Important note: If you own more than $1,000 worth of cryptocurrency then you should definitely be using a hardware wallet instead of keeping coins on exchanges. I recommend a Trezor which you can buy for €89 directly from their website.
This article is a gentle introduction to blockchain technology and assumes minimal technical knowledge. It attempts to describe what it is rather than why should I care, which is something for a future post.
Shorter companion pieces to this are:
- So you want to use a blockchain for that? Some common misconceptions
- Confused by blockchains? Revolution vs Evolution
- No, blockchain is not a solution looking for a problem
- A gentle introduction to immutability of blockchains
PART 1 – EXECUTIVE SUMMARY
People use the term ‘blockchain technology’ to mean different things, and it can be confusing. Sometimes they are talking about The Bitcoin Blockchain, sometimes it’s The Ethereum Blockchain, sometimes it’s other virtual currencies or digital tokens, sometimes it’s smart contracts. Most of the time though, they are talking about distributed ledgers, i.e. a list of transactions that is replicated across a number of computers, rather than being stored on a central server.
The common themes seem to be a data store which:
- usually contains financial transactions
- is replicated across a number of systems in almost real-time
- usually exists over a peer-to-peer network
- uses cryptography and digital signatures to prove identity, authenticity and enforce read/write access rights
- can be written by certain participants
- can be read by certain participants, maybe a wider audience, and
- has mechanisms to make it hard to change historical records, or at least make it easy to detect when someone is trying to do so
I see “blockchain technology” as a collection of technologies, a bit like a bag of Lego. From the bag, you can take out different bricks and put them together in different ways to create different results.
What’s the difference between a blockchain a a normal database? Very loosely, a blockchain system is a package which contains a normal database plus some software that adds new rows, validates that new rows conform to pre-agreed rules, and listens and broadcasts new rows to its peers across a network, ensuring that all peers have the same data in their databases.
PART 2 – INTRODUCING BITCOIN’S BLOCKCHAIN
The Bitcoin Blockchain ecosystem
As a primer on bitcoin, it may help to review A gentle introduction to bitcoin.
The Bitcoin Blockchain ecosystem is actually quite a complex system due to its dual aims: that anyone should be able to write to The Bitcoin Blockchain; and that there shouldn’t be any centralised power or control. Relax these, and you don’t need many of the convoluted mechanisms of Bitcoin.
That said, let’s start with The Bitcoin Blockchain ecosystem, and then try to tease out the blockchain bit from the bitcoin bit.
Replicated databases. The Bitcoin Blockchain ecosystem acts like a network of replicated databases, each containing the same list of past bitcoin transactions. Important members of the network are called validators or nodes which pass around transaction data (payments) and block data (additions to the ledger). Each validator independently checks the payment and block data being passed around. There are rules in place to make the network operate as intended.
Bitcoin’s complexity comes from its ideology. The aim of bitcoin was to be decentralised, i.e. not have a point of control, and to be relatively anonymous. This has influenced how bitcoin has developed. Not all blockchain ecosystems need to have the same mechanisms, especially if participants can be identified and trusted to behave.
Here’s how bitcoin approaches some of the decisions:
Public vs private blockchains
There is a big difference in what technologies you need, depending on whether you allow anyone to write to your blockchain, or known, vetted participants. Bitcoin in theory allows anyone to write to its ledger (but in practice, only about 20 people/groups actually do).
Public blockchains. Ledgers can be ‘public’ in two senses:
- Anyone, without permission granted by another authority, can write data
- Anyone, without permission granted by another authority, can read data
Usually, when people talk about public blockchains, they mean anyone-can-write.
Because bitcoin is designed as a ‘anyone-can-write’ blockchain, where participants aren’t vetted and can add to the ledger without needing approval, it needs ways of arbitrating discrepancies (there is no ‘boss’ to decide), and defence mechanisms against attacks (anyone can misbehave with relative impunity, if there is a financial incentive to do so). These create cost and complexity to running this blockchain.
Private blockchains. Conversely, a ‘private’ blockchain network is where the participants are known and trusted: for example, an industry group, or a group of companies owned by an umbrella company. Many of the mechanisms aren’t needed – or rather they are replaced with legal contracts – “You’ll behave because you’ve signed this piece of paper.”. This changes the technical decisions as to which bricks are used to build the solution.
Another way of describing public/private might be permissionless vs permissioned or pseudonymous vs identified participants.
See the pros and cons of internal blockchains or the difference between a distributed ledger and a blockchain for more on this topic.
PART 3 – MORE DEPTH, PLEASE
Warning: this section isn’t so gentle, as it goes into detail into each of the elements above. I recommend getting a cup of tea.
DATA STORAGE: What is a blockchain?
A blockchain is just a file. A blockchain by itself is just a data structure. That is, how data is logically put together and stored. Other data structures are databases (rows, columns, tables), text files, comma separated values (csv), images, lists, and so on. You can think of a blockchain competing most closely with a database.
Blocks in a chain = pages in a book
For analogy, a book is a chain of pages. Each page in a book contains:
- the text: for example the story
- information about itself: at the top of the page there is usually the title of the book and sometimes the chapter number or title; at the bottom is usually the page number which tells you where you are in the book. This ‘data about data’ is called meta-data.
Similarly in a blockchain block, each block has:
- the contents of the block, for example in bitcoin is it the bitcoin transactions, and the miner incentive reward (currently 25 BTC).
- a ‘header’ which contains the data about the block. In bitcoin, the header includes some technical information about the block, a reference to the previous block, and a fingerprint (hash) of the data contained in this block, among other things. This hash is important for ordering.
See this infographic for a visualisation of the data in Bitcoin’s blockchain.
Block ordering in a blockchain
Page by page. With books, predictable page numbers make it easy to know the order of the pages. If you ripped out all the pages and shuffled them, it would be easy to put them back into the correct order where the story makes sense.
Block by block. With blockchains, each block references the previous block, not by ‘block number’, but by the block’s fingerprint, which is cleverer than a page number because the fingerprint itself is determined by the contents of the block.
Internal consistency. By using a fingerprint instead of a timestamp or a numerical sequence, you also get a nice way of validating the data. In any blockchain, you can generate the block fingerprints yourself by using some algorithms. If the fingerprints are consistent with the data, and the fingerprints join up in a chain, then you can be sure that the blockchain is internally consistent. If anyone wants to meddle with any of the data, they have to regenerate all the fingerprints from that point forwards and the blockchain will look different.
This means that if it is difficult or slow to create this fingerprint (see the “making it hard for baddies to be bad” section), then it can also be difficult or slow to re-write a blockchain.
The logic in bitcoin is:
- Make it hard to generate a fingerprint that satisfies the rules of The Bitcoin Blockchain
- Therefore, if someone wants to re-write parts of The Bitcoin Blockchain, it will take them a long time, and they have to catchup with and overtake the rest of the honest network
This is why people say The Bitcoin Blockchain is immutable (can not be changed)*.
* Here’s a piece on immutability in blockchains.
DATA DISTRIBUTION: How is new data communicated?
Peer to peer is one way of distributing data in a network. Another way is client-server. You may have heard of peer-to-peer file sharing on the BitTorrent network where files are shared between users, without a central server controlling the data. This is why BitTorrent has remained resilient as a network: there is no central server to shut down.
In the office environment, often data is held on servers, and wherever you log in, you can access the data. The server holds 100% of the data, and the clients trust that the data is definitive. Most of the internet is client-server where the website is held on the server, and you are the client when you access it. This is very efficient, and a traditional model in computing.
In peer-to-peer models, it’s more like a gossip network where each peer has 100% of the data (or as close to it as possible), and updates are shared around. Peer-to-peer is in some ways less efficient than client-server, as data is replicated many times; once per machine, and each change or addition to the data creates a lot of noisy gossip. However each peer is more independent, and can continue operating to some extent if it loses connectivity to the rest of the network. Also peer-to-peer networks are more robust, as there is no central server that can be controlled, so closing down peer-to-peer networks is harder.
The problems with peer-to-peer
With peer-to-peer models, even if all peers are ‘trusted’, there can be a problem of agreement or consensus – if each peer is updating at different speeds and have slightly different states, how do you determine the “real” or “true” state of the data?
Worse, in an ‘untrusted’ peer-to-peer network where you can’t necessarily trust any of the peers, how do you ensure that the system can’t easily be corrupted by bad peers?
CONSENSUS: How do you resolve conflicts?
A common conflict is when multiple miners create blocks at roughly the same time. Because blocks take time to be shared across the network, which one should count as the legit block?
Example. Let’s say all the nodes on the network have synchronised their blockchains, and they are all on block number 80.
If three miners across the world create ‘Block 81’ at roughly the same time, which ‘Block 81’ should be considered valid? Remember that each ‘Block 81’ will look slightly different: They will certainly contain a different payment address for the 25 BTC block reward; and they may contain a different set transactions. Let’s call them 81a, 81b, 81c.
How do you resolve this?
Longest chain rule. In bitcoin, the conflict is resolved by a rule called the “longest chain rule”.
In the example above, you would assume that the first ‘Block 81’ you see is valid. Let’s say you see 81a first. You can start building the next block on that, trying to create 82a:
However in a few seconds you may see 81b. If you see this, you keep an eye on it. If later you see 82b, the “longest chain rule” says that you should regard the longer ‘b’ chain as the valid one (…80, 81b, 82b) and ignore the shorter chain (…80, 81a). So you stop trying to make 82a and instead start trying to make 83b:
The “longest chain rule” is the rule that the bitcoin blockchain ecosystem uses to resolve these conflicts which are common in distributed networks.
However, with a more centralised or trusted blockchain network, you can make decisions by using a trusted, or senior validator to arbitrate in these cases.
See a gentle introduction to bitcoin mining for more detail.
UPGRADES: How do you change the rules?
As a network as a whole, you must agree up front what kind of data is valid to be passed around, and what is not. With bitcoin, there are technical rules for transactions (Have you filled in all the required data fields? Is it in the right format? etc), and there are business rules (Are you trying to spend more bitcoins than you have? Are you trying to spend the same bitcoins twice?).
Rules change. As these rules evolve over time, how will the network participants agree on the changes? Will there be a situation where half the network thinks one transaction is valid, and the other half doesn’t think so because of differences in logic?
In a private, controlled network where someone has control over upgrades, this is an easy problem to solve: “Everyone must upgrade to the new logic by 31 July”.
However in a public, uncontrolled network, it’s a more challenging problem.
With bitcoin, there are two parts to upgrades.
- Suggest the change (BIPs). First, there is the proposal stage where improvements are proposed, discussed, and written up. A proposal is referred to as a “BIP” – a “Bitcoin Improvement Proposal”.
If it gets written into the Bitcoin core software on Github, it can then form part of an upgrade – the next version of “Bitcoin core” which is the most common “reference implementation” of the protocol.
- Adopt the change (miners). The upgrade can be downloaded by nodes and block makers (miners) and run, but only if they want to (you could imagine a change which reduces the mining reward from 25 BTC per block to 0 BTC. We’ll see just how many miners choose to run that!).
If the majority of the network (in bitcoin, the majority is determined by computational power) choose to run a new version of the software, then new-style blocks will be created faster than the minority, and the minority will be forced to switch or become irrelevant in a “blockchain fork”. So miners with lots of computational power have a good deal of “say” as to what gets implemented.
WRITE ACCESS: How do you control who can write data?
In the bitcoin network, theoretically anyone can download or write some software and start validating transactions and creating blocks. Simply go to https://bitcoin.org/en/download and run the “Bitcoin core” software.
Your computer will act as a full node which means:
- Connecting to the bitcoin network
- Downloading the blockchain
- Storing the blockchain
- Listening for transactions
- Validating transactions
- Passing on valid transactions
- Listening for blocks
- Validating blocks
- Passing on valid blocks
- Creating blocks
- ‘Mining’ the blocks
The source code to this “Bitcoin core” software is published on Github: https://github.com/bitcoin/bitcoin. If you are so inclined, you can check the code and compile and run it yourself instead of downloading the prepackaged software on bitcoin.org. Or you can even write your own code, so long as it conforms to protocol.
Ethereum works in a similar way in this respect – see a gentle introduction to Ethereum.
Note that you don’t need to sign up, log in, or apply to join the network. You can just go ahead and join in. Compare this with the SWIFT network, where you can’t just download some software and start listening to SWIFT messages. In this way, some call bitcoin ‘permissionless’ vs SWIFT which would be ‘permissioned’.
Permissionless is not the only way
You may want to use blockchain technology in a trusted, private network. You may not want to publish all the rules of what a valid transaction or block looks like. You may want to control how the network rules are changed. It is easier to control a trusted private network than an untrusted, public free-for-all like bitcoin.
DEFENCE: How do you make it hard for baddies?
A problem with a permissionless, or open networks is that they can be attacked by anyone. So there needs to be a way of making the network-as-a-whole trustworthy, even if specific actors aren’t.
What can and can’t miscreants do?
A dishonest miner can:
- Refuse to relay valid transactions to other nodes
- Attempt to create blocks that include or exclude specific transactions of his choosing
- Attempt to create a ‘longer chain’ of blocks that make previously accepted blocks become ‘orphans’ and not part of the main chain
- Create bitcoins out of thin air*
- Steal bitcoins from your account
- Make payments on your behalf or pretend to be you
That’s a relief.
*Well, he can, but only his version of the ledger will have this transactions. Other nodes will reject this, which is why it is important to confirm a transaction across a number of nodes.
With transactions, the effect a dishonest miner can have is very limited. If the rest of the network is honest, they will reject any invalid transactions coming from him, and they will hear about valid transactions from other honest nodes, even if he is refusing to pass them on.
With blocks, if the miscreant has sufficient block creation power (and this is what it all hinges on), he can delay your transaction by refusing to include it in his blocks. However, your transaction will still be known by other honest nodes as an ‘unconfirmed transaction’, and they will include it in their blocks.
Worse though, is if the miscreant can create a longer chain of blocks than the rest of the network, and invoking the “longest chain rule” to kick out the shorter chains. This lets him unwind a transaction.
Here’s how you can do it:
- Create two payments with the same bitcoins: one to an online retailer, the other to yourself (another address you control)
- Only broadcast the payment that pays the retailer
- When the payment gets added in an honest block, the retailer sends you goods
- Secretly create a longer chain of blocks which excludes the payment to the retailer, and includes the payment to yourself
- Publish the longer chain. If the other nodes are playing by the “longest chain rule” rule, then they will ignore the honest block with the retailer payment, and continue to build on your longer chain. The honest block is said to be ‘orphaned’ and does not exist to all intents and purposes.
- The original payment to the retailer will be deemed invalid by the honest nodes because those bitcoins have already been spent (in your longer chain)
This is called a “double spend” because the same bitcoins were spent twice – but the second one was the one that became part of the eventual blockchain, and the first one eventually gets rejected.
How do you make it hard for dishonest miners to create blocks?
Remember, this is only a problem for ledgers where block-makers aren’t trusted.
Essentially you want to make it hard, or expensive for baddies to add blocks. In bitcoin, this is done by making it computationally expensive to add blocks. Computationally expensive means “takes a lot of computer processing power” and translates to financially expensive (as computers need to be bought then run and maintained).
The computation itself is a guessing game where block-makers need to guess a number, which when crunched with the rest of the block data contents, results in a hash / fingerprint that is smaller than a certain number. That number is related to the ‘difficulty’ of mining which is related to the total network processing power. The more computers joining in to process blocks, the harder it gets, in a self-regulating cycle.
This guessing game is called “Proof of work”. By publishing the block with the fingerprint that is smaller than the target number, you are proving that you did enough guess work to satisfy the network at that point in time.
INCENTIVES: How do you pay validators?
Transaction and block validation is cheap and fast, unless you choose to make it slow and expensive (a la bitcoin).
If you control the validators in your own network, or they are trusted, then
- you don’t need to make it expensive to add blocks, and
- therefore you can reduce the need to incentivise them
You can use other methods such as “We’ll pay people to run validators” or “People sign a contract to run validators and behave”.
Because of bitcoin’s ‘public’ structure, it needs a defence against miscreants and so uses “proof of work” to make it computationally difficult to add a block (see Defence section). This has created a cost (equipment and running costs) of mining and therefore a need for incentivisation.
Just as the price of gold determines how much equipment you can spend on a gold mine, bitcoin’s price determines how much mining power is used to secure the network. The higher the price, the more mining there is, and the more a miscreant has to spend to bully the network.
So, miners do lots of mining, increasing the difficulty and raising the walls against network attacks. They are rewarded in bitcoin according to a schedule, and in time, as the block rewards reduce, transaction fees become the incentive that miners collect.
This is all very well in theory, but the more you look into this, the more interesting it gets, and with the bitcoin solution, the incentives may not quite have worked as expected. This is something for another article…
It is useful to understand blockchains in the context of bitcoin, but you should not assume that all blockchain ecosystems need bitcoin mechanisms such as tokens, proof of work mining, longest chain rule, etc. Bitcoin is the first attempt at maintaining a decentralised, public ledger with no formal control or governance. Ethereum is the next iteration of a blockchain with smart contracts. There are significant challenges involved.
On the other hand, private or internal distributed ledgers and blockchains can be deployed to solve other sets of problems. As ever, there are tradeoffs and pros and cons to each solution, and you need to consider these individually for each individual use case.
If you have a specific business problem which you think may be solvable with a blockchain, I would love to hear about this: please contact me.
With thanks to David Moskowitz, Tim Swanson, Roberto Capodieci. Errors, omissions, and simplifications are mine.