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What's in a blockchain?

In this article, we set out the background to blockchain, explain its technological foundations and practical implications, and highlight its potential applications.

Blockchain technology offers a way to people who may not know each other to trust each other through a record that is based upon the approval of everyone involved. This result is achieved by the innovative use of cryptography and distributed ledger technology.

When transferring a tangible asset, such as an apple, from one person to another, we usually validate the transaction through taking possession of the physical good. But with digital goods, which are intangible, usually reproducible at very low costs and ubiquitous (not tied to one place and found everywhere at the same time), the correct allocation of goods to the respective owner is more difficult.

So allocation requires a more sophisticated system of authentication in order to prevent the double-spending of digital money or double-selling of goods. This can be achieved by blockchain technology, which – through the innovative use of cryptography and distributed ledger technology – makes it impossible to double-spend digital goods that are being stored on the blockchain, such as paying twice with bitcoins.

Throughout history, transactions have been facilitated with instruments of trust, such as paper money, land registries, letters of credit or banking systems. Trust is created by the parties relying on a trusted third party or an intermediary, eg for paper money a central bank or for real property a responsible land registry authority.

Trust is also often backed by regulatory supervision. Economically, the trust facilitated by these intermediaries comes at a price: currency exchange costs, the time it takes for third-party validation, risk of fraud and cyberattacks, etc.

Avoiding these flaws, cutting transaction costs and providing accessibility is where blockchain technology shines. The decentralised, open and cryptographic nature of the blockchain allows people to trust each other and to directly transact peer-to-peer, making intermediaries and third parties obsolete.

What’s under the hood?

Blockchain technology is based on the idea of a distributed ledger. Imagine a ledger (a traditional accounting book) continuously being kept, monitored and updated simultaneously by multiple divisions within a corporation or even external parties, such as external auditors, the tax authority etc. The books are digitally stored and each contains the entire data of the account. In practice, this means each blockchain participant holds an entire copy of all transactions being stored on this ledger.

Each block on the blockchain (comparable to one journal entry on a ledger) contains a number of valid transactions, eg data of a payment made or received, and a reference to its predecessor block via a so called 'hash value', which is a unique value computed as a result of the contents of the predecessor block.

The predecessor block again contains the hash value of its respective predecessor block and so on, reaching all the way back to the first block (or journal entry). This linking mechanism is what chains the blocks together, maintains the integrity of the chain and prevents manipulation.

Traditional ledgers can be altered retrospectively but this is impossible on the blockchain, since the latest block (or journal entry) contains data of the prior one, making it basically immutable. Moreover, the blockchain, due to being publicly available, provides irrefutable proof of any prior transaction and a clear allocation to an individual ID at any given time (a 'wallet identifier').

As ownership is attributed  to an individual ID rather than our personal data (name, address, etc.), transactions on the blockchain provide for quasi-anonymity. However, when signing up for certain bitcoin services (such as trading platforms), one might be required to provide personal data for verification purposes imposed by banking and financial services regulation.

Can the blockchain be hacked or deliberately modified?

If one participant tried to alter a prior transaction, for example by changing information in a prior block on the blockchain, the respective hash value stored on its successor block would also have to change. Its successor's block value would have to change as well as a result of this change, and so on until the last block.

As the latest copy of the blockchain is stored in parallel with all participating entities and the hash values are cross-checked between all nodes when a new block is added to the blockchain, the blockchain system would note the modification prior to the update. Thus, the modified block would not be cleared in the system to become part of the updated blockchain.

To succeed, a potential attacker would have to modify the block and all subsequent blocks not only on their own copy of the blockchain but also on at least half of the copies stored with all the other network participants before the next blockchain update takes place. This is usually done every few minutes.

Why half? Adding a new block needs the agreement of a simple majority of all participants, ie if the blockchain copies between participants differ (for whatever reason), the system chooses to update the copy of the blockchain that is the same with most of the participants.

If a participant tried to add an invalid transaction to the blockchain, eg in the case of cryptocurrency, trying to transfer more currency than is attributed to their wallet identifier, this would be automatically recognised by the other blockchain participants (as it does not match the prior blocks on the blockchain) and the modified block would not become part of the updated blockchain.

This safeguard also prevents trying to store the same transaction a second time on the blockchain. This also would only work if the fraudulent participant manages to change more than half of the copies of all participants before the next blockchain update takes place.

So the blockchain can be regarded as secure via the principle of decentralised consent of all participants.

What happens during a power or network outage?

Like the internet itself, the blockchain depends on functioning global networks and reliable power supplies.

As the blockchain is distributed on all participating computers, a regional power outage would not interrupt the process of updating the blockchain and so it is pretty robust.

But due to overall reduced networking computing power, transforming transaction data into blocks might slow down, resulting in slower confirmation and handling of transactions. And of course the blockchain participants subject to the power outage cannot conduct any transaction while without electricity.

If a local copy of the blockchain gets lost due to a power outage, once power is restored, the latest version of the blockchain held by the majority of the participants is automatically downloaded again.

What are current applications? What's the potential?

Blockchain technology is the basis for many current applications, like cryptocurrencies, smart contracts, authentication systems (like Everledger for diamond identification or Bitproof) and digital asset management (like Colu or Ascribe).

The technology could also potentially be applied to the transfer of intangible goods, ensuring privacy by design, access controls or public registries.

Introduction to blockchain