What is blockchain? Do we missunderstaned it?

One of the frequently used terms within the crypto community is the word “blockchain”. In recent years, it has started to be used more and more often outside the financial sphere, and technology enthusiasts are trying to incorporate the technology behind this term into various digital and physical products. The main idea behind blockchain technology is to decentralize control over data.

At its core, blockchain technology is simply a distributed database to which new transactions are added in the form of blocks. This information is sealed using cryptography, and the blocks are linked in time sequence via hash values. After the bitcoin network successfully accomplished this, a large number of programmers began to look for other potential applications of this technology. The very idea of block chaining originates from the previous millennium, and it was related to time-stamping documents. The first practical use of this idea appeared with the creation of bitcoin in 2009. Satoshi Nakamoto used the technology as a mechanism for achieving mutual consensus between nodes in the network. The charm of his invention is not only the achievement of consensus, but the mechanism that ensures it.

CONENSUS

In order for the network to reach consensus on a new block of transactions, Nakamoto incorporated the 256 cryptographic algorithm into the blockchain technology, which ensures that miners must use a sufficient amount of computing power to calculate the hash value of the new block. At first, new blocks could be mined using traditional computer chips, but then the difficulty of mining gradually increased, which required the use of graphics cards, and finally led to the invention of very specific computers that are optimized only for computing SHA256 (secure hashing algorithm 256) of cryptographic formulas. This means that a special supply chain has developed in which many companies compete to build ever more powerful computers whose sole function is to mine bitcoin.

Mining computers use enormous amounts of electricity to operate, a common observation by opponents of bitcoin technology, saying that the network consumes too much energy and thus harms the environment. The truth is that computers themselves have no more emissions than all other electronic devices, as they do not emit carbon dioxide, but only heat. They buy electricity from the grid, just like all households and businesses, and in the process finance power plants that are discovering more and more efficient ways of generating electricity.

The consumption of electricity converted into cryptographic energy through the SHA256 function represents this Proof -of-Work mechanism. This mechanism ensures that no one on the network can cheat when mining new bitcoin blocks, because for each block calculated, they have to spend a large amount of capital dedicated to mining equipment and paying bills for electricity consumption. Since the electricity is obtained from natural energy sources, this ensures that no miner can calculate new blocks without cost. The proof-of-work mechanism thus represents a bridge that connects the bitcoin digital network to the material world, since changing information in the blockchain requires energy obtained from material resources. This helps us understand why the Bitcoin blockchain is so resistant to external influences, as it cannot be tampered with by anyone without having to invest a huge portion of their wealth in the mining process.

Wealth alone does not provide an individual with any decision-making power. The decision-making power comes from the total amount of hashing power possessed by the individual mining computers. With this power, the individual competes with the entire mining network, whose computing power exceeds the computing power of the entire global computer network. It’s true – Bitcoin’s total hashing power on the network exceeds the hashing power of all the other computers in the world combined.

In addition to the difficulty of the mining process, the network is protected by a social layer of protection. The nodes connected in the network determine the version of the bitcoin software in use. The only way to achieve a radical change to the Bitcoin protocol is for the majority of nodes in the network to adopt a revised version of the software and broadcast it to the network. This achieves a consensus on which version of bitcoin is in use. This means that nodes will not accept a version of bitcoin that they believe poses a threat to their assets.

NETWORK SCALABILITY

Forking the main blockchain is the only way to upgrade the network, since the software cannot be changed once the blockchain was published. A fork creates two separate chains that share a history of blocks and transactions. Nodes in the network then voluntarily decide which version of the chain to manage. The version with the most users becomes dominant, forming a consensus. There are two ways to split a chain: soft fork and hard fork.

A soft fork is merely a proposal to improve the code, which is backwards compatible and does not create a new cryptocurrency. The newly formed chain is consistent with the fundamental parameters of the network. Nodes decide whether to update their software to the new version and thus determine the success of the upgrade. If the improvement proposal gathers enough support from miners and nodes within a certain time, it takes over most of the mining power and reaches consensus, and the old chain is terminated. Otherwise, the new chain is terminated. A soft fork is similar to upgrading the operating system on our Apple phone, where the phone remains within the same ecosystem and only the software is updated.

A hard fork is a fundamental software change that is not compatible with the old version of the chain. It creates two completely separate chains with different cryptocurrencies competing for supremacy. They differ in the fundamental parameters of the network, such as the mining algorithm, block size, coin supply, etc. A hard fork is thus similar to trying to exchange our Apple phone for a Samsung phone with a new operating system. The new version is not compatible with the old one.

Many cryptocurrencies, such as Bitcoin Cash and Litecoin, are merely hard forks of the Bitcoin chain. Their market capitalization and amount of mining power, however, determines their performance. Bitcoin remains the most powerful and largest computer network in the world without experiencing a single successful hard fork. This illustrates its resistance to fundamental changes in the main parameters of the network. In the past decade, we could witness many attempts to change the bitcoin “constitution”, but without success. Its community is aware of the importance of the integrity of the network and the randomness of its creation. Any fundamental change would pose a potential risk for further changes that could harm its users.

BLOCKCHAIN: YES OR NO?

As can be concluded from the previous paragraph, ensuring consensus within the bitcoin network is extremely expensive and energy-consuming. This is the price that must be paid to establish a completely independent, decentralized information system, which certainly cannot be tampered with by anyone without following its rules. Many wonder if there are other applications of blockchain technology that could potentially be better than the existing bitcoin. Thus, many developers and investors began to invest in the development of various ways of using the distributed blockchain data chain. In doing so, however, they encountered a number of problems posed by avoiding the centralization of the database, which in the vast majority of cases raised the costs of the blockchain beyond its actual benefit. The only truly beneficial use of blockchain where its benefits far outweigh its costs is the bitcoin network. The creation of an independent monetary system, resistant to the intervention of the authorities and other external influences, is important enough to justify the distribution of the accounting book among its users and demands a high consumption of electricity.

A problem that arises with other applications of blockchain technology is that it is extremely difficult to achieve decentralized consensus despite the distribution of the database among users. In order for users to agree with each other, it is not enough to provide them with the right to vote, but we must equip this right with material costs. If we do not provide this, a group of users may accumulate a sufficient amount of decision-making power to obtain a majority decision-making right. The only way to prevent depraved human nature from interfering with the monetary system is to bind this process to mathematical and physical laws, which are immutable to us. Since this is extremely expensive, we have two sensible options: choose a decentralized blockchain and accept the high administration costs, or choose a more affordable and efficient centralized database. Our decision is based on the importance of the problem we want to solve.

So far, we have not discovered a problem that would justify the use of a decentralized database with a proof-of-work mechanism whose costs would not exceed the benefits, except for the creation of a monetary protocol. It is also possible to implement a blockchain with another consensus mechanism, but only this one combines the worst features of both systems in the vast majority of cases. Not only is it inefficient and expensive, but a blockchain with another consensus mechanism very quickly falls victim to the centralization of decision-making power.