Distributed Ledger Technology: Public Blockchains

Björn Michael Solvan Theilmann

In this blog post we will have a short look into the young history of public blockchains like Bitcoin and Ethereum. Public stands for permissionless and means that everybody can be a part of it. The industry started to create private blockchains which are permissioned and only nodes and validators from an organization or consortium can be part of it. We will look into private blockchains in a separate article.

The first thing most of the people are thinking about when hearing the term blockchain is Bitcoin. Bitcoin was the first use case of blockchain technology and was founded by the person or group behind the pseudonym Satoshi Nakamoto. In 2008 Nakamoto released a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System“. Bitcoin is an electronic cash system and a digital cryptocurrency which is stored in a decentralized database. One year later, in 2009, the first version of blockchain technology was born.

Combining technologies

Blockchain by itself is a clever combination of technologies which were founded over the last 50 years. The modern applications are client-server-based and usually controlled by a single entity. The concept of blockchain is decentralization, made with the peer to peer (P2P) technology which became famous in the late 90s through file sharing. The blockchain is a chain of blocks where every block contains the cryptographic hash of the previous block. Cryptographic hash functions have existed since the late 80s with MD2 developed by Ronald Rivest. The blocks contain hashed transactions encoded in a Merkle Tree, named after its founder Ralph Merkle in 1979. For security reasons and addressing all the members in the network, public key cryptography is used. The first public key cryptography was founded in 1977 by Ronald L. Rivest, Adi Shamir und Leonard M. Adleman. All these technologies together are the foundation of blockchain. But there are more use cases possible as an electronic cash system like Bitcoin.

The next step: Ethereum

The next evolution of blockchain was initiated by Vitalik Buterin who had the idea that there are a lot more possibilities than Bitcoin which can be realized with this technology. The whitepaper was originally published in 2013 and Ethereum was born in 2015 and added the possibility of smart contracts. The crypto value of Ethereum is called Ether but with the smart contract feature it is more of a platform for decentralized applications on which everybody can develop DApps. DApps are decentralized applications that are connected to a blockchain and not client server based. Today, in 2021, Ethereum is the most actively used public blockchain. The second version of this technology was born.

Problems

One of the biggest problem of public blockchain platforms, especially Bitcoin and Ethereum, is the energy consumption of the mining process. Because it is a decentralized database, all nodes in the database have to find a shared consensus of which blocks are allowed to add to the chain. Bitcoin and Ethereum are using the proof of work (PoW) consensus mechanisms and since the network is growing it takes much more energy. Today, Bitcoin consumes more electricity than the country of Argentina.

The blockchains which are using PoW for finding a shared consensus have a slow transaction speed. In Bitcoin there are 5 transactions per second and Ethereum has a speed of 30 transactions per second. For comparison: VISA has a transaction speed of around 1.700 transactions per second.

There are no regulations in public blockchain networks, also there is no defined rule set which the members are following. In the time of a crisis a central system can force a rule set. For example a stock exchange can interrupt the trading for a specific stock if there are inconsistencies. In difficult times this can work as a shock absorber and avoid that the crisis is getting even bigger.

All data which are stored in a public blockchain are public and so it is often a question which data should be stored on-chain and which off-chain. When an application or smart contract needs to know the private identity of a user it would be dangerous to store this data on-chain and so it is raising the question about privacy and data storage policy of applications.

Until now it is too complicated for people who are no computer experts to be part of the blockchain world because it is not user friendly. You need a basic knowledge of how the things are working. On the other hand a blockchain is immutable, that means it is not possible to delete data out of it, which can be problematic with the General Data Protection Regulation in EU (DSGVO in Germany).

When a smart contract in a blockchain needs real world data like a stock course, it is susceptible for manipulation because the stock data are off-chain.

Blockchain as platform for decentralized applications

The development of Ethereum and the concept of blockchain as an infrastructure for new decentralized applications created the base for a lot of more use cases – smart contracts and the ERC-20 token standard created the foundation for fungible tokens (FT). Fungible means that every token has the same value and is interchangeable like for example gold and currencies. Non-fungible tokens (NFT) and the ERC-721 standard are representing something unique that is not interchangeable, like for example a picture from Picasso is not interchangeable with a picture from Vincent Van Gogh. Both have different values. The ERC-20 and ERC-721 standards make it possible to transfer tokens between different blockchains – if they are supporting it.

Decentralized finance (DeFi) are use cases for financial instruments without central financial intermediaries. The most popular DeFi applications create the possibility to lend or borrow money, all based on crypto values without a bank in between.

To connect the blockchain to real world data, oracles were created. The idea behind an oracle is to collect data from a lot of different sources and to find a shared consensus about the truth. A hacker would have to manipulate so many different sources that the effort is in no relation to the benefit. In the near future a lot of sensors will be connected to a blockchain. In daily life, that could look like this: When a car is involved in a car crash, the other cars around the crash site would stop or slow down. An oracle is not only collecting data from the involved cars of the crash but is using the speed sensors from all the cars that are around. The idea behind is that a few sensors can be hacked but when there are a few hundred or a few thousand sensors, it is getting more and more difficult to manipulate all of them. Smart contracts from the car insurances can be also connected to the blockchain and automate the complete process after a car crash is happened.

Distributed Ledger Technology

There is a high chance that blockchains are becoming a substantial part of the future internet, which is high likely the transformation from an internet of copy to an internet of value. A lot of new projects want to improve blockchain technology with new concepts and all these variations are falling under the term distributed ledger technology (DLT). IOTA is using a directed acyclic graph and there are no miners for validating transactions. Polkadot follows the idea of a multichain with parachains and parathreads. A similar concept like Avalanche with its called subnets which are separate instances of chains in a single interoperable network. And the second version of Ethereum is changing the PoW consensus mechanisms to proof of stake (PoS) which needs less energy and has a faster validation process. Algorand and Cardana are PoS based blockchains focused more on financial applications and last but not least have most of these new networks governance included. That means that every stakeholder of the network has a democratic vote for improvements and the future direction of the network.

All these projects will be the foundation for the next DLT evolution, addressing the current problems and enabling a lot of more powerful use cases in the future.