Blockchains are forgery-proof, distributed data structures in which transactions are logged in chronological order, traceable, immutable and mapped without a central instance. With blockchain technology, ownership relationships can be secured and regulated more directly and efficiently than before, as a complete and immutable data recording creates the basis for this.
Introduction to Blockchain Technology
Tables as an analogy
A greatly simplified and shortened way to imagine the basic structure of blockchains is a distributed table. This table is multiplied and distributed over a network of numerous computers. In blockchain technology, this network of computers is used to regularly update this table and document changes. Thus, information stored in a blockchain exists as a distributed and continuously matched table or database. This form of use of networked computers requires some special features: Blockchain data storage takes place not only in one place, but on each of the computers in the network. This increases reliability in particular. In addition, in the case of Bitcoin, the data contained in the blockchain is public and easy to verify for any network participant. There is no central instance of the blockchain that a possible attacker could damage or change without permission.
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The differences between blockchain technology and known methods can be represented by an analogy to online collaboration tools. The traditional way to share electronic documents with business partners is to send a document to a recipient with a request to revise it. The sender must then wait for the copy of the document to be revised and returned before they can see changes or make further changes themselves. During the waiting period, processing is therefore excluded. An alternative to this are, for example, web-based online services for the creation of text documents. Documents can be edited by several users at the same time. All parties have access to the same document at the same time and a single version of this document is always visible to all. However, unlike the blockchain, the document here is managed by a central location.
In other words, blockchains form a data structure through which a state distributed among many participants (e.B. account balance) can be changed together (e.B. transfer of credit). Uniformity and counterfeit protection are ensured by confirming the individual transactions. The way in which the shared state is determined depends in particular on the consensus mechanism used. Counterfeit protection is ensured by the use of up-to-date cryptographic methods. Through a large number of separate and networked participants (nodes), the data structures are distributed and at the same time high availability and reliability are guaranteed. Changes in the blockchain are made through consensus mechanisms and then adopted by all nodes. There are various approaches to prevent unauthorized changes. In principle, participants can view account balances and view all records of all participants’ processes.
Blockchain technology is relatively new. The technology and the possible applications will continue to develop. In addition to opportunities, new risks will also arise.
Differentiation of the terms Bitcoin, Blockchain and Distributed Ledger Technology (DLT)
Bitcoin was the first decentralized, virtual, digital currency (cryptocurrency) to demonstrate a successful implementation of the blockchain idea. The blockchain only forms the technical framework in which Bitcoin is implemented. Bitcoin is therefore only one possible use case of blockchain technology, but this became known as a framework mainly through Bitcoin.
Even if the further broad market success of Bitcoin is still open, among other things due to technical limitations, the concept of blockchain technology has found favour in many areas.
In the context of blockchain technology, the term Distributed Ledger Technology (DLT) is often found. One possible translation of distributed ledger is “distributed ledgers”. DLT is the technological framework for the use of distributed ledgers. However, blockchains or distributed ledgers can be used for many other applications and records besides Bitcoin, such as .B managing digital identities. It is not uncommon to find a synonymous use of the terms blockchain technology and distributed ledger technology in science and practice.
Using the example of Bitcoin, the structure of the network is to be illustrated: A network of computers, which are called nodes or English nodes, forms the blockchain network. A node is a computer that is connected to the blockchain network and can use appropriate software (the client) to check and transmit transactions of the blockchain network. The nodes receive a copy of the blockchain, which is automatically downloaded and continuously updated when connected to the blockchain network.
For each node, there is basically the chance to receive new Bitcoins. Some nodes solve cryptographic tasks or puzzles. These nodes are called miners. This randomly determines which of the miners determines whether and which transactions are valid and can be attached to the blockchain by a new block. Here, the miner receives new Bitcoins and all fees of the validated transactions. Miners regularly join forces to solve the cryptographic tasks or puzzles to form so-called mining pools. However, in the case of mining pools, only the operator determines which transactions are included in the new block and are considered valid. Through mining pools, individual miners have a better chance of solving the cryptographic tasks or puzzles. In this case, the new bitcoins and transaction fees will be distributed to the miners involved in the mining pool.
Blockchain technology represents a decentralized technology. Everything that happens within the blockchain network is a function of the entire network. Due to the special way of verifying transactions, some aspects of traditional trading, such as .B a chain of trusted intermediaries, are not needed. The interaction of all network nodes manages the common database instead of leaving this task to a central authority.
By storing data in the blockchain, risks arising from central data storage are avoided. In this respect, the network has no central weak points that attackers could exploit to modify data. The security methods of blockchain technology use in particular current asymmetric encryption technologies. These are based on so-called public and private keys. A public key (a long, randomly generated series of numbers) represents a user address on the blockchain. Transactions sent over the network are stored as belonging to this address. The private key acts in the same way as a password that gives the holder access to his transferred units of value. Nevertheless, it is important for participants of the blockchain to secure their private keys so that they do not fall into unauthorized hands.
Transparency and immutability
The Bitcoin blockchain is automatically brought to a consensus of all network participants and checked about every ten minutes. As a self-verifying ecosystem of digital assets, the Bitcoin network tunes every transaction at these ten-minute intervals. Each group of these transactions is called a “block”. This results in two properties:
- transparency, since the data is embedded in a network as a whole and thus public, and
- Immutability, since a retroactive change of any information seems impossible according to the current state of knowledge.
Theoretically, an attack on the immutability of a blockchain would be possible, but in practice it would be unlikely, especially since this would, for example.B. call into question the stability of the attacked currency as a whole. This would probably lead to a loss of the value of all currency units, which would make such an attack not profitable for the attacker, since the currency units then acquired without authorization would be worthless.
Consensus mechanisms describe how participants of blockchains find an agreement on transactions and the new state of the blockchain. Depending on the type and design of the blockchain, different consensus mechanisms are used. Individual consensus mechanisms include proof-of-work, proof-of-stake and Ripple consensus.
Smart contracts enable the mapping of contractual logic by computer algorithms. They are programmable contracts that are defined by the program code and can then be automatically executed and enforced on blockchains. At certain times, smart contracts automatically check predetermined conditions. This means that you automatically determine whether, for example.B a transaction is executed or reversed.
Smart contracts thus make it possible to enforce contracts directly. The goal is to reduce transaction costs and increase contract security. Only the programmed code of a smart contract unfolds contractual effect. Smart contracts are a control or business rule within the technical protocol. For example, in the case of a car leased via smart contract, the engine could only start when the leasing installment has been received. For this purpose, a query of the blockchain would suffice.
Smart contracts allow for a high degree of independence because the parties to an agreement do not have to rely on an intermediary. This also reduces potential risks of manipulation by third parties, as the execution is automatically managed by the blockchain mechanisms and not by one or more instances that could commit errors or be biased. Smart contracts also allow for an increase in processing speed, as software code is used to automate tasks. In this way, business processes can be simplified while minimizing human errors, interfaces or media breaks.
Risks of smart contracts arise in particular from the lack of a central authority that could intervene in the event of intentional or unintentional misconduct. This became particularly clear in the case of the crowdfunding project “The DAO” in June 2016, where the project was deprived of cryptocurrency units worth about 50 million US dollars, because of a previously largely unnoticed part of the program in the central smart contract. In addition, legal risks can also arise from smart contracts. At present, it is still unclear whether decisions made by the program code will also be recognized as binding by courts. It is also questionable whether market participants will accept such a procedure, or whether courts should not be able to intervene in illegitimate or inefficient decisions. In addition, the question arises to what extent the contractual conditions laid down in program code are understandable for consumers or private investors.
The crypto game has long been part of the startup and trading bubble. In doing so, all actors throw around the wildest terms. And if you don’t want to be an absolute idiot, you can simply adopt these terms without any idea what blockchain and Co. mean at all.
So that you do not have to come out as a crypto layman at conferences and business meetings in the future, we explain the most important facts. For this, we asked Cryptex the most important questions about the crypto world. Here are the answers:
Bitcoin was first introduced by Satoshi Nakamoto in 2008 on a mailing list for cryptography specialists. However, Satoshi Nakamoto is only a pseudonym, because the true identity is still unknown today.
So it does not necessarily have to be one person, but it could also be a group of several people. Over time, there has been much speculation about who Satoshi Nakamoto might be. There were claims by computer scientist Craig Wright that he was Satoshi Nakamoto. The identity has not yet been proven. Satoshi Nakamoto sent his last email in April 2011 in which he says that he is now devdicating himself to other projects.
The idea of Bitcoin was first presented in October 2008 in a so-called white paper entitled “Bitcoin: A Peer-to-Peer Electronic Cash System”. The white paper specifies how Bitcoin works in an abstract way. In January 2009, Satoshi Nakamoto released the first reference implementation of Bitcoin as open source software.
One can think of the blockchain as a huge, public and distributed cash book, which is able to store financial transactions. If someone wants to send Bitcoin from one person to another, then a transaction, a new entry in this cash book, is generated and, to put it simply, published in the blockchain. Such transactions are not stored individually, but grouped into blocks.
Now it is important to understand that not everyone can simply add blocks of transactions to the blockchain, because only the so-called “miners” are allowed to do that. “Miners” are special participants of the network who group transactions into blocks and if they manage to solve a mathematical puzzle, the so-called Proof of Work (PoW for short), they are allowed to add this block to the blockchain.
The main function of Bitcoin was initially to map financial transactions between two participants without a central server. In this way, uncensable and pseudo-anonymous transactions can be realized. Over time, more cryptocurrencies have established themselves that have even more features:
Ethereum, for example, can store and execute program codes (so-called smart contracts) in the blockchain in addition to transactions. This capability turns the Ethereum blockchain into a giant computer.
The ZCash blockchain, for example, focuses on anonymous transactions in order to maximize data protection for its users.
There are several other crypto currencies and not all of them are revolutionary, for example, the Dogecoin is in principle a fork of Litecoin, which in turn is very much based on the Bitcoin. However, further research is constantly being carried out and new areas of application are being developed.
Are you interested in the advantages of Bitcoin over standard currencies and how the value of Bitcoins is formed at all? You can read this next week in the second part of our “Crypto for Dummies” series.