This paper is part 1 of 2 we have authored on the topic of blockchain. Part 1 delves into more detail on the technology of a blockchain and how it operates. The intended audience includes those interested in a deeper understanding of blockchain technology, particularly the technology that isthe foundation of the Bitcoin and Ethereum cryptocurrencies which are the most notable applications of blockchain technology.
For information on Bitcoin currency, OneBeacon published a whitepaper on this topic in 2014.
Part 2 is less technical and reviews business applications of blockchain technology, and discusses its prospects for revolutionizing certain transactional processes for commercial and personal purposes.
There are varying opinions regarding Bitcoin and cryptocurrencies and whether they will eventually replace fiat currency and bring on a new world order. Bitcoin’s value reached nearly $22,000 in December 2017 driven primarily by speculation. However, since that time it has been undergoing a correction and as of October 4, 2018 is priced at $6,640. Cryptocurrencies may be experiencing growing pains but are certain to be a factor in how we pay for things in the future.
What is more important is the underlying technology of Bitcoin – the blockchain – which is a truly remarkable and highly disruptive technology. At its core, Bitcoin is simply a useful application of a blockchain platform. As noted by Kris Bennett at Blockchain Training Alliance, “bitcoin is to the blockchain what email is to the internet.”1 Bitcoin is one of the first consumer‐grade applications of a blockchain. The blockchain is in its infancy but within 15‐20 years, it may become as ubiquitous and indispensable as the internet.
Our discussion will be focused on the blockchain technology underlying Bitcoin and Ethereum as these are currently the most well‐known and widespread applications of a blockchain. Part 2 of this whitepaper discusses other blockchain platforms that share some of the traits found in the Bitcoin blockchain, but also have key differences that make them more relevant for business usage.
A blockchain or distributed ledger technology (DLT) is cryptography‐based, distributed, electronic ledger technology that is decentralized. It is “a structure for storing data in which groups of valid transactions, called blocks, form a chronological chain, with each block cryptographically linked to the previous one.”2 It records transactions in a decentralized way and enables a trusted ledger amongst trustless participants.
As it is decentralized, there is no central authority (like a bank or government) overseeing the process. It enables various parties to trust and agree on the state of the ledger system even where the parties may have limited or no established trust in one another. This mechanism gives the system the functionality of a trusted, centralized, authority without the need for such control. Since the blocks form a chronological chain, there is visibility to the history of a transaction. Lastly, the use of cryptography to link these blocks makes the ledger immutable. Together, this makes the history of the transactions in the ledger immutable, unchangeable, transparent and trustworthy.
This is then combined with the block hash from the prior block, a time stamp, the transaction list, a number of other logistical data, and most importantly a nonce (see Proof of Work below). It is then hashed again to form the final block. By doing this, all of the blocks from block zero to the current block are linked or chained, thereby forming a blockchain. Although not shown in the diagram below, the transaction data is also appended to the block and is available for review when needed.
Any change made by any of the nodes to any of the transactions within a prior block revises the hash value (digest) of all of the following blocks. This would alert the other nodes that a change has been made. This step and the proof of work process results in the chain being immutable to changes and preserves the history of the transactions. For a Bitcoin blockchain, one can trace back every bitcoin to the date and time it was created – whether that happened yesterday or in January 2009 when Bitcoin was initiated.
To confirm a block onto the chain requires the nodes to solve a cryptographic puzzle, which requires extensive computing power and is therefore an expensive proposition. The PoW process deters attempts by nodes or users to commit fraud such as changing transactions in prior blocks. Changing prior nodes is costly from a computing power perspective as you would have to redo all of the PoW; the further back you go, the more computing resources it would require, thereby increasing the costs exponentially. This makes it highly unprofitable to pursue and this is an excellent deterrent to fraud.
A node that solves this puzzle correctly receives a reward of X number of bitcoins (12.5 coins at this time) or ether (currency in Ethereum platform) and/or a transaction fee (other blockchain platforms). This is the concept of mining and the nodes that are trying to solve the puzzle are called miners.
So what is this cryptographic puzzle?
A concern with PoW consensus is that over time, it becomes quite expensive to solve. There is an exponential increase in computing power and financial cost, and it may become impractical for enterprise/business to use a blockchain requiring PoW consensus.
A more practical approach for enterprise/business application is to use Proof of Stake (PoS) or other consensus protocols. These are discussed in Part 2 of this white paper.
The Ethereum blockchain currently uses a PoW consensus but due to the computing and related energy costs involved, they are considering a move to a PoS consensus sometime in 2018.
Blockchain platforms can be public or private and the ledger types can be permissioned or permissionless. There isn’t a single qualified definition of this but loosely we have the following:
Bitcoin and Ethereum are public and permissionless blockchains that are open to all and everyone can contribute (read, write and audit). This means that everyone can also view all of the transactions that occur on the blockchain due to its inherent transparency. That being the case, the Bitcoin blockchain is clearly not used for any enterprise or business application. It lacks a scripting language for smart contracts and its transaction confirmation rate is extremely slow for business applications.
Ethereum blockchain has capability for enterprise uses but these applications could be limited due to the transparency of all of the transactions.
The purpose of this paper was to provide the reader with a glimpse of how the blockchain technology works – specifically how cryptographic elements are used to create an immutable, distributed ledger that operates in a decentralized environment and enables trust amongst trustless participants. With this understanding, the reader should be better able to understand Part 2 of this whitepaper which focuses on blockchain platforms that are geared towards enterprise/business and ultimately consumer applications.
To learn more about how OneBeacon Technology Insurance can help you manage online and other technology risks, please contact Dan Bauman, SVP of Risk Control for OneBeacon Technology Insurance at email@example.com or 262.623.6558.
1Richardson, Melissa; Bennett, Kris. (November 25, 2017). “Ethereum vs. Hyperledger.” Blockchain Training Alliance and training video on YouTube. Accessed June 2018 https://blockchaintrainingalliance.com/blogs/news/ethereum-vs-hyperledger
2(April 23, 2018). “A glossary of blockchain jargon.” MIT Technology Review. Accessed June 2018. https://www.technologyreview.com/s/610885/a-glossary-of-blockchain-jargon/
3“Can someone explain how the Bitcoin blockchain works?” Blog. Accessed June 2018. https://bitcoin.stackexchange.com/questions/12427/can-someone-explain-how-the-bitcoin-blockchain-works
4Learn me a Bitcoin. Accessed June 2018. http://learnmeabitcoin.com/glossary/target