Cryptocurrency and Blockchain Series – The Blockchain Part 1

Written by Tom Blake on 21 February 2018

Cryptocurrency and Blockchain Technology Series

Welcome to the new Cryptocurrency and Blockchain Technology Series. The intention for this series is to give our readers and clients an understanding of the technology that they are hearing and will hear more frequently about in the news and in their lives. Furthermore, later on in the series we will discuss the relevant accounting and tax implications of trading or investing in cryptocurrencies. I hope you enjoy and please leave questions in the comments at the end of the post as well as ideas for further blog discussions in relation to this exciting technology.

The Blockchain

Like most underlying technologies that we take for granted every day, we are not required to know how the blockchain works in order to use it. However, having a basic understanding of how this technology operates, particularly at the beginning of its introduction into modern life may prove useful and at the very least this chapter in our series will show why it is considered revolutionary.

“The blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.” Don & Alex Tapscott, authors Blockchain Revolution (2016).

In general terms, the blockchain is a decentralised database that continuously keeps track of all transactions that occurs over its network. Being decentralised (also known as a distributed ledger), the database is not stored in any one place, but is replicated and validated over its network via nodes, synchronised each time a transaction is created.

Imagine a spreadsheet of transactions that is duplicated many times across a network of computers. Then when this spreadsheet is updated on one computer, it is pushed to all the computers on the network so that all the computers have the latest spreadsheet. This is similar to a blockchain.

A node is just a computer, usually required to be quite powerful, running the networks’ software. When online, the node is able to connect to other nodes and efficiently relay up to date transactional information across its network. Each full node stores the entire blockchain network, which means the more transactions and blocks there are, the more storage memory is required at each node. The more nodes there are across the network, the more robust the network is as there can’t be a single point of failure. Therefore, the more nodes there are, the more secure the network. This is a critical part of the design of the blockchain protocol.

A block in a blockchain is the name for a group of digital transactions. When a transaction is made on the blockchain network, it is grouped together with other validated transactions by a miner who adds them to the blockchain. A miner1 is a type of node with very powerful and expensive hardware that is utilised to solve a complex mathematical puzzle in order to create the next block in the blockchain from its own candidate block2.

In order to solve this puzzle, the miner must generate a long number and pass it through the networks cryptographic hash algorithm to form the solution. The long number is based on a variety of factors including a timestamp, a reference to the previous block and a random number known as a nonce. The nonce must be adjusted by the miner until the long number is validated by every node on the network. The solution (known as a Proof-Of-Work) is only confirmed once this has happened and a new block is then added to the chain on the network. The successful miner is rewarded with a certain amount of coins as well as all the transaction fees for the transactions in the new block, which motivates the miner to include as many transactions in the block as possible. On the bitcoin network, a new block is created and the network verified on average every 10 minutes3.

 

 

Crypto Currency Cycle

Original Image: https://blockgeeks.com/guides/what-is-blockchain-technology/

The blockchain technologies that you may be aware of, such as the bitcoin network, are public networks and are accessible to anyone who is connected to the internet. Due to the nature of blockchain, in most networks you are able to see a complete history of all transactions. In fact, there are websites like Blockchain.info that show you live information about the latest blocks and transactions on the Bitcoin network. This means the data is completely transparent and allows users to trust each other and transact peer to peer (p2p) without the need for intermediaries. This in itself brings unprecedented security benefits.

Centralised intermediaries such as banking institutions are regularly faced with hacking attacks, which are virtually impossible on the blockchain. As an example, a hacker would not only need to crack into a specific block, but all of the preceding blocks going back to the first block on the blockchain and they would need to do it on every node on the network simultaneously. Blockchain technology is as yet completely incorruptible, with the Bitcoin network which has been running since 2008 operating without significant disruption during its lifetime.

The disruptive blockchain technology means that business and governments will need to adapt relatively quickly in order to understand the true potential of using blockchain technology within their own operations as well as formulate procedures going forward. Implementation is already happening throughout the world, but 2018 may be the year where we as citizens truly begin to see the effect the technology has on our lives.

The next chapter in our series looks at the potential uses for blockchain technology, how it is currently being used now and who is using it.

Endnotes

  1. Blockchain without miners – Currently miners are the preferred type of node to validate the network and are the backbone of traditional blockchain technology. However, there are emerging variations that that have eliminated the need for miners due to issues with poor scalability, cost of mining and transaction validation time. One particular ICO (Initial Coin Offering) which recently completed on 18 February 2018 was the CREDITS blockchain platform and is said to be able to self-execute 100,000 transactions per second at minimal cost to the Sender. IOTA goes even further and has created its own architecture away from blockchain technology, called the Tangle. Instead of miners being used to validate transactions, the Sender in a transaction provides a kind of Proof-Of-Work which simultaneously validates two transactions. This removes the need for miners and makes the network fully decentralised with zero transaction fees.
  2. The miner will look at a transaction as it arrives and then run a series of checks to verify it. Each miner builds its own transaction pool from which it will build its own candidate block. All blocks start off as candidate blocks, but only the successful miner will be able to add his candidate block to the blockchain.
  3. Being a miner is an expensive hobby, due to not only the initial cost of the hardware with the capacity required to win the race for the Proof-Of-Work, but also running costs in the form of electricity. Although estimates vary wildly, it is said that the mining for the Bitcoin network uses 50.1TWh (Digiconomist) per annum, which is more than the whole of Portugal. This estimate for total energy use is based on the estimated energy needed for the required miner hardware multiplied by an estimate for the average amount of miners on the network. This huge energy usage estimation brings into many ethical considerations for the future of the technology. However, for the Bitcoin miner, the cost of mining must be profitable otherwise miners wouldn’t validate the network and it would fail. If you have been following the Bitcoin markets and related news, you may have read that transaction fees have skyrocketed. Due to the recent increased demand for Bitcoin and limited transactional supply over the network, an increasing amount of transactions have been competing for a relatively small number of slots in a block on the ledger. While fees aren’t totally necessary, in the capitalist society that we live, a miner is more likely to choose to include your transactions in his candidate block if you pay him more – this is in the form of higher transaction fees. The Bitcoin network, in its current state, therefore does not work well as a payments system – it is extremely unlikely you would want to pay high fees on top of the cost of your cup of coffee and wait for a miner to include your transaction on the ledger!
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Tom Blake
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