Exploring the Blockchain Technology: From Distributed Ledgers to Consensus Mechanisms

Posted in Crypto Asset Compliance on May 2, 2024
Exploring The Blockchain Technology

Exploring the blockchain technology reveals its transformative potential in diverse industries, from finance to supply chain management and beyond.

The Blockchain is a diary that is almost impossible to forge. The blockchain can be thought of as a distributed database. By these means, Blockchain is a particular type or subset of the so-called distributed ledger technology or DLT. DLT is a way of recording and sharing data across multiple data stores. All of these distributed and individual data stores together make up the database.

The first blockchain was created in the year 2009 by an anonymous person/ group known as Satoshi Nakamoto. The purpose of the blockchain was to facilitate digital transactions using Bitcoin, but later the potential uses of blockchain technology quickly became apparent to developers and entrepreneurs in various other industries. 

Looking back in the past decade, a silent revolution called “Blockchain technology” resulted in significant innovations. Bitcoin is the first and most well-known blockchain innovation. 

It was a proof-of-concept digital currency that launched in 2009. Although its price has fluctuated widely, bitcoin’s market capitalization now hovers between $10 billion and $20 billion. With the help of Acorns, millions of users use blockchain technology for various transactions, including remittances.

Blockchain technology is a revolutionary technology that helped people earn and make money online, but what are some of today’s most popular blockchain applications? 

Exploring The Blockchain Technology

Exploring the Blockchain Technology

Distributed ledger technology (DLT) is the technological infrastructure and protocols that allow access, data validation, and record updating across a networked or linked database. 

DLT technology is created from blockchain technology, and the infrastructure allows the users to view changes and who made them, reduces the need to audit data, ensures that the data is reliable, and it only provides access to those users who need it. 

The DLT technology allows the data or information to be safely stored using cryptography. The data may be accessed using cryptographic signatures. After the storage of information, it can become an immutable database, the rules of the network, written into codes or programs that govern the ledger.

In practice, blockchain is a technology with many faces. It can exhibit different features and covers a wide array of systems that range from being fully open and permissionless to being permissioned.

On an open, permissionless blockchain, a person can join or leave the network at will, without having to be approved by any entity. 

All that is needed to join the network and add transactions to the ledger is a computer on which the relevant software has been installed. There is no central owner of the network and software, and identical copies of the ledger are distributed to all the nodes in the network. 

The vast majority of cryptocurrencies currently in circulation are based on permissionless blockchains. This includes cryptocurrencies such as Bitcoin, Litecoin, and others.

There is also a “Permissioned Blockchain”. On a permissioned blockchain, transaction validators are the nodes and have to be pre-selected by a network administrator. The network administrator sets the rules for the ledger to be able to join the network. This allows us to easily verify the identity of the network participants. However, at the same time, it also requires network participants to put their trust in a central coordinating entity to select reliable network nodes.

In general, permissioned blockchains can be further divided into two subcategories:

On the one hand, there are open or public permissioned blockchains, which can be accessed and viewed by anyone, but where only authorized network participants can generate transactions and update the state of the ledger.

On the other hand, there are closed or enterprise-permissioned blockchains, where access is restricted and where only the network administrator can generate transactions and update the state of the ledger.

What is important to note is that just like on an open permissionless blockchain, transactions on an open permissioned blockchain can be validated and executed without the intermediation of a trusted third party. Some cryptocurrencies, like Ripple and NEO, utilize public permissioned blockchains.

One of the most promising aspects of blockchain technology is its ability to create a trustless system. In a trustless system, two parties can interact without the need for a third party to mediate the transaction. This system could potentially reduce the cost of doing business and make it easier to conduct transactions online. Another potential use of blockchain technology is in the domain of data security. For example, users can use blockchain technology to create a decentralized database that is secure and free from hacks or data breaches.

Essentially, the Blockchain can be thought of as a distributed database. Additions to this database are initiated by one of the members, which are the network nodes. These nodes usually exist in the form of computers. Each node maintains a copy of the entire Blockchain.

The nodes also create new blocks of data, which can contain all sorts of information. Among other information, the block contains a hash. A hash is a string of numbers and letters and each new block generates a hash. The hash does not only depend on the block itself but also the previous block’s hash. This is one of the reasons why the order of the blocks matters and why blocks are added to the Blockchain in the order that they occurred. Even a small change in a block creates a completely new hash.

Exploring The Blockchain Technology

After its creation, a new block is broadcasted to every party in the network in an encrypted form so that the transaction details are protected. The nodes of the network check the validity of each new block that is added. Once a block reaches a certain number of approved transactions then a new block is formed. The determination of the block’s validity happens following a pre-defined algorithmic validation method. This is commonly referred to as a “consensus mechanism”. The nodes check the hash of a block to make sure a block has not been changed.

Once validated, the new “block” is added to the blockchain. As soon as the nodes have approved the new Block, the Blockchain or ledger is updated with it, and it can no longer be changed or removed. It is therefore considered to be impossible to forge it. You can only add new entries to it and the registry is updated on all computers on the network at the same time. 

The blocks are also signed with a digital signature using a private key. Every user on a blockchain network has a set of two keys: Firstly, A private key, which is used to create a digital signature for a block, And secondly, A Public key, which is known to everyone on the network. A public key has two uses. On the one hand, it serves as an address on the blockchain network. On another hand, it is used to verify a digital signature and validate the identity of the sender.

A user’s public and private keys are kept in a digital wallet or e-wallet. Such wallets can be stored or saved online and offline. Online storage is often referred to as hot storage and offline storage is commonly referred to as cold storage.

The consensus mechanism is a central element of the security of the Blockchain and can take many different forms. You will see that different cryptocurrencies use different consensus mechanisms. 

In principle, any node within a blockchain network can propose the addition of new information to the blockchain. To validate whether this addition of information is legitimate, the nodes have to reach some form of agreement. Here a “consensus mechanism” comes into play. A consensus mechanism is a predefined specific, cryptographic validation method that ensures a correct sequencing of transactions on the blockchain. In the case of cryptocurrencies, such sequencing is required to address the issue of double-spending. Double-spending is when the same payment instrument or asset can be transferred more than once and would happen if transfers were not registered or controlled.

A consensus mechanism can be structured in some ways. In the context of cryptocurrencies, there are two predominant consensus mechanisms, which are the Proof of Work mechanism and the Proof of Stake mechanism.

The Proof of Work mechanism. In this kind of system, network participants have to solve so-called “cryptographic puzzles” to be allowed to add new “blocks” to the blockchain. This puzzle-solving process is commonly referred to as “mining”. In simple terms, these cryptographic puzzles are made up of all information previously recorded on the blockchain and a new set of transactions to be added to the next “block”. The input of each puzzle becomes larger over time, resulting in a more complex calculation. The PoW mechanism, therefore, requires a vast amount of computing resources, which consume a significant amount of electricity.

If a network participant solves a cryptographic puzzle, it proves that he has completed the work, and is rewarded with a digital form of value – or in the case of a cryptocurrency, with a newly minted coin. This reward serves as an incentive to uphold the network.

The cryptocurrency Bitcoin is based on a PoW consensus mechanism. Other examples include Litecoin, Bitcoin Cash, Monero, and others.

The Proof of Stake mechanism. In this kind of system, a node as a transaction validator must prove ownership of a certain asset to participate in the validation of transactions. In the case of cryptocurrencies, this would require a certain amount of coins. This act of validating transactions is called “forging” instead of “mining”. 

For example, in the case of cryptocurrencies, a transaction validator will have to prove his “stake” of all coins in existence to be allowed to validate a transaction. Depending on how many coins he holds, he will have a higher chance of being the one to validate the next block. This has to do with the assumption that he may have greater seniority within the network earning him a more trusted position. The transaction validator is paid a transaction fee for his validation services by the transacting parties.

Cryptocurrencies such as Neo and Ada utilize a PoS consensus mechanism.

The PoW and PoS mechanisms are far from the only consensus mechanisms currently in existence. Other examples include proof of service, proof of elapsed time, and proof of capacity. Many other consensus mechanisms are probably developed in this very second all over the world. Eventually, they will emerge and become part of a new cryptocurrency.

Exploring The Blockchain Technology

Final Thoughts

Over the past decade, blockchain technology has burgeoned into a revolutionary tool that goes beyond its foundational cryptocurrency application, Bitcoin. Essentially a tamper-resistant, distributed database, the blockchain ensures data integrity through cryptographic hashes and consensus mechanisms. As the underpinning of distributed ledger technology (DLT), it offers both open, permissionless platforms like Bitcoin and Litecoin, where anyone can participate, and permissioned variants like Ripple and NEO, where entities are pre-approved.

This technology, which can operate without an intermediary, is heralded for its trustless nature, enabling direct, secure transactions between parties. It’s a testament to the system’s potential that from simple digital wallets to complex consensus algorithms like Proof of Work and Proof of Stake, blockchain’s imprint on modern transactions and data storage is profound and expanding. Whether for financial transactions, data security, or emerging applications, its decentralized, immutable nature stands as a groundbreaking paradigm in the digital age.