Why are cryptocurrencies skyrocketing in popularity?  Well, we answer that question by exploring the platform they are built on…blockchain. Here, we demystify cryptocurrencies and blockchain technology.

Blockchain is a distributed ledger database. It stores all individual transactions in groups or blocks. These blocks attach to each other in chronological order to create a chain.  The blockchain-based distributed ledger system involves smart properties and smart contracts. 

The most popular cryptocurrency-based platform for this is Ethereum, a decentralized platform for smart contracts.  As an example, Microsoft adopted Ethereum as the core for its new Blockchain-as-a-Service on the Azure cloud computing environment.

Blockchain Technology

This technology has burst onto the scene because it enables secure, reliable, and transparent transactions…without the potential for manipulation by big financial institutions.  This is possible because of 4 key characteristics.

• Blockchain is a decentralized technology.  This means it is not governed by any government nor does it require the confidence of any financial institution.

• It is a ledger system based on a consensus network.  This network operates through something called proof-of-concept (which we’ll get into further on down).  Therefore, the integrity is based on this network.  Additionally, the scalability of this network is high.

• The blockchain code is open source, meaning anyone can clone the code and use it.

• As mentioned above, it is based on distributed computing systems.  Therefore, it is secure, resilient, and not vulnerable to any single-point-of-failure, so the information of each chain is insured.

Traditional centralized databases can be manipulated.  Records can be changed, hard drives can fail, data can be lost, and the records represent only one party’s view of any given transaction. In the world of blockchains and distributed ledger technology, the exact opposite is true.  The transactions recorded on the ledger represent a transaction that takes place between the parties involved and are confirmed by the blockchain network via consensus. This is hallmark to cryptocurrencies and blockchain technology.

Known Challenges for Cryptocurrencies and Blockchain

Therefore, the blockchain solves the 2 greatest challenges for cryptocurrencies.

Double-Spending

The problem of double-spending occurs when the same transaction is duplicated. It is sent to more than one party.  This potentially arises when there is no central intermediary. 

To illustrate, suppose Jane has 20 coins. She sends all 20 coins to Sam.  How can Sam know that Jane has not sent the same 20 coins to John before? Without having a bank to verify transactions? As well, how can all others using the coin?  In other words, is it just like copying a .png file in one folder? And, then pasting it in 2 different folders?  Or, sending that same .png to 2 different email recipients? 

A cryptographic hash unique to each transaction solves this.  If someone comprises one cryptographic hash in the chain , then the entire chain breaks.  These hashes compile from metadata. This metadata includes the datetime stamp of the transaction.  And, that can only occur on one transaction.  We will cover why further down on the mining process (consensus network).

Single-point-of-failure

In a centralized network, if the central intermediary is down or attacked, the entire network stops working.  With a decentralized network, on the other hand, there is no single-point-of-failure.  If one node goes down or is attacked, the rest of the network can still operate normally. 

In a blockchain, everyone can see everything and there exists a distributed ledger timestamp mechanism. This solves the double-spending problem.  Say everyone knows that Jane sent 20 coins to John yesterday. Then, they reject the transaction to send the same 20 coins to Sam today. This is the verification process without consulting a bank.

Hash-Chain Timestamping

Again, this unique cryptographic hash address with time stamping is inherent in the blockchain.  In this sense, it is a hash-chain.  Accordingly, a block encloses each transaction of coins.  A block may contain multiple transactions and is a basic unit to be verified.  Each block also contains a hash value of the previous block’s header. Thus, it forms a hash-chain or blockchain. 

As all blocks are chained, the order of the blocks is deterministic. Therefore, each block can serve as a timestamp of the enclosed transactions. This solves the double-spending problem.

Note that each node maintains a copy of the whole blockchain. Thus, every node can verify every transaction.  For example, suppose the transaction from Jane to John is enclosed in block 1. The one from Jane to Sam is enclosed in block 2. Everyone in the network can verify that 1 happened before 2 by checking the hashed blockchain. Hence, they reject double-spend transaction from Jane to Sam.

Mining Process

And, about verification, that leads us to the mining.  This is the process of creating blocks with enclosed transactions.  This process should be difficult, or time-consuming and costly. This makes attempts to create invalid blocks prohibitively expensive.  This has an additional cost of increasing the time available to create valid blocks.

To implement this design, Bitcoin adopts a proof-of-work protocol that each block creator must follow.  This process should be relatively easy to check. This is native to cryptocurrencies and blockchain technology.

Proof-of-Work

An example of a proof-of-work protocol includes the nonce mechanism.  Each block contains an additional nonce. This is a counter that serves as one of the inputs to the hashing function.  To “proof” the hashing work, the nonce is incremented by one bit each time for the hash computation (i.e. the “work”). This happens until the hash value contains a predefined number of leading zero bits.

Meanwhile, a memory pool on each node collects the newly generated unconfirmed transactions.  The first node that successfully completes the proof-of-work has the privilege to create a new block, verify the transactions, move the confirmed transactions from the memory pool to a newly created block, and add the block to the end of the longest chain (if there are competing chains).  It also gets paid (e.g. 12.5 bitcoins) for this work. 

As well, the remaining nodes stop the proof-of-work mining for that specific block when the first node completes the proof-of-work.  This way, the mining process becomes difficult. In other words, one needs to compute the difficult hashing problem by trying different “nonce” values. On the other hand, the checking process remains easy. In other words, there is just one hash to see if the predefined leading bits are all zeros. 

Following the earlier example, Jane cannot easily create an invalid block for her double-spend transaction. Sam and John can easily check that the block Jane created is invalid.

Additionally, if an attacker modifies any of the transactions in the first block, then the value of that block’s header, and thus the block itself, need to recalculate. Consequently, all blocks after that first block also need to re-compute.  Therefore, the computational cost of attacking becomes prohibitively high.

Additional Benefits of Proof-of-Work for Cryptocurrencies and Blockchain

Proof-of-work also provides the ability to resolve disagreement of the chains. This lets blockchains be immutable audit trails.  For instance, when an attacker modifies a block, all the blocks after that block re-compute. This is because each block contains the hash value of the previous block’s header. 

Therefore, the computational cost of such modification should to be high enough to prohibit attacks.  On the other hand, when an attacker creates a malicious chain to compete with an honest chain and tries to replace the honest one, the proof-of-work majority voting mechanism can also significantly reduce the probability of such an attack to succeed.

The Bitcoin mechanism also provides rewards to the nodes. This is an incentive to compensate the high cost associated with “mining” a new block and verifying transactions. This contributes to much of the popularity associated with cryptocurrencies and blockchain technology.

Branching Chains

Suppose 2 attackers create 2 malicious blocks to compete with an honest block. This is in an attempt to take over the honest chain. This includes the honest block and all blocks before.  This assumes the computational power of the honest nodes is larger than that of malicious nodes. Another honest block is created right after the first one. This is before the attackers create more malicious blocks after the first 2.  Based on the blockchain mechanism, each node first identifies a valid block based on the length of the chain. It creates a new block only at the end of the longest chain while ignoring shorter chains. 

In other words, the most worked on blockchain wins the competition. In other words, this is a majority voting of 1 CPU, 1 vote, since the longest blockchain represents the majority decision of block creators.  The probability for the attacker to successfully modify a block and all blocks thereafter (i.e. create a malicious competing chain) is very small. This is because the mining process is expensive and the honest nodes have higher computational power than the malicious nodes. In other words, they have more CPU voters.

Nonfinancial Applications of Cryptocurrencies and Blockchain

Distributed ledger technology not only applies to finance.  It has the ability and potential to disrupt every industry and reshape the internet and world as we know it.  Blockchain has potential to reshape any record entry anywhere into a database. 

This not only covers traditional centralized databases. It also covers traditional distributed database management systems (DDBMS).  So, think SQL, Oracle, mongoDB, DynamoDB, and NoSQL-based systems like Cassandra.

A wide array includes digital rights, equity markets, private markets, P2P lending, remittance, betting, debt management, escrow transfers, e-commerce, crowdfunding, microfinance, payment systems, derivates markets, land deeds, IP, voting, ownership records, and healthcare.

Therefore, we are seeing wide applications of cryptocurrencies and blockchain technology.

Key Benefits of Cryptocurrencies and Blockchain

In comparison to traditional database systems (centralized or distributed), blockchain has 5 key benefits: decentralized management, immutable audit trail, data provenance, robustness/availability, and security. These benefits are why cryptocurrencies and blockchain technology are exploding onto the scene.

Decentralized Management

With a DDBMS, the system is logically centralized-managed.  Users feel they are operating a centralized database. However, the underlying machines can be physically distributed.  With blockchain, it’s peer-to-peer, or a decentralized database management system.  In other words, each node runs independently while following protocols.

Therefore, blockchain is suitable for applications where independently manage stakeholders wish to collaborate with one another. This is without ceding control to a central management intermediary.

Immutable Audit Trail

DDBMS supports create, read, update, and delete functions like all database systems.  Blockchain only supports create and read functions. Therefore, it is difficult to change the data on records.

Therefore, blockchain is suitable as an unchangeable ledger to record critical information.

Data Provenance

In DDBMS, the system administrator can modify the ownership of digital assets.  With blockchain, the owner can change the ownership. This is so long as they follow cryptographic protocols. They can confirm the sources or the data and records.  Also, the origins of the assets are traceable, increasing the reusability of verified data.

Therefore, blockchain is suitable for use in managing critical digital assets.

Robustness & Availability

Although DDBMS & blockchain are based on distributed technology and thus do not suffer from single-point-of-failure, it is costly for DDBMS to achieve the high level of data redundancy.  Blockchain does this less costly.  Each node has a whole copy of whole historical data records.

Therefore, blockchain is suitable when the preservation and continuous availability of records are important.

Into the Future for Cryptocurrencies and Blockchain Technology

Blockchain removes the potential for manipulation to take place in systems, because the networks are all about transferring “value”.  It has the potential to rewrite our entire society the way the internet did more than 20 years ago.  Think about this next time you’re sending pictures, streaming videos and music, or sending emails. The wealth of platforms continues to explode every day. Check out some popular ones to earn crypto here.