Few technologies inspire as much excitement and skepticism as blockchains. On the one hand, they’ve birthed a golden age of financial innovation. On the other hand, they’ve enabled a new generation of cybercrime.
But despite the regular headlines, few people know what they are, and fewer still how they work. Without that, it’s hard to distinguish the innovations from the crimes.
In this article:
- Blocks, chains, nodes, and cryptocurrencies
- Consensus mechanisms
- Permissionless and permissioned blockchains
- Blockchain use-cases
- Blockchains yesterday, today, and tomorrow
Blocks, chains, nodes and cryptocurrencies
So: what are blockchains?
A blockchain is a growing ledger of records shared across a network of computers. Each record is called a block, and it consists of transactions, metadata, and a cryptographic hash of the block before it. This hash links blocks together to form a chain that is immutable. If the data stored in any block is modified, the hash of every block after it is invalidated.
The chain of blocks is the foundation of decentralized payment systems. But how does it relate to cryptocurrencies like Bitcoin?
Well: the computers sustaining the blockchain, called nodes, are rewarded cryptocurrency for adding new blocks. Blockchains differ in how they reward these nodes, but the mechanisms for doing so share a common name: consensus.
Blockchain consensus mechanisms
There are several types of consensus mechanisms:
- Proof-of-Work (PoW). A staple of the Bitcoin blockchain, proof-of-work mechanisms incentivize nodes become “miners” of new blocks by solving energy-intensive cryptographic puzzles. When the solution is found, the node broadcasts the result to the network and is rewarded with both newly minted cryptocurrency and the fees from the transactions in the block.
Proof-of-work blockchains are often criticized as slow, expensive, and environmentally impactful. Network upgrades and layer 2 protocols aim to mitigate these issues, as do other major cryptocurrencies’ migrations to proof-of-stake.
- Proof-of-Stake (PoS). Common in other cryptocurrencies’ blockchains, PoS chains encourage nodes to become “validators” by locking up (i.e. staking) some of their cryptocurrency in a smart contract. Validators are then chosen at random to create new blocks and receive the rewards.
Proof-of-stake blockchains are often praised as being faster, cheaper, and much more environmentally friendly than proof-of-work, but have yet to see adoption on the same scale as Bitcoin. That said, Ethereum will soon use proof-of-stake, and blockchains like Solana, Cardano, and Polkadot already do.
- Practical Byzantine Fault Tolerance (pBFT). Often used in enterprise blockchains like Hyperledger, pBFT protocols are not designed to reward nodes for participation alone. This is because nodes on pBFT blockchains are operated only by trusted, known, and otherwise-incentivized parties.
Now that we know how blockchains stay secure—by incentivizing nodes to behave honestly—the next question is: who can operate one? That depends on a blockchain’s permissions.
Permissionless vs. permissioned blockchains
On permissionless and public blockchains, any user can run a node and every node has the same privileges. By installing some computer software and either a) having enough computing power, or b) staking enough cryptocurrency, anyone in the world can help maintain and expand a permissionless blockchain. Bitcoin, Ethereum, and Solana are prominent examples.
On permissioned and private blockchains, only permitted users can run a node, and some nodes have more privileges than others. For example, one node may be allowed to maintain a partial copy of the blockchain, but not be allowed to participate in the creation of new blocks. Enterprise and institutional blockchains like Hyperledger Fabric, R3 Corda, and ConsenSys Quorum are permissioned.
Trade-offs: Permissionless blockchains generally have more nodes than permissioned ones, making them less centralized and vulnerable to network attacks. That said, it often makes them slower (in terms of time-to-settle) and more expensive (in terms of transaction fees).
So—why is blockchain technology useful?
In the future, blockchains may provide a cheaper, safer, more accessible alternative to the banking system—or even converge with it in the form of central bank digital currencies. In the present, blockchain developers are working hard to meet these specifications by way of increased accessibility, security, and scalability.
DeFi developers (a subset of blockchain developers focused specifically on finance) are working in a similar but slightly different direction, creating smart contracts that remove middlepersons from more complicated financial services like lending, borrowing, derivatives trading and currency exchanging.
The integration of blockchains into supply chains could improve the storage, distribution, and tracing of inventory. Companies like Walmart and Amazon have already begun integrating the technology for these purposes.
NFTs—formalized by the ERC-721 and ERC-1155 standards—have enabled provable digital ownership for the first time ever. Following suit, Companies like Twitter allow the owners of image NFTs to wear them as verified profile pictures, while major companies have scrambled to build marketplaces for their exchange.
As NFTs expand beyond images to represent the ownership of even more elaborate digital goods—3-D assets, video game items, music royalties, and more—they may come to reshape how companies and creators make a living.
Decentralized autonomous organizations (DAOs) have brought the concept of blockchain governance into prominence. There are many types of DAOs: some are social clubs, charities, art collectors or NFT creators, and still others are news organizations or venture funds. Whatever they may be, all of them represent a novel experiment in the same thing: decentralized governance, digital community, and fundraising.
Blockchains yesterday, today, and tomorrow
Blockchains have been around for thirteen years now, but within the past three, they’ve been adopted more than ever before. And with rigorous KYC and AML practices becoming staples of the industry, trust in blockchains is growing.
Trust is a scarce resource; it must be earned over time and maintained diligently. Inasmuch as blockchain companies can continue to build on this trust, we believe that blockchain technology stands to benefit everybody.
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