A primer on what makes blockchain special
In business, for one party to trust another party, an intermediary is required. This is a third party with no reason to favor one party over another and is able to enforce the rules. For example, money may only be printed by central banks, which guarantees the money in your account is genuine. Central banks are an intermediary for using the currency.
The revolutionary aspect of blockchain is that it enables “disintermediation”. Blockchain allows parties to trust each other without an intermediary since the blockchain network itself ensures the data is genuine. Most blockchain use cases have the removal of an intermediary at their core, which results in cost reductions for businesses.
Disintermediation is a result of blockchain providing “immutability” of the data it contains. Blockchain guarantees that the data it’s storing cannot be tampered with. A number of use cases of blockchain are dependent on their immutability properties. In these cases, the blockchain is used as some kind of trusted database.
Smart contracts for some blockchains like Bitcoin, the data in a block is limited to simple transactions. On other second-generation blockchains like Ethereum, the block data can also be computer programs called smart contracts.
By storing computer programs in a tamper-resistant data structure, the behavior of those computer programs can be trusted without requiring authorization from any party. In the next few slides, you’ll find examples of applications for smart contracts that you’ll learn more about later in this course.
Immutability is the feature that makes blockchain special. The capability of maintaining a shared and trusted data repository lies at the heart of all blockchain applications.
Disintermediation is a common goal when applying blockchain to business. The nature of blockchain allows it to remove intermediaries, reduce business friction, and lower costs.
Smart Contracts take the properties of blockchain beyond the currency use case of Bitcoin and apply it to multiple products and industries.
A cryptocurrency is a digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of this security feature.
Bitcoin is a cryptocurrency built directly on top of a blockchain, meaning that the only thing the Bitcoin blockchain can do is manage Bitcoin currency transactions. Blockchains capable of using smart contracts can run any number of cryptocurrencies simultaneously, allowing them to integrate with any other smart contract applications in the network.
Cryptocurrencies are bought and sold in financial marketplaces called cryptocurrency exchanges. A cryptocurrency exchange is an online service that allows its customers to exchange the virtual currency into other assets such as traditional government-backed money (fiat currency) or even exchange one type of cryptocurrency for another.
Settlement of Payments
Cryptocurrencies are often used for immediate international payments. For example, FinTech apps allow small businesses who use the JPMorgan Chase payment gateway WePayto process customer card transactions to experience same-day deposits.
Tokenization converts rights to an asset into a digital token that can be traded with greater flexibility. Blockchain securitization has been proposed for diamonds, real estate, and artwork, among others.
Tag & Track is becoming prominent in supply chains. The company tags an item and then tracks its provenance and state changes. This works with fish, diamonds (conflict diamond resistance), refrigerated transportation, and fair-trade goods from the third world or developing countries.
Distributed Autonomous Organizations (DAOs) are a promising new way to build communities with a governance model that is democratically created and supported by its members. Its rules are all translated into smart contracts, and members may both propose and vote on suggestions on how to govern or update the community.
That captured the imagination of the public :
Bitcoin’s original blockchain is permissionless, meaning anyone can view all of the transactions in the Bitcoin blockchain and compete to append blocks to the chain. This was an important aspect of Satoshi Nakamoto’s vision for blockchain –open and transparent for all.
Despite the use of cryptography to ensure the integrity of the data, everything on a public blockchain is clearly visible to anyone. To guarantee basic safety, as little private data as possible should be stored in a public blockchain. When doing so, it should be strongly encrypted.
Making proprietary data publicly accessible is difficult for enterprises to accept. Encrypting the data is often not enough. For this reason, a number of permission blockchain platforms appeared, such as Hyperledger Fabric or Quorum. In a permissioned blockchain, there are mechanisms such as channels to make some data private to certain actors.
Bitcoin and Ethereum have global ambitions and were deployed as public blockchain networks. They are permissionless and anyone with an internet connection can participate from anywhere in the world.
Most blockchain platforms are open-source, including Bitcoin and Ethereum. This means you can create your own isolated network if you wish to have a private blockchain. Private blockchains run completely inside the private network of a business, providing blockchain services that are only available internally.
Public blockchain networks are unappealing to enterprises because of data privacy concerns, and the utility of private blockchains is in doubt because there isn’t enough competition between nodes to guarantee the immutability of the data.
The consortium, hybrid, or federated blockchain networks are a mix of all the variants previously mentioned. They are usually deployed by a group of rival enterprises to provide enough competition to guarantee immutability, but while using permission platforms in a network private to the consortium, to provide data privacy.
Public networks aim to serve a worldwide user base, have no barriers of entry, and offer no guarantees for privacy.
Private networks lack the immutability properties of blockchains due to not being deployed in a peer-to-peer network. However, they are useful for testing and training purposes.
Consortium networks replace individuals in a public network by corporations. In exchange for their isolation and limited user reach, they offer control, privacy, and performance.
A consensus algorithm is a mechanism by which the nodes in a blockchain decide which block to append next. In Bitcoin and Ethereum this is done using Proof-of-Work, which is incredibly wasteful and results in poor performance. Many consensus algorithms that offer superior efficiency and performance to Proof-of-Work have subsequently been developed. Bitcoin is unlikely to ever change its consensus algorithm due to economic incentives. However, Ethereum is working to deploy a Proof-of-Authority variant in 2021.
Consortium and private networks can easily use consensus algorithms other than Proof-of-Work, and in their controlled environments, this tends to be a straightforward choice.
This method of competition is a consensus mechanism known as Proof-of-Work (PoW). With this mechanism, nodes (network members) wishing to add a new block to the blockchain must use a random number generator as many times as they want.
The first node to obtain a number under a preordained “difficulty” value, gains the right to mint the new block. The difficulty is periodically adjusted so that the random number can be found in about 10 minutes, spacing the blocks being added to the blockchain.
If the puzzle takes the network more than 10 minutes to solve, the difficulty is reduced; less than 10 minutes, the difficulty is increased. The time is important for both security and efficiency.
One of the fundamental criticisms of PoW is that it is energy-intensive. One estimate indicates that the amount of energy used to mine one Bitcoin is roughly equivalent to the annual energy consumption of Austria.
You’ve likely heard bitcoin mining can be a profitable venture. Bitcoin mining is a nickname for the process of running the Proof-of-Work algorithm to add blocks to the blockchain. When a node (or miner) wins the right to add a block, they receive Bitcoin in return.
What is Forks?
Bitcoin and Ethereum are community projects in continuous development. As new versions are released, often in response to real-world events, some node owners might disagree with the changes proposed.
When that happens, some nodes might decide to run a different version of the blockchain software, which has the effect of splitting the network in two. This is called a fork. Those that upgraded are on one side and on the other side are those that didn’t. Both networks share the same block history, but each network appends different blocks to their chain after the fork.