This Primer provides an introduction to blockchain technology, outlines some of the benefits it brings and considers the risks and challenges it poses. it is an overview of the key concepts and terms intended to help people better understand this emerging technology and its growing impact.
Basically, blockchain is a combination of already existing technologies that together can create networks that secure trust between people or parties who otherwise have no reason to trust one another. Specifically, it utilises distributed ledger technology (DLT) to store information verified by cryptography among a group of users, which is agreed through a pre-defined network protocol, often without the control of a central authority.
Blockchain has the potential to transform how many industries operate. Its features can increase the transparency and traceability of goods, data and financial assets, facilitate market access and improve the efficiency of transactions. Fulfilling blockchain’s potential, however, depends on a policy environment that allows innovation and experimentation, while balancing the risks of misuse. Governments will play a significant role in shaping policy and regulatory frameworks that help address challenges presented by the technology.
What is blockchain?
A blockchain is a shared ledger of transactions between parties in a network, not controlled by a single central authority. You can think of a ledger like a record book: it records and stores all transactions between users in chronological order. Instead of one authority controlling this ledger (like a bank), an identical copy of the ledger is held by all users on the network, called nodes.
Different Types of Blockchain
It is worthy to note that not every blockchain is the same. While there are a number of different features, two of the most important are the whether it is a public or private blockchain and the level of permissions required to add information to the blockchain (permissioned or permissionless). Public blockchains (like Bitcoin) are open for anyone to read and view, while private blockchains can only be viewed by a chosen group of people. Similarly, permissioned blockchains permit just a select group of users to write (i.e. generate transactions for the ledger to record) and commit (i.e. verify new blocks for addition to the chain). In contrast, permissionless blockchains allow anyone to contribute and add data to the ledger.
Blockchain’s key characteristics
One of the core aspects of a blockchain is that it is a distributed ledger, meaning that the database is maintained and held by all nodes in the network. No central authority holds or updates the ledger, rather each node independently constructs its own record by processing every block (group of transactions), deciding if it is valid, then voting via the consensus mechanism on their conclusions. Once a change in the record is agreed, each node updates its own ledger. In contrast, traditional databases are stored and maintained centrally, which can make them
high-value targets for hackers and criminals.
In general, once a transaction is added to a blockchain ledger, it cannot be undone. This immutability is one of the principal aspects that contribute to the trustworthiness of blockchain transactions. A blockchain’s immutability is secured through its use of cryptography (see below for an explanation of hashing). In a traditional, centralised database, an authorised user can connect to the server to add or modify the data without the approval or detection of other users. Because all the data is held in one place, if the security of the server or the authority that runs the server is compromised, data can be modified or permanently deleted. This may sometimes be irreversible and occur without anyone else realising it.
Agreed by consensus
No block can be added to the ledger without approval from specified nodes in the network. Rules regarding how this consent is collected are called consensus mechanisms. Consensus protocols are crucial in ensuring that every block is valid and that all participants agree and maintain the same version of the ledger. They heavily affect the incentives for nodes to act honestly and are therefore the most important variables when designing a blockchain.
Misinterpretations of blockchain
Contrary to popular belief, blockchain technology does not allow its users to be totally anonymous. Rather, public blockchain platforms tend to be pseudonymous: user identities can be anonymous but their accounts are not, as all of their transactions are visible to all other users. On these platforms, user accounts can be created without any identification or authorisation process. This allows users to use a pseudonym. Permissioned blockchains can require a user’s identity to be verified before they are able to access or use the blockchain.
While rare, it is possible for the blockchain to be compromised if nodes pool their resources and collude to approve incorrect ledger entries. However, the larger the network, the more difficult it becomes to carry out this attack. In most systems, it would cost the attacker many more resources to carry out the attack than they would gain from the attack itself. Additionally, some private blockchains allow for central authority nodes to change information on the ledger.
How does blockchain actually work?
Hashing: a cryptographic fingerprint
A hash is like a digital fingerprint; it is unique to each piece of data on the blockchain. Users put information regarding their transaction (name of receiver and sender along with the amount transferred) into a cryptographic hashing algorithm – a complex mathematical formula – and receive a set of letters and numbers that is distinct to that transaction. The specific input, if unchanged, will always produce the same exact hash. If, however, any part of the data input is changed (for example a malicious actor changes the amount transferred), the hash would change to an entirely different set of characters and make it incompatible with the rest of the chain. Therefore, even without seeing the details of the transaction, nodes can quickly tell that the data within the block has been tampered with and reject that version of the ledger. It is this cryptographic security that makes blockchain ledgers more trustworthy and “almost” immutable.
For some blockchains, in order to add blocks to the ledger, transfers must go through a mining process. Mining is a way of adding transaction records, via blocks, onto a public ledger. Miners are nodes in the network that ensure the transactions in the block are valid. Specifically, they ensure that senders have not already used the funds they want to send to receivers. Once miners finish the verification, they have to ask the network for consent to add the new block to the ledger. In order to do so, they have to follow the consensus mechanisms chosen for the platform.
One of blockchain’s key characteristics is the consensus mechanisms it uses to gather consent. Agreement among nodes regarding the “state” of the ledger is essential for the function of the blockchain ledger. The bitcoin blockchain utilises a consensus model called Proof of Work, which requires the miner to compete against other miners to create and broadcast blocks for approval. If successful, they are rewarded in Bitcoin. There are other consensus mechanisms like Proof of Stake, Proof of Authority, Proof of Elapsed Time, and Proof of Burn – all of these are variations on the means for the network to agree on changes to the ledger.
What are digital assets?
A digital asset that works as a medium of exchange.
The term tokenisation describes the process of transferring rights to a real world asset into a digital representation – or token – on the blockchain. Being in possession of that digital token then gives you the right to that asset and the ability to trade and track it digitally.
There are three main types:
Payment tokens: Commonly known as a cryptocurrency, a payment token can be a store of value and a unit of measurement, e.g. Bitcoin.
Utility tokens: A token that represents a right to a good or service, similar to a gift card, e.g. StorjCoin.
Security tokens: A token that provides equity or equity like investment in a company. The holder of the token has rights to the company’s future profits, e.g. tZERO.
Blockchain technology goes far beyond cryptocurrencies and tokens, and its usefulness as a
wider economic and administrative tool is well worth exploring.