On a fundamental level, blockchain technology is a database structure based on the principle of a decentral, immutable, and transparent digital transaction book. With it, assets and information of various forms can be managed, stored, and transferred. The word blockchain refers to its database structure. Each transaction is recorded in the form of a block of data alongside other data required for the transaction to be validated. The details of transaction data will be discussed later in module 1. Each block is cryptographically connected to its precedent and subsequent block. Accordingly, each block confirms its place in the sequence of transactions. As transactions and storage of data occur, these blocks form a chain of data – the blockchain. A blockchain is a digital ledger controlled by a distributed public computer network. A distinction is made between public (public or permissionless) blockchains and private (private or permissioned) blockchains. More broadly, a ledger refers to an information storage that keeps records of transactions that are intended to be final, definitive and immutable.
A distributed ledger is not stored centrally but is stored and updated ledger on many different computers (so-called nodes). A distributed ledger as a specific calibration of a ledger is a ledger that is shared across a set of distributed ledger technology (DLT) nodes and synchronized between the DLT nodes using a consensus mechanism which is designed to be tamper resistant, append-only and immutable containing confirmed and validated transactions or information.
Blockchain systems can be centralized, decentralized or distributed network systems.
All nodes are connected under a single authority
No single authority controls
Every node is independent and interconnected with each other
Figure 2: Blockchain network architecture
Within this initial differentiation, there are four main types of decentralized or distributed networks in the blockchain which are public blockchain networks, private blockchain networks, hybrid blockchain networks and consortium blockchain networks.
Public Blockchain Networks
Public blockchain networks do not require a central authority to give permission for participation. Per default, a public blockchain network does not restrict access to any user. This equality is also given in the right for all participants to read, edit, and validate the blockchain. Examples for public blockchain networks include Bitcoin, Ethereum, and Litecoin.
Private Blockchain Networks
In a private blockchain network, a single organization or institution controls private blockchains which are also referred to as managed blockchains. The authority running the private blockchain determines which participants have rights or rights such as access and voting. Decentralization only exists to a certain degree on private blockchains since they have access restrictions. An example of a private blockchain network is Ripple, a digital currency exchange network for businesses.
Hybrid Blockchain Networks
Hybrid blockchain networks combine aspects of private and public blockchain networks. One use-case for hybrid blockchains is in banking, where the central institution can grant public access to digital currency but at the same time keep bank-owned currency private. In this way, part of the data stored on the chain is publicly accessible and part of the data is restricted by access control.
Consortium Blockchain Networks
In a consortium blockchain network, there is a group of selected organizations that can govern access, reading and editing rights. This setup is commonly used in industries in which several organizations have common goals and benefit from shared responsibility over goods, data, or assets. For example, the Global Shipping Business Network Consortium is digitizing the shipping industry and increasing collaboration between maritime industry stakeholders.
Blockchain technology is usually in the form of a decentralized database structure or digital register that transparently records transactions and serves as the basis for many digital currencies. The distinct characteristics of blockchain technology are decentralization, immutability, and transparency. It is ultimately an openly viewable ledger that transparently documents all transactions. Typically, such a ledger is not stored centrally but is stored and updated on many different computers or nodes. The decentralized storage ensures that a blockchain does not have to be managed by a central authority, eliminating the risk of a single point of failure. Next to transparency, blockchain technology has the three following main features:
Decentralization in blockchain refers to transferring control and decision-making from a centralized entity (i.e., individual, organization, group) to a distributed network. Decentralized blockchain networks use transparency to reduce the need for trust among participants. These networks also deter participants from exerting excessive authority or control over one another in ways that degrade the functionality of the network.
Immutability means something cannot be changed or altered. No participant can tamper with a transaction once a node has recorded it in the shared ledger. If a transaction record includes an error, one must add a new transaction to reverse the mistake, and both transactions are visible to the network.
A blockchain system establishes rules about participant consent for recording transactions. You can record new transactions only when the majority of participants in the network give their consent. Figuratively, the blockchain can be thought of as a chain of blocks, each of which links transaction data together. The transactions are combined into blocks, checked for validity, and appended to the previous chain of blocks in a process called Proof of Work (PoW) for Bitcoin. The PoW approach involves solving computational problems that can only be solved through frequent trial and error. This ensures that sufficient work is invested in calculating and securing the transactions. Next to PoW, there is a myriad of other consensus mechanisms that may be chosen for specific use cases based on their specific advantages and disadvantages.
Blockchain architecture has the following main components:
A distributed ledger is the shared database in the blockchain network that stores the transactions, such as a shared file that everyone in the team can edit. In most shared text editors, anyone with editing rights can delete the entire file. Not so in DLT – have strict rules about who can edit and how to edit. You cannot delete entries once they have been recorded.
Companies use smart contracts to self-manage business contracts without the need for an assisting third party. Smart contracts are programs stored on a blockchain system that are triggered automatically when predetermined conditions are met. Specifically, smart contracts conduct if-then statements so that transactions can be completed confidently. For example, a lottery may determine that the price money of the lottery is distributed amongst those parties that win the lottery by guessing the numbers correctly. The information about the correct number would be part of the if-then statement.
Public Key Cryptography
Public key cryptography is a security feature to uniquely identify participants in the blockchain network. This mechanism generates two sets of keys for network members. One key is a public key that is accessible to everyone in the network. The other is a private key that is unique to every member. The private and public keys work together to unlock the data in the ledger which will be touched on in a later chapter.
For example, Bob and Alice are two members of a network. Alice records a transaction that is encrypted with her private key. Bob can decrypt it with his public key. This way, Bob is confident that Alice made the transaction. Alice's public key would not have worked if Bob's private key had been tampered with.
Blockchain is a certain type of database management system containing more features as compared to regular databases. Some of the significant differences between a traditional database and a blockchain are the following:
The history of blockchain and that of Bitcoin are intertwined. In 2008, the Bitcoin white paper was published. This white paper presented a conceptual design for a decentralized monetary system. The development of blockchain technology has reached new highs since Satoshi Nakamoto as the unknown author, published the Bitcoin whitepaper. In the meantime, possible applications for blockchain technology exist that go far beyond the function of a financial transaction ledger. For example, smart contracts can be used to handle a wide variety of administrative and process applications that a regular blockchain base-layer is not capable of. The execution of these smart contracts can be tracked in real-time - as a logical further development of the open-source idea, the blockchain thus makes open execution possible.
Thus, thanks to the rapid blockchain development, sensitive data such as health data or property relations such as land ownership can be organized and controlled via a blockchain in this way. At the same time, every entry ever made in a blockchain directory can be traced forever and cannot be deleted or changed. Accordingly, companies are interested in researching this technology. The main motivations are the aspects of security, transparency and increased efficiency (in cost, time, workforce and digitalization).
The possibility of automating processes via a secure infrastructure while eliminating the risk of data manipulation appears appealing to institutions and companies. It must be kept in mind that there is no such thing as "the one blockchain." Rather, a blockchain can be designed in very different calibrations. A blockchain used in the administration of a public authority is designed differently than, for example, the most well-known blockchain, the Bitcoin Blockchain, on which a large number of applications are based.
Traditional database technologies present several challenges for recording financial transactions. For instance, consider the sale of a property. Once the money is exchanged, ownership of the property is transferred to the buyer. Individually, both the buyer and the seller can record the monetary transactions, but neither source can be trusted with the complete elimination of doubt. The seller could claim they have not received the money even though they have, and the buyer could equally argue that they have paid the money even if they have not.
To avoid potential legal issues, a trusted third party has to supervise and validate transactions. The presence of this central authority not only complicates the transaction but also creates a potential single point of failure and adds vulnerability. If the central database was compromised, both parties could suffer as a consequence. Blockchain could mitigate such issues by creating one ledger each for the buyer and the seller. All transactions must be approved by both parties and are automatically updated in both of their ledgers in real-time. Any corruption in historical transactions will corrupt the entire ledger. These properties of blockchain technology have led to its use in various sectors, including the creation of digital currency like Bitcoin and other use cases which are subject to the next chapter.