I recently started working for an innovative Italian startup: MyLime. MyLime is very peculiar as it works with luxury goods and integrates them with blockchain technology. Knowing very little about this field I had to study and understand how it worked, and I have to say it was not easy at all. Blockchain is a slightly tricky topic, but can be learned!
That is why I wrote this article, hoping to be capable of helping others understand this fascinating technology.
Blockchain technology has been rapidly ascending in these past years thanks to the spread of cryptocurrencies. Anyway, this technology still gets too much associated with Bitcoin (and I thought too) while in reality, it offers multiple purposes. To better understand how it works, it is fundamental to have a clear idea of its underlying technologies.
We will go through the core components of blockchain as follows: the technology itself and the concept of distributed ledger technologies (DLT), the peer-to-peer network at the base of DLT, and the consensus rule.
1) Understanding blockchain technology and the concept of distributed ledger technologies (DLT).
What is a ledger? It is a book or other collection of financial accounts. The main function then is to store and structure data. Rather than being kept in an old and dusty library, blockchain is a digital counterpart. Instead of pages and numbers, all the information is stored in blocks to whom a timestamp is associated. Imagine a timestamp as the precise date and time of the insertion of the information.
In this way, each new block can be added after those with the most recent timestamp. Block after block, a chain forms.
Transactions recorded in the blockchain could be:
- An exchange of goods or services
- A money transfer between two people.
What is interesting about blockchain is that this digital ledger is not unique but is distributed in multiple places, avoiding administration functionality. This is a Distributed Ledger Technology. Therefore, to be considered distributed, different users must have access at the same time to the same information. This is where the peer-to-peer network comes in.
2) How does a peer-to-peer network work?
Data is passed from user to user directly in a peer-to-peer network instead of passing from a central server. An example could be when you are trying to send a letter to a friend. If you send your letter through the post office, it acts as a ‘server’. It gets sorted and then delivered to your friend. The letter does not go through the post office in a peer-to-peer network, but you deliver it directly to your friend.
Users are also known as “nodes”, which play an important role in peer-to-peer networks. They work together to update the blockchain as new information is added. Everyone can download the current version of the blockchain, which can then be used to verify the versions of others.
What are the main benefits derivable from the use of this network?
- Blockchain is not centered, therefore truthfulness is granted by the different nodes that participate in the network.
- Since blockchain is composed of different blocks available on multiple computers, it would be tough for a malevolent user to hack them all.
- All information registered into the blockchain is non-deletable and non-modifiable.
A Peer-to-peer network indeed is capable of granting a high level of security. However, the whole blockchain technology has to rely on the consensus mechanism.
3) Now that we know how transactions are recorded and shared among the network, how do we know if the data are correct? And how do we know that there are no invalid transactions within the blocks?
The consensus mechanism is where the underlying magic of blockchain lies, and it is very peculiar.
Enabled by the peer-to-peer network, it allows nodes to work together without them having to know or trust each other. The consensus protocol is needed and sets determined rules when these operations occur: a new block has to be created, a block needs to be validated and to solve the conflict of truth (in case two valid blocks are added and my transaction is recorded with two different recipients).
But how is this possible?
The consensus mechanism involves a verification and approval phase based on computing resources. These resources are made available by blockchain participants and are finalized at solving complex problems or cryptographic puzzles.
It is called Proof of Work (PoW) and is the most commonly used in blockchain.
Those who participate in the resolution of the problem are called Miners. Their intervention requires significant calculating capacity, hence they are rewarded through the issuance of a virtual currency or cryptocurrency. This reward is called ‘gas’ in the Ethereum blockchain and it is what incentivizes miners to validate new blocks.
Only once the Proof of Work is solved, the block can enter into the chain.
The Proof of Work is not the only protocol available. There is also the so-called Proof of Stake. It differentiates from the Proof of Work since each user has to stake to own a certain amount of cryptocurrency.
To better picture it, a staker would say “I bet my coins that I can add this block correctly”. If other stakers find no irregularities, he can add the upcoming block; else, they get all his coins.
Having said that, how is a block validated?
When a Miner solves the riddle all other nodes have to check its validity. Blocks can join the chain, and the state of the blockchain synchronizes if a consensus is reached. To reach it, 50% plus one of the nodes must state the truthfulness of the block. An invalid block will automatically be rejected as the software run by the miners checks its validity.
The consensus mechanism also solves the case mentioned above. In case two blocks are mistakenly added reporting one of my transactions to two different recipients. In this scenario two equally valid blocks would be created, dividing the main chain into two chains. Which chain is the ‘true’ one? This is because miners will start creating new blocks in both chains, but will inevitably focus more on one chain to which blocks will be added faster. Miners will be forced out of the shorter chain to move to the other one. This will lead to the dismissal of the shorter chain.
To conclude, blockchain qualities can be summed up in five main terms:
- Reliability: If one of the nodes in the chain gets violated and damaged, all the other nodes in the distributed database will continue to be active and operational, skipping the chain and thus not losing important information.
- Transparency: transactions recorded are visible by all participants.
- Convenience: making transactions through the blockchain is convenient for all participants as there are no third-party interlocutors.
- Irrevocability: With blockchains, it is possible to make traceable and irrevocable transactions. In this way, transactions cannot be modified or canceled.
- Digitalization: everything gets digitized and application fields of this technology become endless.
To have a clearer vision of what we talked about, you can find a summarizing infographic about blockchain here below.
