What Is Blockchain and (Why) Should I Care?
In my last article, I took a close look at blockchain in the financial area and cleared up with some of the most common misconceptions about this technology. This time, I am going to teach you everything you need to know to have an in-depth discussion about blockchain and why it is a revolutionary technology with applications in almost every industry.
Blockchain is most commonly known for its application in the financial sector, where it helped to revolutionize the handling of financial transactions with cryptocurrencies such as Bitcoin, Ethereum, and others. I have covered this extensively in part one of this series: Blockchain—More Than a Buzzword?
But blockchain is even more than that; for a rapidly growing number of companies it is the foundation to build their software applications on. So, why would these companies want to harness the blockchain concept to power their systems and in many cases bear the burden of large change projects? After all, blockchain is a rather young niche technology with several technical teething problems such as scalability, performance, and, most of all, flexibility.
Isn’t that reason enough not to deal with it? If you believe that, you are wrong. Instead, blockchain has the potential to revolutionize the way how we approach, build, and use IT systems; and in the following, I am going to explain why.
To start with, let me give you a little bit of background information. Today, most of the underlying operations and functions of any technological ecosystem are still either centralized (figure 1, A) or decentralized (figure 1, B). In the course of the last few years, however, we have seen a rapidly growing trend towards distributed systems (figure 1, C).
The concept of distributed communication networks was described by Paul Baran as early as 1964 (On Distributed Communication, Baran 1964) but it was not before 1999 that the launch of Napster started a first revolutionary, practical application of this concept. Napster allowed users to download audio files from a peer-to-peer (P2P) network to which they in return shared their audio library while connected. The lack of central control in this type of system facilitated file sharing and paved the way for Napster’s rocket-like success, which only ended due to legal reasons.
With blockchain appearing on scene, the trend towards distributed systems has finally started to gain strong momentum again. What makes blockchain attractive for many applications is that it removes the need for a single, central entity (database) to verify data transactions. Instead, authority and trust are transferred to many nodes within the network with all transactions being continuously and sequentially stored in public ‚blocks‘ of data, which are linked by including a reference to the respective previous block. This ‚chain‘ of data blocks is what we call blockchain.
The reference to the previous block is stored in the form of a so-called ‚hash code‘, a unique cryptographic identifier. This combination of blockchain technolgy and cryptography ensures that no duplicate of the same transaction exists and also renders it practically impossible to manipulate transaction data.
To better understand what a block is and how blockchain works, let’s illustrate all this by drawing a parallel between a block and an intermodal container (freight container): Each container has a unique production number. Now, let’s assume we store some goods inside of such a container, lock and seal it, put our name and signature on it, and place it in a cargo port. Theoretically, anyone could come by and verify that this container was ours, but since only we would have the private keys to unlock it, only we would know what is inside. And since the container has a unique production number, no one else could claim the same container as theirs. That’s exactly how a block works. Therefore, the blockchain behaves almost like a regular database with the exception of parts being public.
Blockchain Terminology You Should Know
Whenever you come across blockchain, you will always be confronted with certain terminology. In the following, I am going to address the most important ones.
Distributed Ledger & Consesus
Blockchain is one form of distributed ledger technology (DLT), where consesus-based data is replicated, shared, synchronized, and spread across multiple sites, countries, or institutions. When you hear about consensus in a blockchain it refers to a protocol used to keep copies of the distributed ledger in sync. In order to achieve consensus, each entity (node) in the network must solve a complex cryptographic problem to ensure all copies are in sync.
Proof of Work (POW)
The solving of the cryptographic problem is called proof of work (POW) and attracted high media attention with Bitcoin under the term mining.
One huge problem of the proof of work concept is the increasing need for computational power in order to maintain a distributed ledger at a large scale. With Bitcoin, miners provide the computing power of their hardware to assemble blocks with the correct proof of work and, in return, are rewarded with a certain amount of Bitcoins.
The two most known public blockchains—Bitcoin and Ethereum—are said to burn over $1 million worth of electricity and hardware costs per day to keep their consensus mechanism up-and-running. Therefore, some blockchains such as Ethereum (with the upcoming Casper implementation) try to shift to a different consensus mechanism called proof of stake.
Proof of Stake (PoS)
In proof of stake (POS) based public blockchains, the validating nodes in the network take turns proposing and voting on the next block and the weight of each nodes‘ vote depends on the size of its deposit (stake). Every node in the blockchain—holding the blockchain’s base cryptocurrency (e.g., Bitcoins, Ether, etc.)—is able to validate by sending a special type of transaction which locks up their cryptocurrency into a deposit. Through a consensus algorithm, in which all currently validating nodes participate in, the process of creating and agreeing to new blocks is conducted. Benefits are, e.g., reduced quantities of required electricity and, thus, a reduced need to issue new coins (paid to the miners).
Blockchain 1.0 / 2.0 / 3.0
Blockchain has already come a long way but is still evolving every day. For this reason you will often find people talking about different versions of blockchain. The first blockchain to gain traction was Bitcoin, thereby often called blockchain 1.0. The next evolution occurred when Ethereum introduced the concept of smart contracts. Smart contracts are small computer programs that run in the blockchain. They are autonomous and automatically executed based on pre-defined conditions. Running on blockchain technology, it is impossible to tamper or hack smart contracts. Figure 2 illustrates how smart contracts work.
Smart contracts are small computer programs that run in the blockchain.
At the moment, the run for Blockchain 3.0 is still ongoing. It will introduce decentralized applications (Dapps), decentralized computing, and decentralized storage as its essentials. This is especially important since one of the major weaknesses of blockchains is the problem to store large amounts of data. With currently 16.3 zettabytes (one trillion gigabytes) of data created a year and a predicted increase to 163 zettabytes (ZB) by 2025 (published by the research group IDC), this will be a general problem to be solved.
Today, cloud-based storage is provided by centralized server farms operated by Google, Amazon, Microsoft, and others. No alternatives? There are! Devices owned by you and me: tablets, mobile phones and computers. Imagine if data was distributed over the free disk space of all nodes within the blockchain, where nodes provide storage to each other instead of getting it from cloud storage providers.
Public vs. Private Blockchains
When thinking about possible applications in different industries, you will sooner or later have to decide whether a private or public blockchain is the best fit. Very often the terminology of private and public blockchains is misconstrued because they have many similarities:
- Both are decentralized peer-to-peer networks maintaining a copy of a distributed ledger which holds digitally signed transactions
- Both use consensus
- Both try to provide certain solutions to keep the ledger immutable even when entities (nodes) in the chain are malicious or faulty
What really distinguishes those two types of Blockchains is:
- Who is able to participate in the network
- Who is able to maintain the distributed ledger
- Who is able to execute the consensus protocol
In a public blockchain everyone can become a member of the network without conditions of admission whereas in private blockchains an invitation is required and must be validated by either the network starter or by a set of rules defined by the network starter. How access is granted can vary: existing nodes in the network could decide who joins next; a consortium could be responsible for granting access; or licenses for participation could be issued by a regulatory authority.
A public blockchain is therefore ideal when the network has to be truly decentralized with a democratic consensus mechanism and no central entity controlling the participation of new members. Everyone (members and non-members of the blockchain) is able to access all transactions added to the blockchain. These transactions only hold the public keys of the users (digitial fingerprints) and no personal data. However, if someone knows your public key, every transaction you created can be tracked.
With private blockchains the consensus mechanism is centralized in the hands of a single entity which verifies and adds all the transactions to the blockchain. Thus, a private network has no need for any proof of work or proof of stake which are often complicated to implement and expensive. Also security is higher as the conensus mechanism is much lighter to apply and the entity administrating the private blockchain is able to administrate whether transactions are public or not.
Blockchain Cosortia & Blockchain Use Cases
As of now, the leading consortia in the blockchain space are:
- Ethereum Enterprise Alliance
- Digital Asset Holdings (DAH)
- and Ripple
Financial services still have a majority of use cases in those consortia, however, research shows a shift into new industries including logistics, healthcare, and automotive. Figure 3 gives you a comprehensive overview of all those consortia and their areas of focus.
To pave the way for a legal and regulatory foundation, which is suitable for distributed ledger technology (DLT), governments and regulators will have to intensify their current efforts and pick up more speed. Especially with the upcoming 5G wireless network system, blockchain is emerging as the foundation to power a new ‚Internet-of-value‘ paradigm (IoT, Smart City, Integrity Protection, Dynamic Sharing, Autonomous Driving, etc.).