A Blockchain joins groups of financial transactions together in what are called blocks. These blocks result in a growing list of transactions that are linked together via cryptography.
When a transaction is posted, it tells everyone that x amount of the currency was sent from Wallet A to Wallet B. All transactions that occur during that period of time are contained in an individual block.
The data contained in each block, in addition to the transaction, is also a cryptographic hash along with a time stamp.
With each new block created, it is linked to the previous one thus creating a "chain". After the blocks are fully validated and joined, they cannot be chained without the consensus of the block producers agreeing to reverse it.
Consensus Mechanism
Consensus is where all participants in the blockchain agree on the transactions that are being added. Since blockchain is the maintaining of a ledger, all block producers have to be in alignment.
There are various forms of consensus that blockchains utilize. The major ones are:
Each utilizes a different mechanism to arrive at consensus. Regardless of the system, they eliminate the double spend problem. This ensures that balances are correct and everyone can rely on the data provided from the ledger.
Distributed Ledger Technology
Blockchain used Distributed Ledger Technology (DLT) to maintain a public ledger in a decentralized fashion. This is done through node operations who are unrelated all having an duplicate copy of the ledger on their computers. The different nodes all form a network.
A blockchain ledger has no central authority. This means the block producers are the ones responsible for the continued expansion of the ledger. This has a major impact upon money. The present monetary system sees the banks entrusted with the responsibility for the global ledgers.
All operations are done in a peer-to-peer manner. Without a centralized entity, the different nodes interact in a way that allows for the consensus model to be follower. A block producer, one awarded the block, will validate the transactions and update its ledger. After that, the update is broadcast to all the other nodes so they can be updated.
The validators are incentivized to perform this service through rewards. Under blockchain systems, a certain amount of "paid" for each block that is added to the network. This will vary based upon the system and the inflation rate of the currency.
What is paid out is cryptocurrency.
Triple-Entry Accounting
One of the revolutionary aspects to blockchain is something that many find dreadfully boring: accounting. Yet this is the one area where blockchain is going to change the world.
Double-entry accounting was first done in 1494 by Luca Pacioli. This brought the liability to the balance sheet. It was a massive shift in both business and money since it made credit possible. Suddenly, the tracking of who owned money to whom was possible.
Here we see the introduction of ledger-based money.
Blockchain is adding another element. This is taking control of the ledger out of the hands of individuals or centralized entities. Unlike banks and other financial institutions, who maintain the ledger as they see fit, blockchains have different individuals who mirror the ledger. Consensus is achieved among unrelated nodes, thus establishing trust. One validation, a block cannot be reversed.
With double-entry accounting, a debit and credit is applied. The rules state there cannot be one without the other. Hence, if a debit appears, there has to be a corresponding credit. It must always even out.
Triple-entry accounting adds the entry onto the blockchain as the third leg of each transaction.
Thus we have:
- debit
- credit
- block production containing the transaction and block irreversibility
Cryptocurrency
Cryptocurrency is the monetary system that is built upon blockchain. It is the most discussed aspect of blockchain due to the pricing activity in the markets.
Blockchain is the accounting system for cryptocurrency. The latter is a digital medium of exchange which has no physical counterpart. There are no banknotes or any other form of physical form. It exists solely in the virtual world.
Cryptocurrency is built on top of blockchain. They two cannot be separated. Each transaction that affects wallets is posted to the blockchain. Since these are not only permissionless but also public, anyone can view the transaction through a block explorer.
All this creates a digital medium of exchange. Whatever value is tied to a specific cryptocurrency, that can be transferred to another simply by sending it the appropriate wallet. This is where cryptocurrency performs many of the same functions as a savings bank. People are able to send, receive and store money simply using a digital wallet.
Bitcoin is the best known cryptocurrency. It was introduced to the world by Satoshi Nakamoto, the anonymous developer. We also were introduced to the present concept of blockchain at the same time. Bitcoin uses the proof-of-work (PoW) consensus mechanism, something many have opposed due to the energy usage.
Another popular blockchain is Ethereum, developed by Vitalik Buterin among others. This is now being converted to use the proof-of-stake (PoS) consensus. Ethereum introduced the world to smart contracts which is forming the foundation for many parts of the decentralized finance (DeFi) system.
Future Use Cases
Blockchain, overall, is still in the early stages. Outside of cryptocurrency, there really has not been a lot of experimentation. That is starting to change as companies around the world start to see the potential of this new technology.
Trust is an important factor when dealing with commercial and monetary activities. Blockchain is designed to be trusted due to the fact that, once a transaction is added, it is difficult to change. The idea is to have immutability when it comes to the data placed in the blocks. This means the ledger can be trusted since no single party can alter it without a hack such as a 51% attack.
Some of the use cases that blockchain could provide are:
- gaming
- supply chain management
- authenticity/counterfeiting of products
- digital rights ownership/management
- domain names
- financial services
- micropayments
- insurance
The infrastructure being build around blockchain is considered by many to be the foundation of what will become Web 3.0. This is what many feel is the next stage in the evolution of the Internet.
Base Layer Versus Layer 2
Within the world of blockchain, there is a great deal of discussion about base layer verse layer 2 solutions.
The base layer is typically the main blockchain. This is where we find Bitcoin, Ethereum, and Hive. A layer 2 could be another blockchain but does not have to be. A network such as Lightning is a layer 2 on Bitcoin.
One of the biggest discussion is the idea of smart contracts on the base layer versus being pushed to layer 2. Ethereum has them at the base layer as does all the forks, i.e. EVMs.
Layer 2 enters the conversation when it comes to scalability. What exactly is required on the base layer. This is especially true when the blockchain stores more than just financial transactions like Bitcoin. An example of this is Hive which is a decentralized database of immutable text storage.
Access
Every blockchain, even if permissionless, does require some way to access it. This can come in a variety of forms.
The most common is by having each user pay a transaction fee. This is a per transaction cost that allows one to interact with the network. Ultimately, this is paying the block producers for validation and adding the transaction to the ledger.
Another way is through the use of an access token. This is either a token (or coin) that was developed for this purpose or has this feature incorporated into it. By holding the token the user has the ability to engage with the blockchain.
For the first, this encompasses most like Bitcoin, Litecoin, Ethereum, and TRON. It is pretty standard for a blockchain to have transactions fees. The second option is actually much rarer, at least to this point.
An example of an access token is Hive Power. This is on the Hive blockchain and by staking the base layer coin, $HIVE, on receives the ability to interact with the network.
Settlement System
Since blockchain is distributed ledger technology, it can radically alter the world of settlements as compared to the existing financial system. This is done through the use of digital assets, which includes cryptocurrency in its many different forms.
Atomic settlements offer the opportunity to settle trades instantly and the different legs simultaneously. This can occur without delay, while eliminating the counterparty risk of default that could result from said delay.
Under the present system, trades and settlement occur at different intervals. For example, a stock transaction will occur instantly. However, it takes 2 days for the trade to settle. The same is true for bonds, commodities, and most other securities.
Atomic settlements take place without any financial intermediaries. Instead, the blockchain handles it all. This removes financial institutions that operate as a go-between for the different financial networks. Unfortunately, many of these are remnants from an era were financial transactions involved cash and other physical assets that were used to settle.
When dealing with a security such as a derivative, we have a circumstance of Delivery vs Payment (DvP) whereas Payment vs Payment (PvP) deals more with currency. This is commonly referred to as atomic swaps in cryptocurrency.
Micropayments
Blockchain introduces an interesting concept. It brings to the table the idea of micropayments. This is transactions that are fractional units of currency. Since it is difficult to break down fiat currency into smaller units than a penny or pence, micropayments becomes impossible. At the same time, the networks that are used have too high a cost to utilize these. When it comes to the banks and other money transmitters, the transaction fees simply get in the way.
Even with most blockchains, this is an issue. Anytime there are transaction fees, even at a cent or two, this makes micropayments impossible. The cost of transfer is higher than what is being sent.
One blockchain that could make an entry into this arena is Hive. The fact that it is a feeless blockchain means that micropayments can take place.
While still new, people are going to have to experiment and innovate. This means we could see social media and things such as royalty payments radically altered.
Network-State
Blockchain is theorized to be a central part of the development of the network-state. This is the idea that our digital world is expanding to the point where governance systems are being created. This will eventually take over many areas where governments presently occupy.
The nation-state is based upon physical location. With the network-state, the digital ecosystem is what matters. This is established based upon the blockchain network it is built upon.
Web 2.0 was what introduced us to the concept. The growth of social media platforms such as Facebook, YouTube and Twitter show the power of these types of systems. These platforms have more users than countries have population.
The challenge is these are centralized. Here we see the replacing of a government with a corporation. They are in full control of both the front end and servers housing the data.
One of the hopes with Web 3.0 is the establishment of network-states that are decentralized. This is done by building node systems that are run by individuals and entities that are unrelated.
Decentralized Applications (DApps)
Blockchain is the foundation for decentralized applications (DApps). While things such as BitTorrent do qualify as DApps, this concept became popular with the introduction of Ethereum.
This serves as a decentralized database, allowing users to store data in a manner different than what the Internet presently employs. The traditional server-based system has caused siloes to emerge. These are corporations that control not only the front end (or application) but also the servers.
DApps potentially can revolutionize the Internet since they are connected to decentralized node system that are not under the control of any centralized entity. This means that anyone is able to integrate the data into any application.
It is generally agreed that a DApp should:
- DApp must be secured with a cryptographic token
- The data and records must be public
- It must be open source and not be under the control of any single person or group
This is one of the major transitions from Web 2.0. The control exerted by technology companies is pushing for the next stage of the Internet.