What is blockchain technology?

From a cruising altitude, a blockchain might not look that different from things you’re familiar with, say Wikipedia.

With a blockchain, many people can write entries into a record of information, and a community of users can control how the record of information is amended and updated. Likewise, Wikipedia entries are not the product of a single publisher. No one person controls the information.

Descending to ground level, however, the differences that make blockchain technology unique become more clear. While both run on distributed networks (the internet), Wikipedia is built into the World Wide Web (WWW) using a client-server network model.

A user (client) with permissions associated with its account is able to change Wikipedia entries stored on a centralized server.

Whenever a user accesses the Wikipedia page, they will get the updated version of the ‘master copy’ of the Wikipedia entry. Control of the database remains with Wikipedia administrators allowing for access and permissions to be maintained by a central authority.

Wikipedia’s digital backbone is similar to the highly protected and centralized databases that governments or banks or insurance companies keep today. Control of centralized databases rests with their owners, including the management of updates, access and protecting against cyber-threats.

The distributed database created by blockchain technology has a fundamentally different digital backbone. This is also the most distinct and important feature of blockchain technology.

Wikipedia’s ‘master copy’ is edited on a server and all users see the new version. In the case of a blockchain, every node in the network is coming to the same conclusion, each updating the record independently, with the most popular record becoming the de-facto official record in lieu of there being a master copy.


Transactions are broadcast, and every node is creating their own updated version of events.

It is this difference that makes blockchain technology so useful – It represents an innovation in information registration and distribution that eliminates the need for a trusted party to facilitate digital relationships.

Yet, blockchain technology, for all its merits, is not a new technology.

Rather, it is a combination of proven technologies applied in a new way. It was the particular orchestration of three technologies (the Internet, private key cryptography and a protocol governing incentivization) that made bitcoin creator Satoshi Nakamoto’s idea so useful.

The result is a system for digital interactions that does not need a trusted third party. The work of securing digital relationships is implicit — supplied by the elegant, simple, yet robust network architecture of blockchain technology itself.


Defining digital trust
Trust is a risk judgement between different parties, and in the digital world, determining trust often boils down to proving identity (authentication) and proving permissions (authorization).

Put more simply, we want to know, ‘Are you who you say you are?’ and ‘Should you be able to do what you are trying to do?’

In the case of blockchain technology, private key cryptography provides a powerful ownership tool that fulfills authentication requirements. Possession of a private key is ownership. It also spares a person from having to share more personal information than they would need to for an exchange, leaving them exposed to hackers.

Authentication is not enough. Authorization – having enough money, broadcasting the correct transaction type, etc – needs a distributed, peer-to-peer network as a starting point. A distributed network reduces the risk of centralized corruption or failure.

This distributed network must also be committed to the transaction network’s recordkeeping and security. Authorizing transactions is a result of the entire network applying the rules upon which it was designed (the blockchain’s protocol).

Authentication and authorization supplied in this way allow for interactions in the digital world without relying on (expensive) trust. Today, entrepreneurs in industries around the world have woken up to the implications of this development – unimagined, new and powerful digital relationshionships are possible. Blockchain technology is often described as the backbone for a transaction layer for the Internet, the foundation of the Internet of Value.

In fact, the idea that cryptographic keys and shared ledgers can incentivize users to secure and formalize digital relationships has imaginations running wild. Everyone from governments to IT firms to banks is seeking to build this transaction layer.

Authentication and authorization, vital to digital transactions, are established as a result of the configuration of blockchain technology.

The idea can be applied to any need for a trustworthy system of record.

How does it work?

There are three principal technologies that combine to create a blockchain. None of them are new. Rather, it is their orchestration and application that is new.

These technologies are: 1) private key cryptography, 2) a distributed network with a shared ledger and 3) an incentive to service the network’s transactions, record-keeping and security.

The following is an explanation of how these technologies work together to secure digital relationships.


Cryptographic keys
Two people wish to transact over the internet. Each of them holds a private key and a public key.

The main purpose of this component of blockchain technology is to create a secure digital identity reference. Identity is based on possession of a combination of private and public cryptographic keys.

The combination of these keys can be seen as a dexterous form of consent, creating an extremely useful digital signature.

In turn, this digital signature provides strong control of ownership.


Identity
But strong control of ownership is not enough to secure digital relationships. While authentication is solved, it must be combined with a means of approving transactions and permissions (authorisation).

For blockchains, this begins with a distributed network.


A Distributed Network
The benefit and need for a distributed network can be understood by the ‘if a tree falls in the forest’ thought experiment.

If a tree falls in a forest, with cameras to record its fall, we can be pretty certain that the tree fell. We have visual evidence, even if the particulars (why or how) may be unclear.

Much of the value of the bitcoin blockchain is that it is a large network where validators, like the cameras in the analogy, reach a consensus that they witnessed the same thing at the same time. Instead of cameras, they use mathematical verification.

In short, the size of the network is important to secure the network.

That is one of the bitcoin blockchain’s most attractive qualities — it is so large and has amassed so much computing power. At time of writing, bitcoin is secured by 3,500,000 TH/s, more than the 10,000 largest banks in the world combined. Ethereum, which is still more immature, is secured by about 12.5 TH/s, more than Google and it is only two years old and still basically in test mode.


System of record
When cryptographic keys are combined with this network, a super useful form of digital interactions emerges. The process begins with A taking their private key, making an announcement of some sort — in the case of bitcoin, that you are sending a sum of the cryptocurrency — and attach it to B’s public key.


Protocol
A block – containing a digital signature, timestamp and relevant information – is then broadcast to all nodes in the network.

 

     


Network servicing protocol
A realist might challenge the tree falling in the forest thought experiment with the following question: Why would there be a million computers with cameras waiting to record whether a tree fell? In other words, how do you attract computing power to service the network to make it secure?

For open, public blockchains, this involves mining. Mining is built off a unique approach to an ancient question of economics — the tragedy of the commons.

With blockchains, by offering your computer processing power to service the network, there is a reward available for one of the computers. A person’s self-interest is being used to help service the public need.

With bitcoin, the goal of the protocol is to eliminate the possibility that the same bitcoin is used in separate transactions at the same time, in such a way that this would be difficult to detect.

This is how bitcoin seeks to act as gold, as property. Bitcoins and their base units (satoshis) must be unique to be owned and have value. To achieve this, the nodes serving the network create and maintain a history of transactions for each bitcoin by working to solve proof-of-work mathematical problems.

They basically vote with their CPU power, expressing their agreement about new blocks or rejecting invalid blocks. When a majority of the miners arrive at the same solution, they add a new block to the chain. This block is timestamped, and can also contain data or messages.

Here’s a chain of blocks:

The type, amount and verification can be different for each blockchain. It is a matter of the blockchain’s protocol – or rules for what is and is not a valid transaction, or a valid creation of a new block. The process of verification can be tailored for each blockchain. Any needed rules and incentives can be created when enough nodes arrive at a consensus on how transactions ought to be verified.

It’s a taster’s choice situation, and people are only starting to experiment.

We are currently in a period of blockchain development where many such experiments are being run. The only conclusions drawn so far are that we are yet to fully understand the dexterity of blockchain protocols.

What can it do?

Financial institutions have financed the disruption of countless industries over the last 30 years; they have an idea of what a revolutionary technology can do to static incumbents.

So, to stay ahead of change, banks have been proactive in setting up R&D labs, building test centers and establishing partnerships with blockchain developers to fully understand the revolutionary potential of the technology.

Financial institutions were the first to dip their feet in, but academia, governments and consulting firms have also studied the technology.

All of this work is, of course, in addition to what the entrepreneurs and developers are doing, either by finding new ways to use the bitcoin or ethereum blockchains, or else creating entirely new blockchains.

This has been going on for over three years now, and the results are starting to come in.

While some of the waters are still murky, this is what we know a blockchain can do:

Establish digital identity

The identity component of blockchain technology is fulfilled through the use of cryptographic keys. Combining a public and private key creates a strong digital identity reference based on possession.

A public key is how you are identified in the crowd (like an email address), a private key is how you express consent to digital interactions. Cryptography is an important force behind the blockchain revolution.

Serve as a system of record
Blockchains are an innovation in information registration and distribution. They are good for recording both static data (a registry) or dynamic data (transactions), making it an evolution in systems of record.

In the case of a registry, data can be stored on blockchains in any combination of three ways:

  • Unencrypted data – can be read by every blockchain participant in the blockchain and is fully transparent.
  • Encrypted data  can be read by participants with a decryption key. The key provides access to the data on the blockchain and can prove who added the data and when it was added.
  • Hashed data – can be presented alongside the function that created it to show the data wasn’t tampered with.

Blockchain hashes are generally done in combination with the original data stored off-chain. Digital ‘fingerprints’, for example, are often hashed into the blockchain, while the main body of information can be stored offline.

Such a shared system of record can change the way disparate organizations work together.

Currently, with data siloed in private servers, there is an enormous cost for inter-company transactions involving processes, procedures and cross-checking of records.

Prove immutability
A feature of a blockchain database is that is has a history of itself. Because of this, they are often called immutable. In other words, it would be a huge effort to change an entry in the database, because it would require changing all of the data that comes afterwards, on every single node. In this way, it is more a system of record than a database.

Serve as a platform
Cryptocurrencies were the first platform developed using blockchain technology. Now, people have moved from the idea of a platform to exchange cryptocurrencies to a platform for smart contracts.

The term ‘smart contracts’ has become somewhat of a catch-all phrase, but the idea can actually be divided into several categories:

There are the ‘vending machine’ smart contracts coined in the 1990s by Nick Szabo. This is where machines engage after receiving an external input (a cryptocurrency), or else send a signal that triggers a blockchain activity.

There are also smart legal contracts, or Ricardian contracts. Much of this application is based on the idea that a contract is a meeting of the minds, and that it is the result of whatever the consenting parties to the contract agree to. So, a contract can be a mix of a verbal agreement, a written agreement, and now also some of the useful aspects of blockchains like timestamps, tokens, auditing, document coordination or business logic.

Finally, there are the ethereum smart contracts. These are programs which control blockchain assets, executed over interactions on the ethereum blockchain. Ethereum itself is a platform for smart contract code.

Blockchains are not built from a new technology. They are built from a unique orchestration of three existing technologies.

Why use it?

As the implications of the invention of have become understood, a certain hype has sprung up around blockchain technology.

This is, perhaps, because it is so easy to imagine high-level use cases. But, the technology has also been closely examined: millions of dollars have been spent researching blockchain technology over the past few years, and numerous tests for whether or not blockchain technology is appropriate in various scenarios have been conducted.

Blockchain technology offers new tools for authentication and authorization in the digital world that preclude the need for many centralized administrators. As a result, it enables the creation of new digital relationships.

By formalizing and securing new digital relationships, the blockchain revolution is posed to create the backbone of a layer of the internet for transactions and interactions of value (often called the ‘Internet of Value’, as opposed to the ‘Internet of Information’ which uses the client-server, accounts and master copy databases we’ve been using for over the past 20 years.)

But, with all the talk of building the digital backbone of a new transactional layer to the internet, sometimes blockchains, private cryptographic keys and cryptocurrencies are simply not the right way to go.

Many groups have created flowcharts to help a person or entity decide between a blockchain or master copy, client-server database. The following factors are a distillation of much of what has been previously done:

 

Is the data dynamic with an auditable history?
Paper can be hard to counterfeit because of the complexity of physical seals or appearances. Like etching something in stone, paper documents have certain permanence.

But, if the data is in constant flux, if it is transactions occurring regularly and frequently, then paper as a medium may not be able to keep up the system of record. Manual data entry also has human limitations.

So, if the data and its history are important to the digital relationships they are helping to establish, then blockchains offer a flexible capacity by enabling many parties to write new entries into a system of record that is also held by many custodians.


Should or can the data be controlled by a central authority?
There remain many reasons why a third party should be in charge of some authentications and authorizations. There are times when third-party control is totally appropriate and desirable. If privacy of the data is the most important consideration, there are ways to secure data by not even connecting it to a network.

But if existing IT infrastructure featuring accounts and log-ins is not sufficient for the security of digital identity, then the problem might be solved by blockchain technology.

As Satoshi Nakamoto wrote in his (or her) seminal work, “Bitcoin: A Peer-to-Peer Electronic Cash System”: “Merchants must be wary of their customers, hassling them for more information than they would otherwise need. A certain percentage of fraud is accepted as unavoidable.”

Private key cryptography enables push transactions, which don’t require centralized systems and the elaborate accounts used to establish digital relationships. If this database requires millions of dollars to secure lightweight financial transactions, then there’s a chance blockchains are the solution.


Is the speed of the transaction the most important consideration? Does this database require high-performance millisecond transactions?
If high performance, millisecond transactions are what is required, then it’s best to stick with a traditional-model centralized system. Blockchains as databases are slow and there is a cost to storing the data – the processing (or ‘mining’) of every block in a chain. Centralized data systems based on the client-server model are faster and less expensive… for now.

In short, while we still don’t know the full limits and possibilities of blockchains, we can at least say the use cases which have passed inspection have all been about managing and securing digital relationships as part of a system of record.