Blockchain, Bitcoin, and the Digital Economy E-Book

Len Mei

• Herausgeber: Packt Publishing
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 419

Veröffentlichungsjahr: 2024

Beschreibung

This book provides a comprehensive introduction to blockchain technology, discussing its fundamentals, development issues, potential applications, security, and use in cryptocurrency. It also delves into fintech, its current status, and related concepts in the digital economy. The rapidly changing nature of these topics makes the book a valuable resource for anyone interested in blockchain and cryptocurrency. Numerous references offer up-to-date information on these subjects.
The course begins with an overview of blockchain and its basic concepts, followed by an in-depth look at Bitcoin and its associated issues. The journey continues with consensus mechanisms, exploring altcoins, and mutual distributed ledgers. The book then shifts focus to applications of blockchain beyond cryptocurrency, highlighting industrial uses, payment systems, and lending. Governance, regulation, and future trends in blockchain technology are also covered.
Understanding these concepts is crucial for navigating the evolving landscape of blockchain and cryptocurrency. This book ensures a smooth transition from novice to knowledgeable enthusiast, equipping readers with practical insights and comprehensive knowledge. By the end, readers will grasp blockchain technology's impact on various industries and its potential for future innovations.

Leseprobe

BLOCKCHAINBITCOINAND THEDIGITAL ECONOMY

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BLOCKCHAINBITCOINAND THEDIGITAL ECONOMY

Len Mei, Ph.D.

MERCURY LEARNINGAND INFORMATIONDulles, VirginiaBoston, MassachusettsNew Delhi

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L. Mei. Blockchain, Bitcoin, and the Digital Economy.

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CONTENTS

Preface

Chapter 1: What is Blockchain?

1.1 Introduction

1.2 Distributed Computing

1.3 Centralization vs. Decentralization

1.4 Permissioned vs. Permissionless

1.5 Bitcoin

1.6 Proliferation of Blockchain Technology

1.7 Initial Coin Offering (ICO)

1.8 Blockchain Platforms

References

Chapter 2: Bitcoin

2.1 Bitcoin Mining

2.2 How Does Bitcoin Work?

2.3 Digital Signature

2.4 Multisig

2.5 Bitcoin Wallets

2.6 Two-factor Authentication (2FA)

2.7 Hash

2.8 Merkle Tree and Block Header

2.9 Nonce

2.10 Bitcoin Supply

2.11 Bitcoin Addresses

2.12 Zero Knowledge Proof

2.13 Divisible Bitcoin

References

Chapter 3: Bitcoin Issues

3.1 Bitcoin Block Size

3.2 SegWit and the Change of Block Size

3.3 Bitcoin Split

3.4 Keep Your Coins Safe During Forking

3.5 Bitcoin and Decentralization

3.6 The Mt. Gox Incident

3.7 Full Nodes vs. Partial Nodes

3.8 Is Bitcoin Truly Anonymous?

3.9 Transaction Fees

3.10 Transaction Malleability

3.11 BIPs, Hard Forks, and Soft Forks

3.12 UASF and UAHF

3.13 Other Proposed Fixes

3.14 Government Attitude

3.15 The Future of Bitcoin

References

Chapter 4: Consensus Mechanisms

4.1 Proof of Work vs. Proof of Stake

4.2 PoW and PoS Hybrid

4.3 dBFT, an Alternative to PoW, and PoS

4.4 Paxos and Raft: Consensus Protocols for Distributed Systems

4.5 Proof of Concept

References

Chapter 5: Altcoins

5.1 Litecoins – A Lighter Version of Bitcoin

5.2 Zcash – A Token with Privacy

5.3 Ripple – A Digital Equivalent of SWIFT

5.4 Ethereum: The Smart Contract Blockchain

5.5 DAO Hacks and Ethereum Forks

5.6 Legal Issues

5.7 Dapps – Decentralized Apps

5.8 Create Your Own Coins Out of Bitcoin

5.9 Antshares or NEO – A Multi-Use Token

5.10 Bridging Bitcoin & EVM

5.11 Asset Digitization

5.12 Stablecoins

References

Chapter 6: Mutual Distributed Ledgers and Digital Currency

6.1 Identity, Transaction, and Content MDLs

6.2 Identity MDLs

6.3 Tokenless MDLs

6.4 Building MDLs for Financial Services

6.5 Digital Currencies

6.6 The Indian Digital Currency Project

6.7 Chinese Digital Currency – DCEP

6.8 Facebook Libra/Diem

6.9 Non-Fungible Tokens (NFTs)

References

Chapter 7: Blockchain Beyond Cryptocurrency

7.1 BigchainDB

7.2 Lightning Network

7.3 Corda

7.4 HydraChain

7.5 MultiChain

7.6 Quorum

7.7 Hyperledger

7.8 Decentralized Internet

7.9 Other Blockchain Platforms

7.10 Beyond Blockchain

References

Chapter 8: Industrial Applications for Blockchain

8.1 Insurance

8.2 Wealth Management

8.3 Defense

8.4 Healthcare

8.5 Food

8.6 Credit Rating

8.7 Data Management

8.8 Internet Security

8.9 Logistics

8.10 Global Trade, Supply Chains, and Other Areas

References

Chapter 9: Payment and Lending

9.1 Banking and Payment

9.2 Third-Party Payment Market

9.3 Mobile Wallets and Payment Transfers

9.4 Credit Cards and Loan Applications

9.5 Peer-to-Peer Lending

9.6 Online Lending

9.7 Microlending and SME Lending

References

Chapter 10: Governance and Regulation

10.1 Governance and Voting

10.2 Regulatory and Compliance Applications

10.3 Land Title Registration and Real Estate

10.4 Law and Blockchain

10.5 Protection of Intellectual Property

10.6 Conclusion

References

Chapter 11: A Glimpse of the Future

11.1 The Foundation of Future Technology

11.2 The Sharing Economy

11.3 Fintech and AI

11.4 Fintech Regulation

11.5 Data-Driven Fintech

11.6 Communication-Driven Fintech

11.7 Conclusion

References

Index

PREFACE

Bitcoin, the first cryptocurrency, is arguably the most explosive asset in human history. Since its inception in 2009, Bitcoin’s market capitalization has grown from zero to over $560 billion by January of 2022.1 This increase was almost unthinkable just a few years ago. Since Bitcoin first appeared, many other cryptocurrencies have sprung to life. There are thousands of different cryptocurrencies currently and that number increases almost daily.2 Cryptocurrencies have a combined market capitalization of approximately $2 trillion.

Many people believe that the cryptocurrency market is nothing more than a bubble. Indeed, the value of cryptocurrencies has endured violent ups-and-downs. However, such explosive growth is more than just speculation. The underlying technology of any cryptocurrency, the blockchain, shows enormous potential to usher in all kinds of change. Regardless of the future value of cryptocurrencies, the blockchain technology is here to stay.

We are at the beginning of a digital revolution, propelling the world into an era of a digital economy. In the U.S., the overall economy grows at an average rate of 2% a year, while the digital economy is growing at 10%. Today, the digital economy in the U.S. is roughly 10% of the total economy. But by 2030, that number is forecasted to be 22% of the total economy. Blockchain, together with the other nascent technologies, such as artificial intelligence (AI), big data, the Internet of Things (IoT), and many others are the driving forces of this coming digital revolution, also known as the 4th Industrial Revolution.

Blockchain technology is derived from cryptography, a branch of computer science. What makes blockchain technology unique from traditional cryptography is that it was combined with the technology of the Internet. It transformed the Internet from a platform of information, data transfer, and storage into a platform of asset transfer and storage. Suddenly, the Internet and online world finds itself capable of performing many financial functions with the security and speed unmatched by the world’s traditional financial systems.

For example, the Bank of England released a report on how to use the blockchain technology to strengthen its real-time settlement system; Swift proposed a block-linked roadmap; IMF released the first digital currency report. Gartner estimates that blockchain could produce $176 billion in business value by 2025.3

The birth of blockchain technology in the first decade of the 21st century obviously was not an accident. A number of factors drove the innovation, but blockchain mainly relied on the maturity of Internet technology itself, the advance in computer science capabilities, the spread of cheap computing power, and high speed, high bandwidth communication technology, as well as things such as the globalization of e-commerce and trade.

Blockchain technology is still at the nascent stage. It is evolving and changing. Thousands of startups and large companies are experimenting with it for the development of new applications. Blockchain’s application to cryptocurrencies has caught the attention of the news media. However, in time, its other applications may have a much more profound impact.

Blockchain is revolutionary because, for the first time, we can transfer objects with a monetary value over the Internet and store them in the database securely and quickly.

Before the invention of Bitcoin in 2009, nobody could figure out a way to make a digital currency work. Since the replication of data on the network is easy, such data cannot represent an asset. This is the double-spending problem. This changed when a person called Satoshi Nakamoto invented Bitcoin using blockchain technology in 2009. If blockchain can create and transact digital currency, it can also create and transact any and all digital assets.

Blockchain-based smart contracts and distributed apps open up a wide frontier for transaction applications. Blockchain can create an immutable digital identity, which provides a chain of custody and proof of the ownership of assets, furnishing all the elements necessary to conduct financial activities online.

However, blockchain is not the only technology that is altering many aspects of the financial, business, and trade systems today. It is the combination of artificial intelligence, blockchain, big data, communication, Internet technology, computing power, and many others to cause a drastic shift in the best and most efficient ways to do things.

With the development of blockchain, there is also a newly evolved technology called fintech, short for financial technology. Fintech promises to revolutionize the financial industry just like automation revolutionized manufacturing. These new technologies can add trillions of dollars to the global economy. The implications are staggering.

This book discusses basic concepts and fundamentals of blockchain technology, the issues in development and potential applications, and its use in cryptocurrency. We will also discuss fintech, its status and applications, and some aspects of the digital economy. This subject is vast and quickly changing, so it is impossible to cover the subject entirely in one book. This book serves as a comprehensive introduction and background to anyone who is interested in blockchain technology and cryptocurrency. This survey provides ample opportunity to do further research on any of the topics covered. Many references are cited to make further exploration easier.

Len Mei, Ph. D.April 2022

1.https://www.investing.com/crypto/

2.https://www.statista.com/statistics/863917/number-crypto-coins-tokens/

3. “Predicts 2018: top predictions in blockchain business”, https://www.gartner.com/doc/3827065/predicts--top-predictions-blockchain

CHAPTER 1

WHAT IS BLOCKCHAIN?

Blockchain is the technology that gave birth to Bitcoin, Ethereum, Dogecoin, and every other cryptocurrency in existence, helping to ignite a revolution in the digital economy. Blockchain is a technology to transact, distribute, and store digital information on the Internet. It does so by linking blocks of data and distributing them across a network.

1.1INTRODUCTION

The data in blockchain is secure and immutable. The first application of blockchain was to create a digital currency – Bitcoin. However, blockchain is now being applied in other ways, such as for product traceability and copyright protection, as well as financial transactions, entertainment, publishing, energy, healthcare, and other industries.1 It can be used across the entire value chain, benefiting businesses and consumers alike.

Blockchain is an encrypted database technology. It enables immutable data to be accessible by parties involved in a transaction securely, thus it is an ideal universal irrefutable depository for all transactions. Such a capability allows blockchain to transform the way that individuals, organizations, businesses, and entire industries collaborate and interact with one another. With its capability of guaranteeing data security, blockchain technology will be a foundation for many industries in the future.

One of the difficulties in using the blockchain today is the difficulty in developing apps. Such an effort requires extensive blockchain knowledge and ingenuity. However, this is about to change. The blockchain enabled network for service, or Blockchain Service Network (BSN), is embedding blockchain technology into Internet protocols, which will allow anyone to develop and implement blockchain-enabled apps, such as those for remittances, cross-border settlements, and travel. In BSN, blockchain implementation is standardized. Such a network removes the difficult blockchain development work from the users and provides turn-key blockchain solutions to users.

A standardized blockchain platform allows for plug-and-play applications. Even small-to-medium-sized enterprises (SME) or an individual can afford to access the critical tools to participate in the digital economy. Developers can use a single private key to deploy and manage decentralized applications (Dapps) on multiple frameworks, and to realize interconnectivity and mutual communication between Dapps. These Dapps retain the unique features of a smart contract and consensus mechanism.

BSN will greatly reduce the cost of development of blockchain-enabled applications and accelerate the adoption of blockchain technology. It is envisioned that BSN can facilitate increased global trade and bilateral economic activity through more efficient cross-border trade, investment, and international collaboration. According to market research firm Grand View Research in California, the global blockchain market size was valued at $5.92 billion in 2021 and will grow 86% annually to 2030.2

A typical blockchain application involves several basic components: participants, assets, access control, and transactions. Its value chain ranges from hardware manufacturing, software platforms, and cybersecurity to application services, investments, media, and human resources.

Since blockchain resides on the Internet and its objective is to move “valuable assets,” whether it is money or contracts, it is also known as the Internet of Value (IoV).3

The difference between the Internet as we know it today and the IoV is the asset value of the contents. The Internet today can move duplicated copies of data around. These data are for information only. The data in blockchain applications are either original or a verified copy of an asset that is as good as the original. When blockchain technologies spread more widely, many, many more applications will be developed.

A significant number of these applications will be targeted for financial uses. These applications are known as fintech, short for “financial technology.”

Many blockchain applications are revolutionary and create paradigm shifts. Blockchain technology can automate financial industries, just as robots automate manufacturing. Banks, stock exchanges, insurance companies, supply chain managers, and land registration companies are experimenting with blockchain technology. Other potential blockchain applications include medical records management, vote tracking, identity management and protection, long-term record storage, chain-of-custody for insurance policies, and the management of legal documents, such as those for real estate ownership.

When blockchain is used in conjunction with other technologies, such as the IoT (Internet of Things), it allows companies to track virtually every kind of digital record and transaction, which requires privacy and confidentiality. This is because all kinds of data collected by the IoT can be constructed as a blockchain.

Other names for blockchain are Mutual Distributed Ledger (MDL), or Distributed Ledger Technology (DLT). A ledger is a chronological record of transactions. The word “Mutual” denotes the shared nature of the distributed ledger. It is a special type of the more generalized distributed ledger.

In addition to being a distributed ledger, blockchain is also a distributed database. It enables multiple parties to share and update data in a safe and secure way, even if they do not trust each other. Blockchain allows for the secure transfer and storage of assets online. Blockchain can be used in a wide variety of applications to perform transactions or exchange value safely and securely.

Blockchain’s fundamental construction mechanisms make this technology unique: It is distributed in a P2P network, decentralized, and encrypted. The signed, encrypted, validated new transactions are bundled together into a “block.” The new block links to the previous verified block in the blockchain cryptographically. As such, the blocks are forming a permanent and immutable chain of records. It is as if each new page of the ledger, when filled, is bound to the previous page of the ledger. The balance at the beginning of a new page must match that of the end of the previous page. In this way, the balances on each page form a chain with the balances of previous pages. Multiple copies of the identical ledger stored in different locations will receive a duplicated new page so that all the ledger books are instantly updated and identical to each other. In doing so, any altered copy will be different from the original so that the alteration can be easily identified.

Identical copies of the blockchain are replicated across all nodes in the network. In the construction of Bitcoin’s blockchain, a new block is generated and attached to the blockchain every 10 minutes, and all copies of the blockchain automatically update themselves. During this short interval, different versions of the blockchain may appear in different nodes. This phenomenon is called forking. When a new block emerges by consensus, it is attached to all the blockchain copies to make all of them identical. Forks dissipate quickly and automatically.

The nodes communicate over a network and collaboratively construct the blockchain without relying on a central authority. Faults can appear when individual nodes crash, the communication between nodes fail, or there is a malicious attack. However, because there are many more nodes, the record remains safe. Such safe record keeping is achieved by a consensus protocol. That is, the identical copies kept by majority nodes are considered as the authentic copy.

The number of nodes is so vast that it is impossible to alter the transaction replicated in the majority of the nodes to form a consensus. In addition, all data are vertically integrated along the chain in the blockchain. Any attempt to alter the data inevitably creates a discrepancy among the data in the sequential blocks and different copies of the blockchain. Regular updates prevent any attempt to alter the data, making it immutable.

Blockchain is accessible to anyone on the Internet. Therefore, it can be regarded as a public Internet ledger. All copies of the blockchain are more than just secure sequential distributed databases. Because they can be trusted, they offer the ability to simplify and automate transactions and make it easier and cheaper to conduct financial activities.

Blockchain resides on the Internet. In many ways, the blockchain network is similar to the Internet and really is something of a subset of the Internet. On the Internet, Web servers or HTTP servers manage Web applications. In the same way, in the blockchain network, the consensus servers manage distributed applications. The application sends a transaction to the platform, which handles communication and consensus. When the community agrees on the order of transactions, it then changes the state, which is recorded in the distributed database.

Bitcoin was the first application of blockchain technology. It is also fair to say that blockchain was invented to create Bitcoin. P2P (peer to peer) distribution and decentralization are built into the Bitcoin blockchain and some of the first blockchain applications. As Bitcoin started to proliferate, interest in blockchain technology grew. Since the idea of Bitcoin was initially developed, countless industries, from financial services to health care, have begun contemplating how to leverage the technology for themselves.

Blockchain’s distributed nature, validation and encryption methods, and trust mechanisms are evolving to meet the needs of developers.

As applications have evolved, the basic mechanism of constructing blockchain has also changed. Some of its derivatives are far from the idealistic distributed, decentralized blockchain originally invented for Bitcoin. However, this does not diminish the importance of blockchain technology. This evolution contributed to creating fintech, which would not be salient without the blockchain technology.

1.2DISTRIBUTED COMPUTING

Modern computing infrastructure is becoming more distributed for many reasons. First, the price of CPUs/GPUs and storage media (memories and disk drives) has decreased. These provide computing power and data storage on a broad scale. They are not only cheaper than before, but also more powerful, thanks to the progress made in semiconductor technology.

In 1971, the first commercial integrated circuit (IC) made by Intel – the Intel 4004 – had 2,300 transistors. In 2021, the most advanced IC had 54 billion transistors (an example is the NVIDIA GA100). Today, a single smartphone has more computing power than NASA did in 1969, when the United States first put a man on the moon.4

The ever-increasing communication speed and bandwidth make remote services possible. Powerful applications residing in the cloud provide supercomputing power at the fingertip. Therefore, data processing is no longer confined in one location. This is known as distributed computing.

Widespread computing and communications generate high volumes of data. Cheap storage also encourages data safeguarding by replication; when one of the storage devices fails, valuable data are not lost. Almost all the online applications access data remotely and process these data either locally or remotely. In this way, distributed computing co-exists with a distributed database.5

When multiple computers are processing the same dataset, they may generate different outputs. For example, searching the same keywords using Google on different days may give different results. In some applications, this may not be acceptable. To avoid conflict, distributed systems need a consensus mechanism. A consensus mechanism is a fundamental necessity in the distributed systems as it guarantees the consistency of the outcome of a process. Consensus is a mechanism of reaching a collective agreement on some value, and it makes it possible for a distributed system to act as a single entity. A distributed computing system without consensus is like a city without traffic lights.

In the world of blockchain-based distributed computing, there are two types of consensus mechanisms: hashing power (computer power) and economic power. Before 2016, economic power was the only type of consensus. However, as the power of Bitcoin miners became more concentrated, hashing power became stronger. In 2022, roughly 10% of the Bitcoin miners controlled 90% of the Bitcoin mining.6

1.3CENTRALIZATION VS. DECENTRALIZATION

Another characteristic of blockchain is the concept of decentralization. Distribution applies to the location of data: A distributed database resides in many computer nodes, whereas a non-distributed database resides in one location. A centralized database has an owner or central authority overseeing the database, while a decentralized database does not.

Blockchain for Bitcoin is decentralized, which has led many to believe that blockchain in general is decentralized. However, it is not true: A blockchain can also be centralized.

The word “decentralization” does not have a clear definition in the context of blockchain technology. As the technology evolves, the blockchain technology also evolves.

Vitalik Buterin, the founder of Ethereum – another popular cryptocurrency – defined centralization through architectural, political, and logical concepts.7Architectural centralization refers to the database distribution nature of the ledger; an architectural decentralized database is the same as a distributed database. Political centralization refers to the ownership or presence of a central authority. Logical centralization refers to the state and the behavior of the blockchain. Buterin considered blockchain politically and architecturally decentralized, but logically centralized. This is true for certain types of blockchain.

When a blockchain is not truly public and has an owner, it is called the permissioned blockchain.8 The permissioned blockchain is politically centralized because its owner controls it. To access a permissioned blockchain, transactions, validation, and other privileges require permission from the owner/administrator, who retains control over how the blockchain operates.9 Since there are many privileges that have different levels of centralization, this makes the exact boundary between decentralization and centralization blurry at best.

The permissioned blockchain is also called the private blockchain, or consortium blockchain. This is because the creator of a permissioned blockchain has a specific object in mind for its application. There are many permissioned blockchain platforms, such as Hyperledger Fabric, Tendermint, Symbiont Assembly, R3 Corda, Iroha, Kadena, Chain, Quorum, and MultiChain.

To differentiate the centralized nature of the permissioned blockchain, the originally developed Bitcoin-like decentralized P2P blockchain is now called the permissionless blockchain, or the public blockchain. The difference between the permissionless (or public) blockchain and permissioned (or private) blockchain is akin to that of the Internet and an intranet. While the Internet belongs to the public, intranets are internal and private and belong to individual particular organizations. It can also be compared to a public park and private garden. Anyone can visit a public park, but one needs permission to visit a private space. In a permissionless blockchain – such as Bitcoin’s blockchain – anyone can be a user or run a node, invoke transactions, and participate in the consensus process. In the permissioned blockchain, the participation is by invitation only.

Most of the Bitcoin nodes receive data from other nodes, checking its validity, and passing it on further without doing the mining work. Nodes accept the block only if all transactions in it are valid and not already spent. There are over 15,000 reachable full nodes at any given time. However, the actual number of computers running the full nodes in the Bitcoin network can be much larger.10 (The United States alone has 12.1% of all the full nodes in the Bitcoin network, followed by Germany at 9.64%, and France at 3.2%.) These full nodes constitute the Bitcoin community, and within the Bitcoin community, a small group of full nodes operate as miners. The hashing power resides in the miners, but the economic power resides in the Bitcoin community.

A permissioned blockchain can be distributed, but is not necessarily decentralized. Even a centralized permission blockchain still offers benefits over a traditional centralized database, although, the claim is sometimes rebuked by critics. Some of the benefits are as follows:

• Each participant retains full control over assets;

• The data are encrypted and cannot be altered easily, and are therefore considered safe;

• Alterations are traceable;

• Control of the database is distributed across entities;

• The loss of any one server does not compromise the network.

There are different degrees of the centralization or decentralization. For example, in the Bitcoin or Ethereum platform, miners can create coins and anybody can be a miner. This is distinguishably decentralized vs. a national digital currency, which can only be created by the government. The decentralization is relative: for example, Bitcoin is more decentralized than Ethereum.

The Bitcoin platform can create up to 21 million Bitcoin as coded in the software. Nobody can change the protocol unless there is a consensus in the Bitcoin community. This is the designed decentralization. The maximum number of ETH (the Ethereum currency) that can be created is around 100 million, which has also been codified. However, Ethereum Foundation holds the power to change the protocol, including the capacity for its coins. In this aspect, Ethereum is less decentralized than Bitcoin.

Nevertheless, Ethereum allows anyone to develop an application on its platform. There are multiple clients written by independent parties, but the Ethereum Foundation has control only over its own client. Furthermore, if the Ethereum Foundation forces a change in its own client, and some people do not agree, they can split off as a hard fork. This is what happened in the Ethereum and Ethereum Classic split. From this point of view, Ethereum is still considered decentralized.

Figure 1.1 shows the degree of centralization for three criteria: authority, power, and control. There is no such thing as a 100% decentralized system or centralized system. Each system has its own degree of centralization for authority, power, and control – independently represented by lines AB, AC, and AD. Point E indicates the degree of centralization of authority. Likewise, Point F is for power and point G is for control. When the point is closer to the apex, the degree of centralization is higher. Therefore, we can use a triangle formed by the vertexes of three lines connecting three points along the axis of power, control, and authorization (triangle EFG) to represent the degree of decentralization.

FIGURE 1.1 Degree of centralization.

Permissioned blockchain development was very important because most fintech applications are this type. Some decentralized properties for the permissionless blockchain do not apply to the permissioned blockchain. Permissioned blockchains do have owners, who act as centralized authorities to the blockchain. These two branches of blockchain are evolving in very different directions as they have a different philosophies and applications.

Both types of blockchain guarantee the validity of transactions by recording them in a connected distributed system with a secure validation mechanism. Most blockchain applications reside in a network of computers connected to the Internet. Some blockchain applications reside in a cloud environment. Each computer node – a client – performs validation and relays the transaction to the next node. These computer nodes store a copy of the blockchain they validate.

The blockchain can be as long as the history of transactions of a particular asset it represents. In the case of Bitcoin, it creates a block every 10 minutes and grows 6 blocks per hour, 144 blocks per day or 52,560 blocks per year. It contains all the transaction history of Bitcoin. In addition, it exists in all the nodes in the Bitcoin blockchain network, so it is impossible to alter the data and make them consistent throughout the chain during the 10-minute interval. The 10-minute period is a result of the Proof of Work (PoW) algorithm, which takes miners 10 minutes to construct a block with hash lower than the target value.

A permissionless blockchain network is a subset of the Internet. Every node is equal and joins the network voluntarily, which is a form of mass collaboration. The incentive for participating in the network as a miner is the chance of winning Bitcoin. In addition, the incentive for participating in the network as a full node is to have the most private and secure way to use Bitcoin.

Blockchain technology creates a channel for the peer-to-peer transaction and may change the way we make all types of transactions. The technology provides a distributed transaction ledger that connects each transaction to its previous transactions, protecting them all with encryption. The blockchain tracks and verifies digital assets so they cannot be hacked or copied without permission. It operates without the need for intermediaries. The high level of security is why blockchain is used for cryptocurrency, but it can also be used for other assets, anything from votes in an election to stocks, tax payments, and property deeds.

What is revolutionary about the blockchain is that it decentralizes ownership and control of assets, and by doing this, it remodels fundamental structures in our society. It also replaces the traditional trust wholly or partially by cryptographic technology. By doing so, it removes one of the biggest barriers to transact valuables. From this point of view, it is the most important invention since paper money. It will stimulate the transactions or economic activities between unknown parties – globally – which was previously impossible without the third party as trust element. Blockchain technology has the potential to allow untapped economic activities that are currently impeded by a lack of trust.

The global economy is based on the power and trust we place in intermediaries like banks, governments, utilities, and large technology companies such as Facebook and Google, because we have no alternative. They add no value to transactions beyond the trust, yet they wield tremendous power over us all, make money from the transactions, and slow the transactions down in the process. If transactions and assets remain secure without these intermediaries, then we do not need them; we can retain our own property and stop paying them to insert themselves into various processes.

Interestingly, blockchain will take power and wealth away from even relatively new corporate intermediaries like Uber and Facebook. Imagine that if drivers and passengers can contract themselves securely without risking their identities or financial information, then the intermediary – here Uber – is extraneous.

However, the permissionless blockchain has its weakness. Because there is no central authority, any change requires majority consensus. Sometimes, the consensus fails because of different interests that different groups in the blockchain community represent. This was apparent in the 2017 disparity in fixing Bitcoin’s scaling issues, where miners were pitted against users. It ended up with a split of the Bitcoin blockchain.11

There are many potential applications of the blockchain technology. Since it is a transaction-based system, the most obvious applications are in the financial sector. For example, international remittances, which amount to over $400 billion in transactions per year, are one of the primary targets of blockchain. It not only cuts out the intermediary to handle the transaction, thus lowering the cost, but it is fast and secure. Cryptocurrency can transact across national borders instantly. This greatly promotes e-commerce on a global scale.

Blockchain is secure because it is encrypted, and its network does not have the vulnerability of a single system that computer hackers can exploit. Most of the service industries, such as banking, real estate, and insurance, will be transformed beyond recognition by blockchain technology.

Banks will need to add value rather than simply guard money and move it around, because, with blockchain, buyers and sellers will be able to verify the presence of funds and exchange them on their own.

Utility companies will also change as individuals switch to highly efficient renewable sources and store extra power; they can then sell their reserve power locally, effectively creating multiple mini-grids — unless utility companies include consumers as partners.

Even governments might eventually have a less involved role in its governance and a more streamlined bureaucracy with the help of blockchain. While societies would still probably opt for group decision-making and policymaking processes, with blockchain the execution of programs and distribution of benefits could be managed efficiently without as much corruption.

When technologies such as self-driving cars come onto the scene, blockchain technology will help prevent malicious attacks on the autonomous driving and help to ensure safety.

1.4PERMISSIONED VS. PERMISSIONLESS

We have briefly discussed the permissioned vs. permissionless blockchain. In a blockchain such as Bitcoin and Ethereum, any user can join the network and start mining. One does not need anyone’s permission to join the blockchain. In addition, one does not have to prove his/her identity to anyone – as long as one can commit the processing power to be part of the network and extend the blockchain. The permissionless blockchain is like a public park that anyone can walk in. Since the network is open to all, the only way to make the transactions secure is that the participating nodes do the block verification by performing PoW/PoS/dBFT type of work. It is just like you need to buy a ticket to go to a public zoo.

As more large corporations embrace blockchain technology, they are creating applications that are very specific and only involve certain parties. For example, if a bank develops a blockchain application to serve its clients, naturally, it will only allow its clients to use such application. In this type of permissioned blockchain, the central authority establishes the trust. To open an account at a bank or apply for a credit card, the necessary ID and financial information of the applicant already serve as a kind of “trust.”

There are two aspects of the permission: one is the right to access, the other is the right to validate transactions. In the permissioned blockchain, only a restricted group of users (who have access by invitation) has the rights to validate the block transactions. The right to validate transactions is more restrictive than the right to access. In the real world, there are also different levels of privilege: a bank’s client has the right to see his account balance and to write a check, but he does not have the right to change the account maintenance fee or to see other clients’ balances.

Similarly, in a blockchain belonging to a bank, the right of validation is restricted to the bank’s network nodes, and the right of access is restricted to the bank’s clients. Therefore, the permissioned blockchain is like a private club where only admitted members can enter. In addition, there are different levels of members that have different privileges and rights.

The permissioned blockchain has an owner who approves the participation membership. The owner builds the blockchain to serve his purpose. When banks and financial institutions build blockchain applications, they use the permissioned blockchain to do so. A national digital currency also uses the permissioned blockchain because the digital currency has an owner – the central bank.

The permissionless blockchain needs to provide coins as the incentive to validate the blocks and build the blockchain, which requires resources. However, in the permissioned blockchain, the token does not serve this purpose anymore. Unless transactions require tokens, the blockchain does not need tokens. Some permissioned blockchains are token-less blockchains where the owner controls the validators and block-creators – they do this for different reasons other than receiving tokens (for example, someone whose job is to operate a blockchain application as a part of their business operation).

As a result, the validation work can be very different in these two types of blockchains. In the permissionless blockchain, PoW or PoS (Proof of Stake) mining is necessary to achieve consensus. The Bitcoin blockchain uses hashing power to build trust, and Ethereum currently is using PoW but is moving to a consensus mechanism using PoS.

Permissioned blockchains already operate based on the trust of the institution that owns it; therefore, their blockchains do not require PoW to validate transactions. The institution (e.g., bank) provides the trust. The most important attribute of their blockchain application is security and efficiency. They can use a simplified version of PoS or dBFT or use very different kinds of consensus algorithms like RAFT, Paxos, or PBFT.

Even without the PoW or PoS consensus mechanism, the permissioned blockchain still has the following advantages:

• Privacy – only members have rights to view the transactions;

• Scalability – by not using the resource-intensive PoW, a permissioned blockchain can be easily scaled up; and

• Access Control – a permissioned blockchain can restrict access to the data within the ledger as the owner (bank) desires.

SETL, a London-based company, has created a permission-based blockchain settlement and payment system that can move cash and assets in real-time to settle market transactions.12 It maintains a distributed ledger of ownership and transaction records, simplifying the process of matching, settlement, custody, registration, and transaction reporting. The platform enables investors and distributors to easily subscribe and redeem fund units via a direct connection with the asset management company, thereby removing the need for the transfer agent, which in turn reduces transaction costs. The platform increases transparency, optimizes operational workflow, and enables the development of new value-added services.

In summary, the permissioned blockchain is a closed, private blockchain with an owner. It has a certain degree of centralization. In a way, permissioned and permissionless blockchains can be thought of in terms of a comparison of the Internet and an intranet. The Internet is a robust high-capacity global network for transmitting information within an organization. This enables many enterprises to make use of virtual private networks (VPNs), which use the Internet as a backbone but encrypt the organization’s traffic over these public pipes. VPNs allow enterprises to enjoy the Internet’s economy of scale while ensuring that their data is not visible to outside observers. One can imagine a comparable process playing out between the permissionless/public blockchain and permissioned/private blockchain.

1.5BITCOIN

As mentioned earlier, the concept of blockchain evolves from cryptography, a computer science discipline that focuses on encryption technology to ensure the security of data stored or transferred digitally. It has become more important since the volume of data generated and stored by humans has grown exponentially.

In 2008, a computer scientist named Satoshi Nakamoto wrote a paper to propose the use of cryptography to create a digital currency called Bitcoin.13 In his original publication, he envisioned a purely peer-to-peer version of electronic cash that allows sending online payments safely and directly from one party to another over the Internet without going through a financial institution.

In building the Bitcoin platform, he included several elements, including a digital signature, network timestamp, and hashing into a chain of blocks of data. Such a chain forms a record that is unchangeable without redoing the PoW. The basic concept of the blockchain technology was born. As long as a majority of owners in the nodes do not collaborate to attack the network, the data are safe.

The network itself requires minimal structure. Any computer on the Internet can be a node if it is running the Bitcoin software downloaded from Bitcoin’s platform. Nodes broadcast messages on a best effort basis – they are free to leave and rejoin the network at will. The functionality of the Bitcoin blockchain does not depend on a particular node, and this flexible structure makes the Bitcoin network easy to grow.

The blockchain encryption uses public and private “keys.” The public key is the user’s address on the blockchain. It is a destination that people can send Bitcoin to across the network. It is also where a transaction record is kept. The public and private key pair represent the ownership of the Bitcoin. The asset tied to the public key belongs to the owner of the public key. The private key is a password that gives its owner access to his digital assets. Consider the following analogy: a public key is like a post office box number and private key is like the key to open the box. The box itself can store valuable objects.

Another analogy is as follows: if the blockchain is a ledger book, the public key is the page number plus the line number where a transaction is recorded. By providing such information, one can immediately identify a transaction.

The pair of public and private keys is one entity, because the public key is generated from the private key by elliptic curve multiplication.14 The creation of a public key from a private key is a one-way process. It is impossible to recreate the private key from the public key. Protecting the private key is essential to protect the digital assets associated with the private key. Therefore, safeguarding the private key is critical to the possession of the Bitcoin stored in the corresponding public key. Many forms of “wallets” can safeguard the private keys. Figure 1.2 shows Bitcoin public and private keys in printed form.15

FIGURE 1.2 A printed Bitcoin Public Key and Private Key.

Even without considering all the current and possible applications of blockchain technology, the technology itself is a breakthrough in computer science. It is built upon more than 20 years of research in cryptographic currencies and 40 years of development efforts in cryptography by thousands of researchers around the world. Satoshi Nakamoto put the pieces together in a useful form. He incorporated all the essential elements into one place: the Bitcoin software.

Bitcoin is a solution to a long-standing issue with digital cash: the double-spend problem – a digital file cannot have any value as an asset because anyone can copy or duplicate it with minimal effort. Satoshi Nakamoto proposed a solution to the double spending problem in his original paper published in 2008.

He constructed the Bitcoin platform that hashes the transaction into an ongoing chain of hash-based Proof-of-Work, forming a record that cannot be changed without redoing the Proof-of-Work.

The ownership of Bitcoin is nothing more than the receipt or record of the transaction, which contains payer, payee, transaction time, and the amount. The payer and payee are represented by their respective public addresses. The transaction is recorded in the payee’s public address in the blockchain. You prove your ownership by showing your public key with a private key. Only the person who has the private key can spend the Bitcoin stored in the public key address.

After you spend the Bitcoin stored in a particular address, this address becomes invalid, because the Bitcoin in this address has passed to another address. You cannot use the same address again. This prevents double spending. The transaction is broadcasted to the Bitcoin network, much like you send a message in Twitter. A group of nodes called “miners” catch transactions floating in the network. They verify if the address is valid before accepting the transaction. If the address has been used as a payer in the previous transaction, the transaction is rejected.

When there are enough transactions to fill the block, the block is complete. The miner who completes a block first wins the race. Other miners stop constructing their unfinished blocks. There is only one winner per block. All other unverified blocks dissipate. Bitcoin nodes doubly verify the validity of all the transactions in the winner’s block before the block becomes official and is attached to the blockchain. There is little chance that the Bitcoin in an address can be spent twice. The transactions included in the block are eliminated from the pools of transactions in circulation in the Bitcoin network. The construction of the next block then starts. This process repeats every 10 minutes.

In the first quarter of 2021, the price of Bitcoin reached almost $60,000 and the market cap of Bitcoin grew to well over $600 billion, as shown in Figure 1.3.16 If we include Bitcoin Cash, which is a fork of the Bitcoin, the combined market capitalization is greater. This is the proof that the concept of Bitcoin proposed by Satoshi Nakamoto has enormous popularity.

FIGURE 1.3 Year-by-year Bitcoin price.

Today, more businesses accept Bitcoin as payment. In Japan, over 260,000 stores accept Bitcoin as legal tender. In the U.S., large, brand name companies also accept Bitcoin as payments, such as Whole Foods, Expedia, Home Depot, CVS, Subway, and Microsoft.

The main Bitcoin merchants processing solutions for vendors to accept Bitcoin are BitPay and Coinbase in the U.S. and Coinify in Europe. Mobile payment functionality for quick point-of-sale Bitcoin purchases will further stimulate a greater adoption of Bitcoin.

In Chapter 2, we discuss Bitcoin and how it works in much more detail.

1.6PROLIFERATION OF BLOCKCHAIN TECHNOLOGY

Blockchain technology has not only created many cryptocurrencies, but is also the foundation of fintech. Hundreds of applications are flourishing, and many of them will have a significant impact in the near future.

With such explosive potential applications, blockchain technology is in a pivotal phase. The activity is not limited to the startups, as a number of large companies, including financial, technological, and logistic companies, are embracing blockchain technology.

Today, cryptocurrency seems to dominate blockchain applications, however, digital currency is not the only application of blockchain. Hundreds of transactional applications are in development using blockchain technology. Some people consider it the biggest invention since the invention of the Internet itself.

The nascent blockchain industry is developing a new generation of transactional applications that establish trust, accountability, and transparency at their core while streamlining business processes and legal constraints. It is akin to an operating system for marketplaces, data-sharing networks, micro-currencies, and decentralized digital communities. It has the potential to reduce the cost and complexity of real-world transactions, and therefore greatly improves the efficiency of economy.

There is no lack of effort to introduce blockchain into financial applications. For example, Linux Foundation hosts an open source, collaborative software development platform, known as Hyperledger, in conjunction with the leaders in finance, banking, and the IoT, supply chains, manufacturing, and technology to develop the applications in their respective fields.17 This approach ensures the transparency, longevity, interoperability, and support required to bring blockchain technologies to mainstream commercial adoption.

R3, the largest blockchain consortium, raised $107 million from global financial institutions like SBI Group, Bank of America Merrill Lynch, HSBC, Intel, ING, Banco Bradesco, Itaü Unibanco, Barclays, UBS, and Wells Fargo to develop commercial applications for the MDL technology.18

Once again, the Internet has spawned the greatest value generating, revolutionary technological breakthrough since the invention of e-commerce (e.g., Amazon) and online advertisement through a search engine (Google). There is no reason to doubt that blockchain will not be able to give birth to giant companies on a par with Amazon and Google. In fact, there is every reason to believe that blockchain technology will make an even bigger impact on the world than search engines and e-commerce. Not since the invention of the Web itself has a technology promised broader and more fundamental revolution than blockchain.

1.7INITIAL COIN OFFERING (ICO)

Blockchain technology is creating a completely new financial market called the Initial Coin Offering (ICO). ICO is a process whereby the cryptocurrency companies sell their newly launched crypto coins. ICO bypasses the regulated capital-raising process required by venture capitalists or banks. In an ICO campaign, the early backers of the project buy a percentage of the newly issued cryptocurrency. The proceeds are to fund the company. The ICO process is also known as crowd sales. Ethereum, a company that developed a blockchain protocol, which can transact smart contracts in a distributed network, is a great success story of the ICO.

Much like the traditional angel funding, the startup company with a vision to create a business generates a project plan. The project plan includes a business plan with a whitepaper. The plan describes the project mission and vision, detail plan, execution strategy, technological approach, target market, potential applications, goals, risks, and its differentiation from other similar projects, funding needed for execution, number of new coins the founders keep for themselves, and the ICO campaign period.