Blockchain 101
Summary
In this primer you will be introduced to blockchain technology, the different structures for a blockchain, how it provides security and why it is considered to be unchangeable, and a brief history of the technology.
Blockchain is the foundation of cryptoassets. A blockchain is simply a distributed ledger which records information and transactions that cannot be manipulated.
Blockchains publicly verified by miners or stakeholders, also known as permissionless blockchains, allow anyone with internet access to see the transactions on the blockchain.
Blockchains rely on cryptography and computational power to provide the security of verified transactions.
Open blockchains are permissionless and entirely decentralized. Closed blockchains are permissioned and governed by a central authority, negating the main functions of decentralization.
Estimated time: 5 minutes
To understand cryptoassets, you must first understand what a blockchain is. Don’t stress, the inventor of Bitcoin didn’t even use the word “blockchain” in the white paper that started it all; Satoshi Nakamoto referred to it as “proof of work chain”. The term blockchain came about in 2014, used as a corporate moniker to help market and sell the technology.
Blockchain technology, also known as distributed ledger technology (DLT), is the foundation on which all decentralized finance rests. If you’ve ever balanced a checkbook, this concept should resonate with you. Ledgers record transaction details; they keep track of where items (typically money) have been in the past, and how they change hands over time. A blockchain performs this same function, recording all transactions that occur on the network. These transactions are then grouped together into “blocks” that computers on the network (aka miners) validate and secure using a cryptographic process (aka mining). These blocks are created in chronological order thus creating a chain of blocks. This is why it’s called a blockchain.
The unique aspect of blockchains compared to traditional financial ledgers is that blockchains are maintained, validated, and secured by a distributed network of computers rather than an individual or corporation. Whereas in the past, we have had to rely on third-party intermediaries such as PayPal to move money digitally, blockchains allow us to move value in a pure peer-to-peer fashion anywhere in the world.
A ‘coinbase transaction’ (yes, this is where the now public company derived its name) is the first transaction in a block.
Once a block is verified and added to the blockchain, those transactions, amounts, and other data associated with the transaction recorded are there forever. Furthermore, the transactions can never be changed or undone and for this reason, blockchains are viewed as immutable. There are also no limitations on the number of blocks that can be chained together in a blockchain. Hypothetically speaking these blockchains could continue in perpetuity.
In a public blockchain such as Bitcoin, all transactions ever recorded on the blockchain since its creation can be viewed by anyone. Thus, public or ‘permissionless’ blockchains such as Bitcoin are extremely transparent (note that capitalized Bitcoin refers to the blockchain itself, whereas lowercase bitcoin or BTC refers to the cryptoasset). At any point in time, anyone across the globe with internet access can run a “node” (a computer with software to access the blockchain) giving them a real-time database of all transactions to occur on a given blockchain. Regardless of who you are, anyone who runs a node at the same point in time will have identical data, eliminating the risk of information asymmetry.
Security
Cryptography is an integral part of blockchain technology. It is a technique that ensures secure correspondence in the presence of adversaries. In other words, cryptography allows data to be communicated to appropriate recipients, while also ensuring that unintended third parties cannot decode the message. Transactions are encrypted and decrypted using public and private keys. Public keys can be freely communicated to the outside world and allow people to know where to send cryptoassets. Private keys, however, should be kept secret and ensure only the correct parties involved can authorize and accept a transaction. So long as you are the only one who knows your private keys, it's impossible for anyone or any entity to access or take your cryptoassets from you. Most hacks in crypto aren’t hacks of the underlying blockchain but rather malicious actors gaining access to users' private keys.
Another important aspect of blockchain security is the hash rate. Hashrate is a measure of the computational power per second used when mining. When aggregated across all miners, it’s a measure of the computing power of the network. Blockchains work on a consensus mechanism, meaning that 51% or more of the participants in the blockchain must verify the details of each transaction before it is added to the block. Therefore, one of the few vulnerabilities they have is what is known as a 51% attack. If any one entity controls a majority of the network, that entity would be able to dictate which transactions get verified and which don’t. The larger the hashrate, the more difficult and more expensive it is to carry out a 51% attack. Thus, hashrate is a good measure of the security of a blockchain.
When Bitcoin was first launched in 2009, it was very susceptible to this attack because the network was small and nascent. Luckily, the project was able to grow in obscurity for a period of time where the only people contributing to it were those who wanted to see it succeed. Over time the network grew to the largest computing network on the planet, with more power on the network than Google, Facebook and Amazon combined. By 2018, Bitcoin’s processing power was 6-8x larger than the top 500 supercomputers combined. Thus, the network has grown so large that at this point a 51% attack is not practically possible. The Bitcoin blockchain is by far the largest blockchain and most secure.
“The technology most likely to change the next decade of business is not the social web, big data, the cloud, robotics, or even artificial intelligence. It’s the blockchain…” — Harvard Business Review
Hashrate also prevents altering transactions that have already occurred. Because blocks are chained together in chronological order, the only way to potentially alter a previous transaction is to undo every prior transaction in reverse order. However, each subsequent block requires exponentially more computing power to “rehash” making Hashrate also prevents altering transactions that have already occurred. Because blocks are chained together in chronological order, the only way to potentially alter a previous transaction is to undo every prior transaction in reverse order. However, each subsequent block requires exponentially more computing power to “rehash” making altering transaction history after a couple blocks nearly impossible. This is why some services will wait for a few blocks to be verified before confirming a transaction.
Open vs. closed blockchains
There are two types of blockchains, open and closed. Open blockchains such as Bitcoin are permissionless and entirely decentralized. Anyone can access the network and participate in it. All transactions are validated by participants collectively (i.e. consensus), requiring agreement by 51% or more for each individual transaction. As a result, the blockchain is truly autonomous and does not require any single entity or individual to supervise the day-to-day functioning of the network. The code used to create open blockchains is transparent as well. Open blockchains such as Bitcoin encompass the majority of all blockchains in existence.
Contrarily, closed blockchains negate some of the main functions of decentralization. They are typically created for commercial use to fulfill the needs of a specific organization or a collective of organizations. A central authority is given the power to maintain oversight of the blockchain and make alterations to transaction history when deemed suitable. Access to a closed blockchain is restricted by the central authority, thus why closed blockchains are known as permissioned.
Bitcoin is the culmination of various technological innovations that span decades. There are many facets that contributed to how blockchain came to be, from game theory and economics to cryptography. The legacy of blockchain technology can be traced back to cryptographer David Chaum’s work in 1982. As we now know, this evolved into something monumental. The creation of blockchain represents the breakthrough of creating ‘digital cash’ without relying on a trusted third party. It all came together in October of 2008, when a group or individual using the pseudonym Satoshi Nakamoto published, “Bitcoin: A Peer-to-Peer Electronic Cash System.” The white paper is mandatory reading for anyone learning about cryptoassets. The timing of Nakamoto’s white paper was impeccable. It was released in the wake of the Global Financial Crisis, a time of widespread distrust of financial institutions and central banks. In the paper, Nakamoto walks through the inefficiencies and unfairness within the legacy financial system, and presents the benefits of decentralized networks, suggesting Bitcoin as a solution.
Blockchains are heralded by many as a transformational technological innovation that is capable of democratizing and improving financial markets, economic activity, and even the internet itself. Bitcoin, the best-known blockchain, is a decentralized, borderless, and immutable version of digital cash that exemplifies all the basic properties of money: divisibility, durability, portability, recognizability, and scarcity. Since the Nakamoto paper was published, blockchain technology has become the vehicle for explosive innovation within and around legacy systems and has also led to a new economy of cryptoassets and decentralized finance. A few examples include coins (bitcoin, ether), Central Bank Digital Currency (CBDC), Initial Coin Offerings (ICOs), and Non-fungible tokens (NFTs.) Beyond the financial impact, which was our main focus here, there are numerous computational, logistical, and social impact solutions that are enabled by blockchain. The future is at once bright and unknown, and we look forward to continuing to explore and evaluate the opportunities that result.
