throughout this article, we will look at several different ways that blockchain applications are being developed both pertaining to cryptocurrencies and in other fields.
Anecdotally, one of the more fascinating details in the history of blockchain technology is the identity of its creator. Although there are many theories, nobody has ever uncovered the true identity of Satoshi Nakamoto. Whether Nakamoto is an individual or a group of people, we may never know. What is certain, however, is that their contribution to the future of technology is incredibly significant. Many prominent thinkers and voices from within the tech industry see the revolutionary potential for blockchain technology, and with good reason!
Blockchain Basics – Managing Digital Transactions
There are several underlying concepts that make blockchain technology uniquely suited to handle digital transactions. Today, the most well-known and widely implemented application of blockchains is found in the cryptocurrency space, where blockchains are used to handle financial transactions that happen digitally on a peer-to-peer basis.
While the applications for blockchain technology are not limited exclusively to digital financial transactions, this is a good place to begin exploring how blockchains work in a real-world context. Digital currencies, pioneered by Bitcoin, have emerged as a new asset class, which is remarkable in and of itself. Beyond the emergence of digital assets, the blockchain framework also provides a model for rethinking institutional structures in terms of how power is organized and value is distributed. We are still in the early stages of exploring the possibilities for blockchain technology, but space is developing quickly. It is not an understatement to suggest that blockchain technology will fundamentally reshape the nature of governments, personal property, and the global economy within the next decade.
In order to get a clearer picture of how blockchains work, it is helpful to begin by looking at digital currencies, like Bitcoin. Digital currencies are, as of now, the most well-established implementations of functioning blockchains. In the case of digital currencies, or “cryptocurrencies,” blockchain technology is used to handle financial transactions. Before we look at how the blockchain model works, it is helpful to look at how financial transactions have worked historically.
How We Handle Financial Transactions
For centuries, people have relied on centralized institutions like banks and governments to serve as intermediaries when it comes to storing and transacting financial assets.
As a practical matter, most people keep the majority of their finances stored in a bank. There are many advantages to this. If, for example, you had your entire life savings buried under the floorboards of your house and your house burned down, you would be in big trouble. Banks provide a promise of security, protecting your assets in exchange for various transaction fees. We trust banks to keep our funds secure in exchange for a percentage of our money. Over time, this model of keeping money in banks emerged as the norm. In an increasingly digital world, however, many people have begun to search for alternatives to the historical model of consolidating resources in centralized institutions.
Today, as more and more transactions take place digitally, the need for trust and security has become even more significant. Financial information exists largely as data, and transactions are ultimately just filed transfers. Without a secure process, it is incredibly easy to manipulate data. Hackers regularly compromise bank servers, ATM machines, and other places where financial data is stored or transactions occur.
One of the biggest challenges of managing financial transactions on a peer-to-peer basis is the “double-spending problem,” or how to ensure that someone isn’t spending the same money twice. When Bitcoin arrived on the scene, it offered a solution to this problem, enabling direct peer-to-peer transactions to take place in a secure way that did not require trust from either party or a third-party intermediary, like a bank. That solution was the blockchain.
What is a Distributed Ledger?
While Bitcoin paved the way for blockchain technology, many subsequent applications, including but not limited to other digital currencies, have been built on the blockchain framework. One of the fundamental concepts driving the success of blockchain technology is its use of a distributed ledger system.
Ok, so what is a distributed ledger? Basically, a distributed ledger is exactly what it sounds like. A ledger is just a list of records. Instead of keeping this list in one place, a distributed ledger is stored in many different locations simultaneously. Not all forms of distributed ledgers are blockchains, but all blockchains use some version of a distributed ledger.
Decentralization is one of the core concepts behind a blockchain. By keeping multiple copies of the record of transactions in different locations all across the world, visible to anyone, the need for a “trusted” third party institution to serve as a middleman and oversee transactions is eliminated.
To delve a bit deeper into how distributed ledgers work, let’s imagine a hypothetical situation: pretend you have a big three-ring binder where you write down every financial transaction you make in a year. Any time you make money or spend money, you write down the details in this binder. Only one binder exists and you keep it on your desk. A lot of things could go wrong in this scenario: your house could burn down, a nefarious person could sneak in and tamper with the information, you could forget to include a few documents and end up with numbers that don’t add up, or any number of other unfortunate mishaps.
Instead of having only one binder, imagine that hundreds of thousands of identical copies of this same binder existed in desks of people all across the world. Every time any detail was added into the binder, the information would have to be checked against all of the copies to make sure that the numbers added up correctly, and the new information would be added into all of them at once. If once binder contained a transaction that didn’t show up in any of the others, we could assume that binder was faulty. Now, in order for someone to tamper with your information, they would have to tamper with every single one of these binders all over the world at the same time.
Obviously, using a system of binders on desks is not very practical. In the virtual world, however, this is actually somewhat similar to how a distributed ledger works. In blockchains, each individual transaction, no matter how big or small, is recorded in a “block”.
Each block contains a special timestamp that links it to the previous block. This allows computers to check each proposed transaction against the previous one. If the timestamps do not add up properly across the majority of computers, the transaction will be rejected. If the majority agrees that the proposed transaction is valid, it will be verified and added into a new block in the chain, or a new record in the ledger. Now, the next proposed transaction will be checked against that block’s timestamp, and so forth.
In order for someone, such as a hacker, to enter false information into the blockchain, they would have to alter the information not only on one block but on every single block on the entire blockchain simultaneously across the majority of participating computers all over the world. Even with current technology, to accomplish that would require such a massive amount of computing power that it is effectively an impossible feat. Thus, the blockchain’s distributed ledger system is secure by design.
Because each transaction is checked against the entire history of previous transactions by multiple machines all distributed all over the world, it is impossible for someone to “cheat” the blockchain by attempting to spend the same money twice. One of the transactions will not match the historical record, and it will be rejected as invalid.
Not only is the “double spending” problem solved but transactions do not require either party to trust the other or a third party institution in order to be conducted. Person A cannot claim that they sent Person B money that “got lost in the mail” and Person B cannot claim that they “never received the money.” All transactions are publicly visible, and therefore both parties will be able to see a record of the transaction on the blockchain.
Blockchain and Bitcoin
One of the most confusing and misunderstood aspects of blockchain, as a concept, comes when we try to uncouple it from Bitcoin. As stated previously, Bitcoin is simply one application built on a blockchain framework. It is also the first, largest, and most well known functioning open blockchain in the world. Bitcoin’s implementation of blockchain technology is often cited as definitive, meaning that when people say “blockchain” they are often talking specifically about the blockchain model used by Bitcoin.
It is important to understand that the Bitcoin model is not definitive of blockchain technology. Bitcoin demonstrates one implementation of this technology. There are several factors that make Bitcoin’s blockchain work the way that it does, and it is worth examining each of them to get a fuller understanding of which aspects of Bitcoin’s implementation of the blockchain are specific to Bitcoin and which are aspects of blockchain technology in general.
The Bitcoin Blockchain
There are several fundamental concepts that work together to create a blockchain ecosystem that is unique to Bitcoin. Other cryptocurrencies have implemented similar models, but for our purposes, it makes sense to zoom in on Bitcoin and break down how the Bitcoin blockchain works.
We already know that blockchains are a form of a distributed ledger. If we dig a bit deeper into this idea of a distributed ledger, some questions that may arise are: how are transactions are verified? Who records them? How can we be sure this information is accurate?
Encryption
If you recall from above on the history of Bitcoin, you may remember that the concept was introduced initially to a popular cryptography mailing list. Why cryptography?
The field of cryptography has developed rapidly alongside digital technology as a way of securing information. Cryptography has traditionally been a somewhat obscure field, historically used largely in military contexts. In the days of the Roman Empire, Julias Cesar famously used an encryption technique to send coded messages to his generals.
In the digital age, encryption has become a fundamental part of everyday life. As hacking and identity theft has become more and more prominent, basic encryption practices have entered the mainstream as protective measures for keeping one’s personal data safe.
Whether we are aware of it or not, most of us today are already familiar with basic encryption techniques, such as using passwords to access our email accounts or enabling two-factor authentication on our smartphones. Most of them rely on encrypted transactions on a regular basis, from making online purchases to access our bank accounts. It should come as no surprise then, that Bitcoin relies on cryptographically secure algorithms to validate transactions and manage the blockchain.
The SHA-256 Hashing Algorithm
Bitcoin uses a cryptographically secure SHA-256 hashing algorithm. While an in-depth explanation of exactly how this works is beyond the scope of this article, it is helpful to get a basic overview. One way to think of this is to imagine a black box. That box is the SHA-256 algorithm. For our purposes, we aren’t really going to worry about what happens inside the box, the nuts, and bolts of the algorithm itself. We will just proceed with the assumption that inside the box, mysterious mathematical things happen.
The important aspect, for us, is that you can take any kind of data, of any size, and feed it into the box. Ultimately all digital data, even complex things like movies that are many gigabytes in size, exist as a sequence of 1’s and 0’s, or “bits.” When we feed any kind of data into the black box of SHA-256, the bits in that data are processed. We can think of the bits as being “rearranged” in a certain way inside the box. When the data has been processed by the black box, it spits out a 256-bit string of seemingly random characters, which looks like nonsense. We can think of this string as a unique “fingerprint” representing the exact data that we fed in.
Truth be told, the apparent “nonsense” that comes out is not actually nonsense. SHA-256 is determinative, which means that if you put the same data into the “black box”, you will get the same exact output string, or “fingerprint”, every single time. If you apply SHA-256 to the word “hello” you will get the identical 64-character string.
Another feature of this hash function is that it is a one-way function. This means that you cannot take the output string and convert it back to the original data. So, in our example, we cannot reverse the process by using the “nonsense” to get back to the original “hello”.
One example of how this is used is to verify documents, such as PDFs. If you sign a contract and send it to someone along with the SHA-256 fingerprint, they can test the hash to ensure that not a single bit of the data has been altered. If they feed the document into SHA-256 and get the identical output string, then the document has not been changed.
If, on the other hand, the slightest change has occurred- regardless of whether it was a well-intentioned modification such as a typo being fixed or a case of nefarious tampering – the fingerprint that comes out will be completely different. The nature or scope of the change to the original data doesn’t matter to the algorithm; the output of the SHA-256 algorithm will be totally different unless the data is 100% identical. For example, in the above example, if you change the word “hello” to “Hello” or “HELLO,” you will get a totally different output string.
Now that we have a basic grasp on how SHA-256 works you might be wondering how this relates to the Bitcoin blockchain. This can be one of the more complicated concepts to grasp in terms of what goes on under the hood of Bitcoin’s protocol. In order to understand the role of SHA-256 in the “Proof of Work” model that makes Bitcoin function, we need to dig a bit deeper into how Bitcoin miners participate in the blockchain ecosystem.
The Role of Bitcoin Miners
Many explanations of how Bitcoin transactions are verified say something akin to: “miners solve complicated math problems to add blocks to the chain in exchange for a reward.” This is accurate, and it is a fine explanation in terms of getting the big-picture. When it comes to understanding the larger architecture of blockchain technology as it applies to Bitcoin, however, we find that this explanation is a bit oversimplified. For our purposes, we need to explore the mechanics of Bitcoin mining a bit more closely.
Mining involves complex computation designed to find certain combinations of random numbers (called “nonces”). These nonces are combined with information about particular Bitcoin transactions to yield an SHA-256 string that meets very specific criteria.
Data concerning Bitcoin transactions are found in the header, or first “chunk” of any block on the blockchain, which is displayed as an SHA-256 string. So, the first “chunk” of the string that makes up each block contains information about the transactions contained in that block, such as the time, amount of Bitcoin, addresses involved, and other details. The remainder of the string is produced by finding a nonce that, when added to the transaction data, will produce an SHA-256 string that meets the aforementioned target criteria.
So, what are the criteria, and who decides them? Bitcoin blocks need to be constructed according to a set of rules in order to be considered valid by the consensus model governing all “nodes” on the Bitcoin network. This rule set- the criteria that must be met to generate a valid block- is written into the core code of Bitcoin’s software. The “rules” are a set of functions written into the C++ code that runs on every machine (or “node”) that is connected to the Bitcoin network.
A miner needs to create a block following this set of rules. First, the block needs to include information about the most recent Bitcoin transactions. Then, the miner must find a nonce that, when added to the transaction data, will produce an SHA-256 string that meets the criteria set by Bitcoin’s software (for example, the criteria might be something like the string must contain 15 zeroes in a row).
There is no way to find the nonce other than using a “brute force” method, which basically just means trial and error. Miners try a bunch of random numbers really quickly until they find one that works. When a miner “solves a block,” it means that they have found a nonce that produces an SHA-256 hash that meets the criteria for a valid block. They can then submit their answer to the Bitcoin network and other nodes will check it and confirm that it is valid.
To give you an idea of how complicated it is to find the nonce, the Bitcoin network produces upwards of 500 quadrillion hashes per second. These are all attempts to find a nonce that produces the necessary result. Even with that massive amount of work, it still takes an average of 10 minutes to solve a block, or to find a viable nonce. When a miner does solve a block successfully, they are rewarded with a small amount of Bitcoin.
Bitcoin Miners Pay to Play
You may have heard people talk about Bitcoin mining as a way to make “free money.” This has never been the case, even in the early days of Bitcoin, and it is even less so today as the complexity of solving blocks increases over time in correlation to the amount of Bitcoin in circulation.
The specificity of the SHA-256 string gets more complicated over time (this is known as the “difficulty target”), making the amount of power required to find a valid nonce more significant. Today, special equipment is needed to successfully mine Bitcoin in any sort of meaningful way, and even then most miners combine their resources into pools that share both the burden of work and the rewards.
Miners use their equipment to test hashes at an incredibly rapid rate. As you can imagine, this kind of computing power requires a lot of electricity, which is generally not free. The reason that the Bitcoin mining infrastructure works are due in part to the fact that to participate, miners incur a cost. Without sacrifice, there is no reward. The only reason that someone would mine Bitcoin is that they believe the incentive is worth more than that hefty electric bill that comes from mining.
When a miner does find a nonce that works, their result will be checked and validated by the wider Bitcoin network. If it checks out, they have provided Proof of Work and can receive their reward. If the rest of the nodes on the Bitcoin network see that something in a proposed block does not meet the criteria, either by following a rule incorrectly or by failing to provide a nonce that meets the criteria, the block will be rejected and that miner will have just wasted money and resources. For example, if someone attempts to “double-spend,” this will be caught and the block will be rejected.
Bitcoin’s use of a Proof-of-Work consensus model makes it virtually impossible to cheat or hack the blockchain. With Bitcoin, miners pay to play, and it only pays to play fair. Not only that, but those who don’t play fair will actually lose money due to the cost of electricity required to operate mining rigs.
Blockchain Beyond Bitcoin
When we look at the Bitcoin Blockchain, we can see that it is made up of several distinct parts that work together to create the overall architecture of the ecosystem. Three of the components that we have looked at thus far are the idea of a distributed ledger, the use of SHA-256, and a Proof-of-Work consensus model.
Which of these are unique to Bitcoin and which are baked into the concept of blockchain technology itself? That’s a good question, and the answer may depend on whom you ask. There is some debate over where Bitcoin stops and blockchain begins, or rather what features of Bitcoin’s blockchain are essential to creating other blockchains that actually work in a practical way.
On a basic level, when we remove the trappings of Bitcoin from the fundamental concept of a blockchain, we are left ultimately with the notion of a distributed ledger that contains a record of transactions. What kind of transactions and how they are handled, verified, and recorded is something that different blockchain applications may handle in different ways.
When we start to look into other implementations of blockchain technology, we need to look closely at how they function. How are they ensuring security? Are they open and accessible to anyone? Do they operate in a decentralized manner? How are they encrypting information? Are transactions anonymous? What kinds of transactions are being handled? Do they use Proof of Work? Is there another consensus model? These are all questions that arise when we begin to look at blockchain technology as it applies to spaces beyond Bitcoin.
Cryptocurrency Beyond Bitcoin
Ethereum
The cryptocurrency space is notoriously volatile. Things change on a daily basis and new coins are being developed all the time. What is considered revolutionary one day can be obsolete the next. That being said there are some digital currencies that have achieved relative stability. Bitcoin is widely considered to be the leader in blockchain-based currencies, but Ethereum has gained a lot of traction since its inception in late 2013.
Ethereum was developed by the programmer Vitalik Buterin. Unlike Bitcoin, which functions solely as a digital currency, Ethereum is a blockchain-based platform for developing decentralized applications that run using “smart contracts.” Where Bitcoin serves as an electronic peer-to-peer cash system, the Ethereum blockchain runs the code making up decentralized applications.
It may be helpful to visualize Ethereum as similar to a smartphone. A smartphone comes with a general operating system, like iOS or Android. Anybody can create apps that do any number of different things to run on that operating system. Ethereum, in this analogy, is like the operating system: a framework to build upon.
One application that runs on Ethereum is a digital currency, which is often also referred to as “Ethereum,” although technically it is called Ether. This can be confusing since both the currency and the platform are usually called “Ethereum,” but it is important to remember that the currency is merely one aspect of the Ethereum blockchain framework. As a reward for maintaining the Ethereum blockchain, Ethereum “miners” are rewarded with Ether.
From its inception, Ethereum mining has worked on a Proof-of-Work consensus model similar to Bitcoin. As of 2017, however, the team behind Ethereum has announced plans to shift to a Proof-of-Stake model. Understanding the difference between these two systems of validating blockchain transactions is crucial to gaining context for some of the most pressing debates in the larger blockchain space today.
When we looked at “Proof of Work” as integral to the Bitcoin protocol, we covered how Bitcoin miners have to invest in special mining equipment that requires a lot of electricity to run in order to solve a block. Proof-of-Stake (PoS) works a bit differently.
A Proof-of-Stake model is a bit more like gambling. Rather than being called “miners,” Ethereum is moving towards the term “validators.” Validators stake a certain amount of their own money (Ether, in the case of Ethereum) towards solving a block. The more money a validator stakes, the higher the probability that they will solve the block.
The Proof-of-Stake model simulates the “work” involved with performing meaningless calculations, which thus reduces the real environmental impact of energy consumption created via mining. We know that validators stake their funds towards solving a block, like placing a bet, but what happens if someone tries to “cheat”?
In Ethereum’s Proof-of-Stake algorithm (called Casper), what will happen, in the event of a bad actor, is that the funds belonging to anyone trying to do something nefarious will simply disappear! The system will erase them out of circulation. So, the incentive for a validator to participate in earnest is high, and the consequences for trying to “validate” a false transaction are high.
The Proof-of-Work and Proof-of-Stake models both ultimately strive for the same outcome: they want to validate blocks and add those blocks to the blockchain in such a way that the broader network is in consensus about the validity of those blocks. Both models, ideally, will achieve the same result through a different protocol.
As a potential investor and/or participant in the blockchain space, becoming familiar with different consensus models is a good way to deepen your understanding of how projects function in the real world. The shift in Ethereum’s model from Proof-of-Work based on mining to Proof-of-Stake based on validation will further set Ethereum apart from Bitcoin in terms of its structure, but it is also worth examining some of the other ways in which these two technologies are already fundamentally quite different.
We have already mentioned that Ethereum, while it is a currency in part, is primarily a platform for developing decentralized applications. The idea of decentralized applications (often called “dApps”) can be a little bit confusing, largely because it is a really new way of organizing information. Why do we need a blockchain-based platform to run applications? This is actually a question that many programmers are still exploring the answers to. One answer, however, has to do with a concept that is referred to in the world of programming as “state”.
“State” basically just refers to the status of any given application or program at a certain point in time. One of the things that make Ethereum’s blockchain different from Bitcoin’s is that “transactions” that happen on the Ethereum blockchain can actually trigger code to be executed. So, programs can be triggered to run as a result of transactions that happen on the Ethereum platform. Each time something changes within an application, that application’s state changes. The Ethereum blockchain keeps a record of every state change that occurs within an application. For example, a smart contract can be paid when work is delivered entirely through the Ethereum blockchain.
If you’re feeling a little bit lost here, don’t worry. Unless you plan on developing applications on the Ethereum platform, you really don’t need to understand the technical aspects of state change. That being said, it is worth becoming familiar with these concepts if you plan to get involved in the blockchain space as an investor or entrepreneur. To get a better idea of what Ethereum is capable of, it let’s look at one of the decentralized apps being developed on the Ethereum platform.
Golem
Golem is one popular project based on the Ethereum framework. The idea is fairly simple. A lot of people have computers. A lot of people who have computers don’t use them all of the time, and even when they are using them they often don’t use them to their full capacity in terms of processing power. At the same time, there are a lot of fields where massive amounts of computing power are required to accomplish certain tasks. For example, rendering video is very costly in terms of computing power. It takes a long time and it can be pretty slow on a slow machine. Many scientific studies also require computationally intensive data analysis and other forms of high-level computer processing.
The Golem project is designed to allow people to essentially rent out their unused computer processing power to people who need it for projects. Using a decentralized structure means that people from all over the world can contribute small amounts of their computer power towards completing a computationally intensive task that would normally require a very powerful computer to accomplish.
By using a blockchain-based framework that allows for code to be executed when transactions occur, i.e. Ethereum, Golem is working towards creating what are essentially decentralized supercomputers that are accessible to anyone. Because the entire history of a program’s state is recorded on the Ethereum blockchain, participants can ensure that nobody is using more power than they have paid for and vice-versa, as well as ensure other features concerning their transactions.
Golem also has its own digital currency, based on Ether, through which participants can buy and sell their resources, and, of course, which anyone can invest in regardless of whether or not they are participating in the project directly. Golem is widely considered to be one of the more popular and successful applications built on the Ethereum platform as of the time of this writing.
We’ve already covered some of the ways in which Ethereum differs from Bitcoin. One thing that we have not yet noted is that Ethereum, unlike Bitcoin, is managed by a central team of known people. This group determines what happens with Ethereum, such as the move from Proof-of-Work to Proof-of-Stake, and therefore exercises a certain level of control over the platform in a way that is more centralized than Bitcoin. Even so, Ethereum is still an open blockchain platform, accessible to anyone.
Ripple is another example of a variation on blockchain technology. Ripple is twofold: both a cryptocurrency and a technology company in the blockchain space. Ripple’s focus is less on peer-to-peer transactions and more on the financial industry itself, partnering with banks and financial institutions to integrate blockchain technology into their infrastructure.
Ripple remains somewhat controversial amongst cryptocurrency enthusiasts, but it does claim to solve some of the problems posed by Bitcoin. Most significantly, Ripple eliminates the waiting period associated with verification. Transactions can happen instantly. However, Ripple’s consensus model differs from Bitcoin’s “Proof of Work” model and instead relies on a centralized network of “trusted” servers, which poses some big questions for those whose interest in blockchain technology lies in the promise of decentralized architecture.
The concept of a distributed ledger as it is implemented via blockchain technology represents a fundamental reimagining of institutional organizations from a hierarchical model to a distributed network. For many investors, this is the key to the revolutionary potential of blockchain technology. The implications of decentralizing information are significant, and almost certainly have not yet been fully realized.
