04/04/22 - 2PM EST/7PM GMT/8PM CEST
Disclaimer: All information given in this presentation is researched and intended to be educational and illustrative to the specific topic as always. Any companies, products, people or other items mentioned do not constitute an endorsement, recommendation or relationship. Every owner has to do their due diligence, as the decisions and responsibility about any investment lies with the owner. This is not financial advice.
What is a blockchain?
A blockchain is a system for decentralized transmission of data from participants in a database. The database is called a distributed ledger, which works like a peer-to-peer network, where every other node on the blockchain takes a copy of the blockchain and can start verifying transactions directly.
The data is secure against forgery because the data is verified and stored in the respective blocks, which can be initiated by a user and verified by all nodes and systems in the network. This block is then encrypted, creating a collection of blocks that form a chain of data within encrypted areas and are historically traceable. This virtual string of blocks is called a blockchain.
Accordingly, this data collection is secure and understandable because it is encrypted, chronological and historically verifiable. In addition, transactions are openly visible and constitute the maximum transparency for the facts of trading on the open market.
The first blockchain was developed for Bitcoin to create the representation of a web-based, decentralized accounting system, which is now several hundred gigabytes in size and spread across a vast network of participants, enabling everything from DeFi applications to smart contracts and NFTs.
How do blockchains work?
A blockchain is designed to digitally record information and make it available but not editable. That is why there are immutable ledgers, which record the data but do not allow it to be changed, destroyed or deleted. This technology is also called ‘distributed ledger technology’ or DLT.
Distributed ledger technology represents the technological infrastructure and protocol confirmation in a simultaneous network, in which validation, updating and encryption are distributed and verified among several networks. Proper encryption provides a unique representation of information without corruption and prevents tampering and data theft.
Each user of the system is called a ‘node,’ and each action of the user is called a ‘transaction.’ For each transaction, fees are incurred that benefit the operator of the blockchain or the nodes.
There are seven different variations of nodes that can occur on a blockchain:
1. Light nodes Light nodes (originally called lightweight nodes) do not have an entire copy of the blockchain, but rather a part of the significant data for the respective function of the node to be used, which they download from the blockchain. This is called a ‘block header’ and saves time, resources and space when it is used. This is mostly used for simple payment procedures, which are called ‘simplified payment verifications’ or SPV.
2. Archival full nodes Archival full nodes are the backbone of every blockchain and form the so-called ‘full node.’ They are mostly servers that serve as the archived host of the blockchain and have recorded every transaction in the database. These nodes are used to validate blocks and maintain the consensus mechanism. An archival full node can also have an additional function to add new blocks if required.
3. Pruned full node Pruned nodes are nodes that separate information from older blocks in the blockchain. As we know, information cannot be deleted or destroyed, but the prune node does something else in this term. It loads the entire blockchain and then starts deleting blocks for itself. Since this is a copy, the node can edit for itself - before the node's information is attached. All old information on the blockchain that is not relevant to the current use (such as the transactions of a specific, forked, new currency, which has nothing to do with the creation and duration of the old currencies on the blockchain) is deleted. A pruned node works only within its designated parameters. It cannot prune any more data after the predetermined node size is reached.
4. Mining nodes Mining nodes are a variation of the light or full node, as it has the same basic attitude in both conditions. They are used to validate the work for the creation of a new block. This is where ‘proof of work’ derives its name - the process to create a block can be created and validated through mining. The miner itself must receive the information from other nodes in advance or be an archival full node.
5. Authority nodes Authority nodes are used by consensus mechanisms in the network algorithm to validate or reject authority authentications for access and to guide decisions within a blockchain. These nodes are used in the consensus mechanism ‘delegated proof of stake’ or ‘proof of authority,’ but authority nodes can also be found in other consensus mechanisms. They have the same weighting as full nodes in every blockchain.
6. Master nodes Master nodes record and validate transactions; they cannot add blocks to the blockchain. They can be operated independently by any user holding a predefined number of tokens of the respective network where the master nodes are located.
7. Lightning nodes Lightning nodes (not to be confused with the light nodes mentioned above) do not have direct migration on the blockchain. They are only used to connect transactions outside the blockchain to the blockchain itself and to validate the trade in the principle of "off-chain-transactions." This reduces the load on the local network, speeds up transactions and makes transactions cheaper. For example, a Bitcoin transaction via a lightning node costs a part of a penny.
To commission a node, two steps must be applied:
1. Select a blockchain.
2. Purchase the necessary hardware and software to match the blockchain to be deployed.
With some exceptions, the nodes can also be started and used by smaller hardware systems, such as a Raspberry Pi, which can then be run via the web cloud of certain providers. There are also providers who offer ready-made systems for attaching a node, which are called ‘node-in-a-box.’
Each user has a public and private key, the public key is used to find users and transfer money to them, any transactions are made exclusively with the private key.
This is how a transaction takes place:
1. A new transaction takes place and enters the blockchain.
2. The transaction is transmitted to a global network of peer-to-peer computers.
3. The computing power on the network in question calculates the equation of the transaction and validates it.
4. The validated transaction is directed and stored in a block with other transactions.
5. The blocks are added in the historical sequence, set in the correct chronological time on the blockchain and fixed permanently.
6. The transaction is completed, the confirmation of the transaction is made to the user and the initiator.
What are the properties and aspects of a blockchain?
Each blockchain acts on the principle of three properties: decentralization, consistency and scalability.
A blockchain is decentralized because it does not use third party applications, censor content, or withhold data. Of course, there are also special blockchains that make use of special properties with third-party applications, but these are very rare and almost non-existent.
The data on the blockchain is displayed in a freely available form and is anonymous due to the documentation on the blockchain, so that no personal data can be viewed and all transactions can be tracked openly and live at any time.
Therefore, no management or supervision is necessary, as the data is handled in a so-called "trustless environment" due to the aforementioned handling of security and encryption.
2. Consistency The blockchain is exactly identical on all nodes at all times. Old transactions are immutable and stored and the entire history of the blockchain’s information is traceable and identical in every node.
3. Scalability The power of a blockchain should grow as the network grows. Performance, usability and availability are very important. Additional requests must not reach a limit, otherwise the accounting system will not be able to post any further transactions and a standstill will occur. Therefore, it is important to set the appropriate focus for the given use of any blockchain, as not every blockchain has the same benefit.
Decentralized blockchains such as Bitcoin and Ethereum, which are public and openly available and aim to make transactions clear and quickly traceable at all times, focus more on consistency and decentralization, under which the growth of the respective system receives less attention. This does not mean that these blockchains are not growing, because as mentioned before, all aspects have to grow, but less weight is given to it.
Private blockchains (which are not called centralized because the utility of this blockchain exists, but it is only assigned to certain entities), on the other hand, are different. Here, the focus is more on consistency and growth to quickly attach a system with new features, as decentralization plays a less important role in the direct connection. In the case of many blockchains that are private in nature, no distinction is even usually made between the three properties and thus they even run with almost the same weighting. A suitable example for this type of blockchain is Ripple, also known with the token XRP.
With all three properties, there is always a problem of weighting the aspects for the operators of a blockchain, which is decided early and has long-term implications. This is called ‘the blockchain trilemma.’
Three aspects of weighting are focused on, which, in addition to the previously mentioned three properties of a blockchain, now represent three decision thresholds that the operator must make.
This means that the interaction of the properties always pulls in a certain direction due to given aspects and wishes of the operator, as in the case of tug-of-war. It should also be noted here that there is never a single, final property that can have 100% and that every property in the system has at least a 1% share, even if a property is not actively lived out. The best example of this is a private blockchain that does not value decentralization. Even in this case, there is still the user who is still decentralized to a certain aspect due to the use of their wallets or trading methods.
The three aspects of weighting for the operator of a blockchain are decentralization, security and scalability.
1. Decentralization Decentralization represents - as already explained for the property - the anonymization of data with complete transparency. Users do not disclose any private information, the system is transparent, and all transactions can be traced historically and at any time.
2. Security Security represents the safeguarding of data, both in the block and in the system in general. The encryption of data, the elaboration of transaction possibilities and trading stations, the connection to systems and the prevention of system gaps are only some aspects of the consideration that an operator must take into account. With every expansion and change to the system, there are potential security gaps that must be well tested and prevented in advance, so that a release of data is not possible, otherwise theft, data theft or even manipulation and destruction of the projection can take place.
3. Scalability Scalability refers to the growth of project planning in the operator's decision. Here, the blockchain can be arbitrarily set and expanded based on the desired use and design for future functions and sub-functions, so that the transactions provide a satisfactory basis in price and performance for the user and operator, as high usage without updated structure and available capacities can result in extreme fees (as for example with Ethereum) or it can come to a standstill as no capacities are available and certain functions fail or cannot even be added to an expansion because the basic capacity is not sufficient.
Taking the above aspects into account, the operator now has to decide which weighting of the available total capacities is most important for him. There are three conflicts that need to be considered here:
1. Decentralization vs. Security The more decentralized a system is, the fewer security risks there are. So it is actually a positive aspect for both. How could this be a problem?
The security here does not refer to decentralization, but to the security of the system in general. For example, if you use a fork of a blockchain - a fork or copy of an existing system to modify and create your own blockchain - instead of creating your own blockchain, you lose certain freedoms. This can then lead to the decentralization aspect, which is with the existing system, being weighted so heavily that the security mechanisms are not updated because too much reliance is placed on the anonymity aspect. It is clear that this then creates gaps in security, in which so-called data theft, data breaches or even fake bridges can be created, which can then enrich themselves from the work or steal data and create redirections of transactions despite anonymity.
Too much emphasis on safety can also be a problem, in which case overly cautious measure regulation. This wouldn't even be necessary because security measures are already secure. Overly cautious regulation would just slow down every transaction and validation on the blockchain. In the process of decentralization, for example, this may mean that new users who want to use the blockchain anonymously may experience delays. After all, if decentralization is not given much attention and is only present in its simplest version, functions can become a qual, for example, due to the security mechanisms, as one is only annoyed by multiple confirmation, extended validations, multiple fees for multiple, unnecessary processes and more, and has to pay significantly less fees for the comparably same service on other blockchains.
2. Scalability vs. Safety The benefits of the blockchain are set against the security. The dilemma that is apparent here is that when a blockchain is overused, the costs of the blockchain and all available trading venues also increase. This can only be reduced by expanding the hardware, improving the software and optimizing the processes, which can lead to huge security risks if the changeover is made too hastily.
Data breaches, delays and duplications of transactions resulting in failed transfers and extra costs or even loss of money are some of the things that can happen in a crowded network with the same or less considered security risks.
From the security side, this offers the same disadvantage as decentralization. If a system is in such high demand that demand increases dramatically, but little attention is paid to the mechanism and security is increased, capacity is unnecessarily taken from the available resource force. This limits and delays transactions and reduces opportunities for growth to a very low level.
3. Scalability vs. Decentralization The scalability and growth of the blockchain with constant decentralization is not a huge problem. If the demand is so great that the transactions and thus the hash rate - the computing power within a network - increases while decentralization remains constant, there is no risk for the time being. However, the increase in interest is usually accompanied by a fundamental change in the blockchain in connection with an expansion of the offering or certain functions, which, if decentralization remains unchanged, either abandon the aspect of anonymity or are faulty and have to be anonymized subsequently. Since this aspect is weighted less in the example here, this is always a forced rework.