One technique that has been extensively discussed in recent years is blockchain. Blockchain is best known as the technology that paved the way for Bitcoin. Bitcoin got its breakthrough already in 2010 but has been around since 2009. It has been found that the use of blockchain is significantly greater than merely providing a cryptocurrency and technology is predicted to revolutionize how we share data and protect our data.
In this post, we will briefly give an introduction to how the technology behind blockchain works and describe the opportunities that technology brings. It should be emphasized here that this post aims to provide a basic understanding of the technology as well as its uses. For this to be possible, a somewhat simplified blithe of the technique is presented.
Distributed Ledger Technology
Distributed Ledger Technology (“DLT”) and blockchain are often described as synonyms, but this is not true. Instead, blockchain should rather be seen as a sub-category of DLT, but to understand how blockchain and other similar technologies work, one must first understand what DLT is.
DLT is a method of securely distributing registers (or in other words – databases) with information. Instead of a system where one central unit for registering the transactions that are carried out is done in a decentralized register that all users have access to. An example of this is that all Bitcoin users who are connected to the chain have access to a complete copy of the register, which means that it becomes clear to all users what transactions are carried out in the register. This transparency and common control is a contributing factor to why DLT is one of the safest technologies available for data storage.
How does blockchain work?
Blockchain is based on a decentralized network where all users secure (validate) new transactions that are added to the register. Information is added to the chain in the form of a block, and this block can be described as an entry in the register. The blocks are added one by one and given a specific identification number (so-called hash). This hash number is always linked to the previous block, so the blocks that are added are linked to a chain. This is also an aspect that contributes to the blockchain being incredibly secure, which we will describe in more detail later.
Blockchain is most easily described by way of example, and we will, therefore, go through the central aspects of how a transaction is executed on Bitcoin’s blockchain.
A transaction is initiated by a party wishing to make a payment of cryptocurrency. We call this party A. A registers a new payment to B in the software linked to the chain. This new transaction is then sent to a user in the chain who creates the new block for this specific transaction.
The user who creates the new block is compensated for this by issuing a small proportion of new Bitcoin to the user and a small amount of existing Bitcoin is paid in transaction fee. The process of creating new blocks is called mining and the users who create new blocks are called miners.
It is these miners who add the processing power necessary to keep the chain accessible. It can be described as the miners working to maintain the chain and getting paid for their work in the form of new Bitcoins – thus creating an incentive to work for the chain. Since miners play a central role in blockchain’s function, it is important that not one and the same miner create all new blocks. That user could then have a far too large influence on what information is entered into the chain.
To prevent this, all miners get a complicated cryptographic problem to solve in connection with each new transaction. The mines that solve the problem most quickly are rewarded with creating the next block. The process of creating new blocks by solving its problems requires large amounts of energy and processing power. This has resulted in the mining being done today being done in computer centers built for this specific purpose.
The large amount of energy required is one of the biggest problems with blockchain. According to rough estimates, the blockchain that drives Bitcoin consumes as much energy per year as the whole of Denmark. It is difficult to determine how close to reality this frequently used parable lies, however, it is clear that blockchain technology requires enormous amounts of energy.
When the block is created, it gets its hash number. This number is created using cryptographic software and is based on the previous block’s hash number and the contents of the block. The security created by this is based on the fact that each block is linked to the others through these hash numbers.
This makes it very easy to find out if someone would, presumably, manage to change the contents of a block or even erase a block completely, as this results in the hash numbers in the chain no longer being connected. In other words, the hash numbers hold the chain together and modifying a block breaks the chain.
When a miner has created a new block, this is distributed to all users in the network for approval. Only after the block has been approved is it added to the chain. The content of the distributed block is not examined in detail, but it is the other users’ software that validates that the new block follows the rules that are in the chain. Only after the block is inserted in the chain is the actual transfer of the cryptocurrency from A to B.
Another aspect that contributes to the high level of security is that all information is encrypted when it is entered into the chain. Private and public keys are used to unlock the information. Each user has a private and public key. The public key can be seen as an address in the chain belonging to the specific user. In order to execute the exemplified transaction, B gives its public key to A. In this way, both A and B can remain anonymous when the public key acts as a user’s address or identification. B then uses his private key to “unlock” and gain access to the transaction.
When it comes to Bitcoin, a user has a so-called wallet, a digital wallet where your assets are saved. The private key unlocks this wallet. It is incredibly important that you do not lose your private key as it is not possible to recreate it. If the key is lost, all assets in your wallet will be lost. Recently, cryptocurrency to a value of approx. $ 135 million was lost when the founder of Canadian crypto company Quadriga suddenly passed away. Many question marks remain about how the company’s operations are handled and how it is possible that only one person has access to the key. However, the example illustrates the importance of these keys.
The process where miners create new blocks and then distribute the blocks for approval by other users in the network is called proof of work and network consensus. These are two key concepts when discussing blockchain. It is this process in combination with the encryption that provides a high level of security offered by the blockchain technology.
However, the process is slow, which means that the number of transactions that can be executed at the same time is relatively small. The bitcoin chain has a maximum capacity of around 7 transactions per second, which can be compared to a normal credit card provider whose maximum capacity is around 25,000 transactions per second. This is another of the major problems facing blockchain technology, which is usually referred to as the “scalability problem”. In order for the technology to be applied in new areas and have a major impact, capacity must be increased.
What has been described above is the first generation blockchain that was introduced to the world in connection with the launch of Bitcoin. The first generation really only functions as a decentralized database where transactions or other types of information are recorded by the users.
At present, a large number of companies and entrepreneurs are working to develop the third generation of blockchain. It is this third generation that is predicted by many to change how we view information management fundamentally. Before we get there, we will briefly describe the second generation that now forms the basis for most of the blockchain-based projects that companies develop.
The second-generation blockchain centers around the concept of the decentralized application (“DAPP”). A DAPP does not differ from a regular application (“APP”) in any other way than it is based on blockchain technology. While the first generation blockchain only served as a database, the second generation blockchain has an additional level. The second level consists of software that can read and execute any form of code, which means that you can create applications that are run on a blockchain. It was only with the second generation of blockchain that a greater number of people began to see the wider potential of blockchain.
Developers can now create, for example, social networks where the information is stored in a decentralized database which mean that every user gets real control over their data. As mentioned above, one of the major advantages of blockchain is security, which is of great importance when developing new applications. The benefits of a DAPP are many. However, the problem discussed above remains. The second generation of blockchain is also extremely energy-intensive, which means that it is not sustainable from either a commercial perspective or an environmental perspective.
One of the companies that were early in providing a platform for developers to build and launch their DAPP’s was Ethereum. Ethereum is one of many companies but quickly became, and still is, a leader in the industry. Ethereum provides a blockchain-based platform with virtually unlimited opportunities to develop different types of decentralized applications.
Ethereum and a number of other companies are currently working to solve the problems that currently prevent blockchain from being exploited to its full potential.
What comes next is hard to predict. However, there are a number of potential solutions to the various problems facing blockchain technology, but no concrete solutions regarding energy consumption or scalability have yet emerged in the market. It should be mentioned here that blockchain is used extensively already today. This is usually done through smaller chains where energy consumption and scalability do not have as much impact. However, there are also several major projects such as IBM Food Trust, which is a service where users can track food products’ production and supply chain. By using an open blockchain for production and delivery, transparency is provided to consumers that have not previously been possible. In addition, the service has contributed to a reduction in food waste and to a better way of predicting consumption patterns.
In future posts, we will look more closely at the positive aspects as well as the problems briefly described above, and also the possible solutions that companies active in this area are working on. Of course, we will also discuss the legal questions that technology brings.