These notes are from the Blockchain Theory 101 course by Melanie Swan on Udemy. Highly recommend checking it out!

What is blockchain and why do we need it?

• Blockchain is a software protocol that tells the Internet how to transfer assets & money similar to how SMTP tells the web how to send emails
  • i.e. blockchain and SMTP are layers on the Internet (like plumbing for the Internet) and Bitcoin, Outlook, Gmail etc are applications on those layers
  • These apps don’t need to know how SMTP or blockchain work – they just need to know the other person’s email address or wallet address to send emails/money to
• Money needs to be securely transferred across the Internet – so it isn’t able to be copied and spent more than once and so transactions are valid – blockchain solves this
• Blockchain allows securely transferring info via smart networks that algorithmically verify the info was transferred
  • The Internet effectively becomes a VPN/tunnel between two parties
• We need blockchain because:
  • It’s scalable – algorithms can verify identities, execute transactions, check balances etc far quicker than human beings
  • More scalability means access to financial services/credit for everyone
  • Greater reach enables niche/long-tail economics, finance and governance to provide for every market rather than current one-size-fits-all approaches

Technical aspects of blockchain

Cryptographic wallets and the public ledger

• Software wallets don’t hold money, they hold public/private keys that allow you to access your money on a publicly-accessible Internet ledger on the blockchain
• This ledger keeps track of all transactions and everyone’s balances and updates when a transaction in the network clears
  • Ledgers are pseudonymous – everyone can see how much money is in a wallet address but noone knows the personal entity that holds the wallet address
• To send money – get the other person’s wallet address and submit an amount to send
  • The blockchain confirms you have enough in your wallet and then transfers it

Peer-to-peer distributed system

• Tons of machines run the blockchain/host its infrastructure – no single machine controls everything – it’s a global peer-to-peer distributed software system on the Internet
• Every machine on the network needs to hold the same copy of the ledger and sync when a transaction is created (the ledger is updated)
• Every so often (e.g. 10 minutes), transactions on the network are collected into blocks which are only recorded on the blockchain after being validated by miners
• Every subsequent block calls the next block as the first element
  • That chains together the ledger into “blocks” of transactions that are time-stamped and hosted on machines globally – this is why it’s called the blockchain

Mining

• Mining is how some blockchains validate & record transactions in a ledger:
  1. Every so often, when a block is created with all the transactions in the period, a random number is issued (called a nonce)
  2. Then every miner tries to guess this random number (~billions of times/sec)
     • Note – while you can run mining software on your machine, you’ll likely never make a correct guess because it’s not fast enough
  3. Once a miner guesses correctly, it gets monetary rewards (new block rewards in the system + transaction fees from parties submitting transactions)
  4. The winning miner confirms and validates all transactions in the block that are valid
  5. All other miners/peer machines on the network then also confirm/record those tx’s
• The entire system constantly updates the ledger periodically for all new transactions
  • Every peer machine should have the current state of the ledger
• The point of mining is to be purposefully wasteful so only trustworthy people are kept on the network
  • The more costly it is to guess the nonce, the harder it is to make a fraudulent transaction (and harder for miners)

Risks of blockchain

• Scalability
  • Democratic nature of blockchains results in slow decision-making that can slow the growth of the blockchain as more people get involved
  • Hard fork – an updated version of the blockchain separate from the current one
    • All wallet balances on updated nodes in the current chain get included in the new hard fork of the blockchain while the wallet balance on older nodes don’t
    • This can be avoided with soft forks (which are backwards compatible)
• Cybersecurity – people can hack/steal coins through software that doesn’t run directly on the underlying blockchain network (e.g. exchanges, wallet software)
  • e.g. hacker impersonating your wallet and telling you to send money in a transaction again (but redirecting it to another wallet address)
• Concentration of mining – while Bitcoin is decentralized and peer-to-peer, the bitcoin mining operation is highly centralized and run mostly by 6-10 companies in China & Russia
• Regulation – Different state governments could ban or regulate crypto

Initial coin offerings

• Initial coin offerings (ICOs) are like Kickstarter for crypto projects – a blockchain/crypto project gives away coins (not equity) which allows:
  • Investors to have liquidity immediately
  • Crypto projects to raise money in a liquid way

Applications of blockchain

• While digital payments are the most obvious usecase, blockchains have other applications:
  • Digital registries for all kinds of assets (cars, houses, money etc) and identity documents (like passports and VISAs)
  • Logistics (supply chain) – record the status and location of shipments on a blockchain so transfers can be smoother, quicker and obvious to all parties
  • Healthcare – standardised “digital health wallets” to securely hold insurance plans, prescription info, health history etc
  • IoT (Internet of Things) – autonomously control millions of items securely
  • Registry of assets (e.g. stocks, bonds etc) – once registered, assets can be immediately transferred or controlled in the future via smart contracts
    • e.g. bond rates could be increased automatically depending on market conditions
  • Governance
    • Register all legal docs (like land title, auto registrations etc) on blockchain and transfer without bureaucracy of government
    • Confirm identities without government approval – register driver’s license, birth certificates, VISA, passports etc on blockchain
      • e.g. instead of sending schools your transcript, they could look it up themselves on the blockchain to confirm
    • Secure voting systems (e.g. quadratic voting, delegative democracy, random sample elections, Page Rank voting)
    • Legal contracts – legal docs can be pushed onto the blockchain with a proof-of-existence hash corresponding to doc’s contents at that particular point in time

Implementing blockchain in your organisation

• There are three ways to think about implementing blockchain today in your business:
  • A way to connect to other parties in your industry
  • A way to offer clients better services via blockchain (i.e. transfer info and money better, reach more customers, automate things etc)
  • A way to reduce costs and risks within your business
• To move your organisation onto blockchain, follow this process:
  1. Identify processes within your org where there’s a transfer of info, money or assets
  2. Separate the act of transferring into a human decision-making component and a pure execution part
  3. Automate whatever you can via blockchain

Smart contracts

• Smart contracts are agreements between two or more parties that execute code on a blockchain if they meet the conditions of the contract
  • Issue – they automate a lot of human effort but are we ready for code that automatically executes without any humans involved?

Blockchain consensus algorithms

• Blockchain consensus algorithms address two important technical problems
  • The double spend problem – we don’t want multiple copies of money made/spent – we want to ensure money is only spent once
  • Byzantine General’s Problem – we don’t know the status/trustworthiness of nodes distributed on our network – so how can we protect our network from bad actors?
• A consensus algorithm figures out how the network comes to the correct, synced state and updates all nodes after the state is changed (i.e. because of a transaction)
• Types of consensus algorithms:
  • Proof of work (used by Bitcoin) – uses mining to randomly guess the nonce and validate & update state when guessed
    • Works very well but isn’t scalable – miners convince the network they’re trustworthy by performing computationally expensive tasks to get rewards
  • Proof of stake – depositing some stake in the network’s coin to convince the network they’re acting in good faith to validate transactions on the network
    • More human-based voting system, much more scalable but may seem untrustworthy to new participants
  • Prediction markets – getting external parties to review/guess the accuracy of transactions on the network and giving them rewards when they do
  • Self-mined networks – algorithmic participants in the network (not human ones) could mine for each other (e.g. kitchen sensor in IoT network mines for bathroom sensors etc)

How to get involved in blockchain today

• Blockchain is future tech but you can get involved in it today and personally benefit:
  • Download a digital e-wallet so you can receive crypto (like Bitcoin)
  • Fill your wallet from your bank or different kinds of exchanges or from friends
  • Purchase things (i.e. with QR codes in-store or online using your address)
  • Invest in/speculate on crypto – just be aware it’s quite volatile and high-risk
  • Accept crypto as payment through payment merchants like BitPay

Cover photo by Terry on Unsplash