Chapter 1

Blockchain & Ventre à Terre

“Sorry to be a wet blanket. Writing a description for this thing for general audiences is bloody hard.”

—Satoshi Nakamoto, anonymous creator of Bitcoin

When I first set out to describe blockchain in a simple fashion, I spent months poring over the original research papers: David Chaum’s 1977 dissertation, Satoshi Nakamoto’s 2008 white paper, Vitalik Buterin’s Ethereum whitepaper, and a list that could go on for quite a while., , I wasn’t satisfied. I extended my search to simplified explanations: an example of this was the University of California Berkeley’s 2015 “Blockchain Technology—Beyond Bitcoin” paper. Even YouTube videos such as “Blockchain Explained Simply” contained a surprising amount of chaos in comment sections. People didn’t seem to understand. Even if they did, they didn’t have the confidence to echo it back at others.

The realization during my research was this: we are not taught the concept nor logistics of ledgers, and because blockchain is just a radically futuristic ledger, the dilemma the majority of people encountered on their first attempt to learn about blockchain became rapidly apparent.

We know how to go to the gas station and purchase a soda, but we don’t really stop and think how this transaction is recorded by the gas station, the bank, and all of the intermediaries that take a slice of any given transaction. At best, the average person tracks how the balance in their account/ledger increases or decreases. We are stuck viewing the world using a single-ledger paradigm.

Understanding ledgers is the first step in comprehending blockchain. A ledger is a living record of financial transactions. You use ledgers every single day and other ledgers are at play other than your own account that are an integral part in confirming your own account balance in what I like to call the “ledger ecosystem.” Because truthfully, your current balance of $34,220 in your bank account is merely the sum of all the transactions that have been coming to and from your account.

The paycheck from your company adds +$832 to your account (of which the company’s ledger reflects -$832), the transfer to your PayPal account nets -$150 on your bank account (with PayPal’s ledger gaining +$4.99 for the transaction fee), and the outbound transaction to buy that Big Mac is -$2.32 (+$2.32 on McDonald’s ledger). Your own account balance you use every day is a simple ledger interacting with hundreds of other ledgers that are constantly reconciling and balancing with each other.

This is the starting point of understanding blockchain. We need to start viewing the world as hundreds of different ledgers constantly reconciling and balancing with each other, with many centralized ledgers of dollars being the centralized point of authorization and ownership. Additionally, not all ledgers are created equal. Some have more power than others. And this is true of not just banks, but any sort of mass data system. Databases (Facebook servers, Twitter, eBay, or Amazon) are merely ledgers of data instead of ledgers of dollars. All of these are centralized intermediaries that attempt to facilitate transactions between two parties.

With the current system, many ledgers are centralized in their control over many people’s dollars and data, introducing the risk of manipulation and distrust. This is why we have accountants and audits all the time (which are quite expensive). We come to find out that reconciling disputes between huge centralized ledgers is expensive. Centralized players do not like trusting each other. The whole system is built on a shaky system of trust.

“ . . . the duplicate and time-consuming post-trade processes that banks, brokerages, custodians and clearing houses undertake to reconcile multiple ledgers represent a very large cost of trust embedded in the existing system”

—Center of Economic Policy Research

A Decentralized Solution

But what if there were a way for truly peer-to-peer interactions between you and me or between businesses without any sort of human third party intermediary slowing down and sucking up value along the way? What if you and I truly controlled our own accounts? What if there were a system, backed by mathematics and cryptography, that everyone could trust as the facilitator of transactions in an entirely automated fashion that we know to be secured, auditable, and permanent?

That is precisely what blockchain does. Blockchain flips the centralized ledger paradigm on its head.

We now know what blockchain exists to solve, but what precisely is blockchain?

Blockchain is a decentralized ledger of transactions, accounts, and data secured by a decentralized ownership of the ledger, in which mathematics and cryptography are the digital law of the ledger. The maintenance and use of the shared ledger is made possible within the ecosystem using digital cryptocurrency as the medium of exchange, which is simultaneously the incentive for those who maintain and secure the ledger to continue to do so.

Instead of trusting a chain of centralized parties to backup, update, and verify your own transactions and your own wealth, we instead trust publicly visible coded protocols to manage and maintain our transactions. The digital laws of the ledger are built with mathematics—a perfectly neutral party we can all trust as the facilitator of truly peer-to-peer transactions.

What’s more is that the control of the digital ledger and its rules are made up of a decentralized community—stopping any single party from manipulating the rules of the ledger or the ledger entries. Because everyone has the same copy of the ledger, it becomes easy for protocols to spot anyone who attempts to manipulate the ledger.

In the end, leveraging public-key cryptography (the same stuff that makes the internet work) allows everyone who uses this decentralized ledger to now make peer-to-peer transactions without the need to be reliant on multiple intermediaries to make a simple transaction possible.

How Does Blockchain Work?

You’re with a group of friends and you decide to loan ten dollars to your friend Austin. Your two friends Dakota and Tony see this transaction take place and take note of it mentally. A week later, Austin pays you eight dollars and says, “That’s how much I owe you.” Naturally, you are upset! What is the proof that Austin has returned the wrong amount? Dakota and Tony back you up: “It was ten dollars—we were there when you made that transaction.” As a friend group, the accepted consensus is that Austin owed you ten dollars, not eight. Your group has created a pseudodecentralized ledger in which each party is cross-checking to make sure the record of transactions is kept fair and balanced.

Also known as a Decentralized Ledger Technology (DLT), blockchain is a system of record keeping in the form of a digital ledger.A blockchain has the following set of properties: the ledger is distributed, shared, immutable, and composed of cryptographically linked entries in the ledger that take the form of “blocks.” The protocol—the coded law that controls how the transactions and balances are maintained and executed on the ledger—is designed to continuously build consensus on what the shared ledger contains at any given moment.

Your friend group of twenty people decides to make its own currency. We will conveniently call this currency “cryptocurrency.” You’ve decided the only way anyone is allowed to transact with each other is if everyone is present for the transaction, and the majority of the people will allow the transaction to be made. Everyone records the same transaction on their own personal ledger. Using this system, everyone has an identical ledger, and consensus is maintained. If Tony purchases an item for ten dollars from Dakota, all twenty people will record this transaction in their own ledger.

If anyone attempts to change their balance on their ledger from ninety to one hundred dollars, the next time they attempt to trade or transact with someone else in the group, all other parties individually own their own identical “shared” ledgers that point to the fact that the individual does not have a ledger that matches the rest of the group. Because the group catches a mismatch in ledgers, the person is then punished with some sort of fee and is not allowed to trade with anyone else until they adopt the ledger that the rest of the group is using. This is another feature of blockchain: it eliminates the danger of any single party manipulating the ledger in their favor—creating a more secure network of transactions than a traditional centralized system.

We have highlighted the following valuable features of a blockchain ledger: consensus, enhanced security, corruption resistance, distributed ledger (by design), and decentralization of power. This leaves the following features of decentralized ledgers: immutability, auditability, and permissionless participation to be examined and explained.

The Perfect Data Fingerprint

The council of twenty friends decides to sit down and figure out a way to make the process of seeing if everyone’s ledgers match easier. You are three years in, and what was once a small notebook for a ledger has now turned into a thick dictionary of transactions. People are concerned a majority of the twenty individuals could collude to make a series of changes in the ledger from the past and have that corrupted ledger become adopted, robbing the innocent and enriching the nefarious actors.

What if there were a mathematical way to ensure no entries in the past could be changed? This guarantee would give the decentralized ledger the property of immutability. What’s more, could that mathematical surety become a part of the protocol “law” that automatically and “trustlessly” ensures no one can game the system?

This is where the power of programming and mathematics crosses over. A “hash” function is the perfect mathematical solution to this exact problem. Hashing is the algorithmic process of turning a given set of data into a unique digital fingerprint in the form of a perfectly unique string output. This function works no matter how big or small the data input is. Tom Scott, a web developer and owner of the famous YouTube channel “Computerphile,” explains it as follows: “A hash algorithm is kind of like the ‘check digit’ in a barcode on a credit card . . . The last digit in a barcode on a credit card is determined by all of the others digits.”

An example of using Secure Hashing Algorithm 256 (SHA-256) is as follows:

Figure 1: SHA-256 Hashing Example

Figure 2:SHA-256 Hashing Example with Changed Input

“[Austin = $10 Carter = $5 Tony = $20 Dakota = $173]” as input.

SHA-256 hash of the input = 19409681d75421fd47fa76f9eb0c47051af27a9a64fcbcabaafc4a06d9c3b03c

“[Austin = $10 Carter = $5 Tony = $20 Dakota = $100]” as input.

SHA-256 hash of the input = 1dfcffc46e60f433d29381efe48e798efd402c7d70ab998591f4f859cdac5b6c

Any changes to the data, in this case Dakota’s total money as $100 instead of $173 (sent in as input to the hash function), produces a drastically different fingerprint. That is remarkable. You could enter a one hundred thousand-page dictionary into a hash function, and if someone changed even a single word in the dictionary or character anywhere in the dictionary, the output will be visibly different than the original hash of the entire dictionary. This is jaw dropping. It is utterly shocking—the type of fact that makes me pause and ponder the beauty of mathematics and research that makes this possible. Hashing gives a mathematical guarantee; a way for computer systems and people to know with 100 percent confidence that a given set of data has not been tampered with in any capacity.

Before we incorporate “hashing” into our circle of friends, we need to think about the difficulties. Hashing an entire ledger or dictionary of transactions takes a significant amount of time. What if a quicker way existed? This is where “blocks” enter the playing field. We make a simple rule. No one is allowed to go back into the history of the ledger to change any records. If you break this rule, it will be easy to spot.

Here is how: Everyone starts a new distributed ledger, same as before. Every page of this new ledger contains a set of records and account balance updates. When a new page or “block” is created, the hash of the previous page of data is stamped onto the new page. We do this again and again as more transactions and pages are added to everyone’s identical ledgers/books. This means every new page contains a perfectly unique fingerprint created by the fingerprint from the previous page of the ledger.

Example 3: Chain of Fingerprints

You cannot recreate these “hashed” fingerprints on each page unless you have an identical history of data and fingerprints from all of the previous pages or “blocks.” This is the guarantee generated from these blocks/pages “chained” together using a hash function. Thus, the name “blockchain” is used.

This chain of records, known as blockchain, is a mathematical guarantee that gives an extremely convenient method for checking that the decentralized digital ledger has been unaltered. Instead of comparing every single page and entry, we now have a single value on the most recent page of the ledger all twenty friends can compare with. Simply compare the most recent hashed page of transactions. No human party needs to be trusted with making an error during the check. It’s math. One plus one equals two. Forever and always. Trustless trust.

This mathematical guarantee, in combination with the design of decentralized ledgers, creates trust—simultaneously giving the property of both immutability and auditability. The blockchain is immutable because the past financial records cannot be altered without destroying the chain of fingerprints, and thus the validity of any nefariously changed ledger (in comparison to the agreed-upon distributed ledger everyone else is using) is destroyed and ignored. Because the past is unalterable, you can easily flip through the pages/blocks of the ledger and observe the entire perfect unaltered history of transactions and balances within the ecosystem. Zero arguments result about who traded with whom and for what amount. All transactions are in the blockchain ledger. Publicly visible. Perfectly auditable. Concrete in immutability.

Finally, what does it mean for blockchain to be permissionless? Simply put, anyone can join your circle of twenty friends. Anyone can trade with anyone. You are free to transact within the rules of the protocol. In a digital sense, this means anyone with an electronic device, internet connection, and a “wallet” (of which there are many) connected to your favorite blockchain allows you to immediately participate in an entire ecosystem. This setup is as simple as downloading a browser extension or installing an app on a phone that is designed to be integrated into a blockchain. You are permissionless in that you have complete agency separate from any centralized authority. There are no complex forms to be filled. No credit scores. Nothing. You can jump straight into transacting with others in a peer-to-peer fashion.

What does this look like tangibly? Well, I am two clicks away on my computer from opening my secure crypto wallet on a Chrome browser. This crypto wallet is also on my phone. The user interface is no different than Venmo; I can interact with websites, games, and apps that are integrated on a blockchain, all of which are designed to take advantage of the properties of blockchain. I can send cryptocurrency anywhere, to anyone in the world, at any time: peer to peer, whenever I want. I can use decentralized exchanges that are entirely automated and out of the control of a single party. I can take out collateralized loans in a blink—no paperwork. I can partake in derivative markets from scratch in a couple of seconds using Augur. I can purchase from traditional stores with crypto—over fifteen thousand vendors globally accept cryptocurrency, including Wikipedia, Microsoft, Expedia, AT&T. I can digitally tip an author of an article I like. And the list goes on.

This is all seamless, all integrated on the blockchain, and none of it looks wildly different than our current web browsers. You will still have your phone apps and your websites. What is different is the degree of freedom and functionality you have by simply having a crypto wallet. Anyone with an internet connection can start one—zero paperwork.

What characteristics of blockchain are the catalyst for this greater degree of freedom and functionality? Consensus, enhanced security, corruption resistance, distributed ledger (by design), decentralization of power, immutability, audibility, and permissionless in nature are the fundamental components that give blockchain technology (and by extension cryptocurrency) intrinsic value. These are the attributes that separate the systems that can be built with decentralized ledger technology, or blockchain, in contrast to many of the centralized systems that exist today.

Welcome to a decentralized future.

Decentralized Value

Blockchain at its core is a digitally distributed record-keeping system in which any individual in the world who has an internet connection can partake in updating and verifying these shared digital records.

With digital banking, you have an account number with a balance. Anytime you make a transaction, the bank updates the centralized ledger by keeping track of the exits and entries of your digital cash movement and changing your overall balance accordingly.

Traditionally, in order to be able to send money to someone else or transact between parties, a series of links are set up: your bank to PayPal or a debit card, and then that information entered on a centralized platform such as Amazon or eBay. If a customer purchases from another customer, banks down the chain must communicate and complete the transaction on their own ledger after leapfrogging from the platform facilitating the transaction.

Figure 3: Centralized Ledger

Instead of trusting a chain of centralized parties to backup, update, and verify your own transactions, we instead hand over control of the digital ledger to a decentralized community, making all transactions peer to peer, updating the shared ledger universally instead of funneling through a series of centralized intermediaries.

Figure 4: Decentralized Ledger

No longer do you need to hand off the question of “one plus one equals what?” to the bank. You don’t even need permission from the bank to ask that question! Instead, you have agency and control over how much cryptocurrency you will send and where you will send it. The decentralized group of nodes that support the distributed ledger answers “one plus one equals two” as a collective unit—drowning out any single nefarious actor who attempts to answer with “three” instead. This contrasts with a centralized ledger, which could answer “three” without any challenge, damaging your personal ledger and trust in the system.

What makes this shared ledger valuable from a business perspective? The distributed ledger is valuable because it is publicly maintained, agreed upon, and decentralized in its ownership. In the twenty-first century, the majority of records are maintained, updated, and sold by a single party.This is expensive for anyone who needs to use the records held by a centralized party, and leads to trusting a human organization to be ethical and consistent with the data. In addition, centralized players have a hard time trusting other centralized parties’ ledgers of data. Lo and behold, even the biggest players don’t trust each other!

Let me paint a picture. You open your bank account and attempt to wire $50,000 to your “friend” in South Africa (looking at you, Nigerian prince email scammers). The transaction gets flagged and blocked by your bank. In addition, something went wrong. The money was accidentally subtracted from your account. You then engage in a long legal dispute in which you attempt to prove ownership of the money with receipts and checks to a court. The bank’s ledger gets final say, and you are left grappling with the ramifications of never truly having control of your own money.

There are a couple of frustrating pieces at play here. Why can’t you send your money anywhere in the world to anyone? Why do you have to prove ownership to someone else who is merely the custodian of your assets? Why do you have to interact with so many third parties in the process of attempting to prove what you own and what you were trying to transact?

What happens if we were using a blockchain for this transaction instead? You would simply open your digital crypto wallet (of which there are many) and send $50,000 worth of Bitcoin to your friend’s public wallet address (similar to a mailbox, but on digital highways instead). In the process, you would incur a micro fee to pay the decentralized nodes on the blockchain network that facilitates the transaction. The transaction will either happen or it won’t—binary in its execution.

No gray area and no possible transaction limbo exist. Either your assets are transferred, or they are not, all of which is recorded publicly on the blockchain. There is no need to go to a third party. Your ownership of the assets is already recorded on the blockchain, just as your transfer of ownership to your friend in South Africa is recorded onto all of the identical decentralized ledgers distributed globally.

This is all seamless: no single third party and no centralized ledger. Your decision to transact was permissionless. The ability to control what you want to do with your own assets was not contingent on a third party. The power was entirely in your hands—facilitated by a decentralized network.

Gears and Levers

Now we rewind the clock. How was that transaction possible? If every transaction is added to the chain of records, and everyone must be on the same page for a decentralized digital ledger to work, how in the world do we come to a conclusion as an entire group?

The answer is once again “consensus.” There are hundreds of thousands of nodes, or computers, that all have the same copy of the digital ledger. Whenever someone wants to make a change to the ledger, more than 50 percent of this decentralized network must agree to make the change. This is no different than an election, and much of the economic groundwork reuses the principles of normal elections.

This should be slightly alarming to you. Couldn’t someone arbitrarily set up an enormous number of nodes and take control over more than 50 percent of the network? If the network has the attribute of being “permissionless,” indiscriminately allowing anyone to join in on maintaining the ledger, how would this attack be stopped? If the majority of the network decides a certain crypto wallet should move an asset from address A to B, then that is precisely what will happen—with or without the wallet owner’s consent.

This is called a Sybil attack. It is known as a “51 percent attack.” This was the final problem in the blockchain space to be solved before a blockchain could truly exist. What is stopping someone from forging multiple identities to influence the consensus process?

This is where the brilliance of the anonymous Satoshi Nakamoto, creator of Bitcoin, bridged this torrential issue in 2008. You see, up until 2008 a huge number of the components to make a blockchain reality were researched and possible to implement. The 51 percent attack was a fundamental bottleneck that remained to be solved. How do we stop a Sybil attack? How do we stop people from gaming the consensus system?

What Satoshi Nakamoto realized was that no cost was attached to gaming the consensus system. Game theory made it easy to break consensus. A finite resource that has real-world value needed to be sacrificed in return for the ability to publish a set of transactions to the chain of records.

Nakamoto solved the problem by engineering a solution known as the proof-of-work consensus model (PoW). In order to propose a transaction or change to the digital ledger, a price must be paid to the network in the form of computation power, or electricity. Computation in PoW is spent on solving a puzzle that takes a significant amount of electricity to solve. This is where the term “mining” was introduced. Anyone can strike gold and solve the puzzle, but those who commit more resources are more likely to hit a vein of gold.

Figure 5: PoW Mining

Ultimately, the goal of this mining incentive-cost system is that no one entity can, over time, take over record updating (block production) because of the vast amount of resource consumption required. What is more, the number of wallets or identities that were created on the blockchain no longer mattered—consensus was now based on a cost. Proof-of-work does not pay nefarious actors, only those that contribute to the continued success of the ledger. Using the proof-of-work consensus model, blockchains could finally be permissionless while simultaneously containing strong deterrents against malicious attempts at breaking consensus.

The most brilliant detail Nakamoto devised is that the difficulty of the puzzle is automatically adjusted based on the total amount of computation power attempting to solve the puzzle—the more nodes solving the puzzle, the more difficult the algorithm becomes. When the puzzle is solved, the block (or page) of transactions the “miner” is attempting to add to the ledger becomes the de facto newest block appended onto everyone’s ledger. A ledger/miner refusing to adopt the newest block would be ignored—the “hashed” fingerprint on the most recent pages would no longer match all the other identically distributed ledgers.

By only having one block/page of ledger updates be added at a time (roughly every ten minutes for Bitcoin), another problem is solved—time-stamping problems. If more than one block could be added at the same time, the “double spend” problem would result. If a user submitted two outbound transactions from their balance using the same set of Bitcoin on the ledger and sent this to two different blocks at the same time, we’d encounter an issue of ordering. One of those transactions should be allowed through, and one of them not, or else the user gets to “spend the same dollar twice” and break the fairness of the cryptocurrency. By only having one block of changes made to the ledger at a time, the blockchain design solves the “double spend” problem by having the protocol automatically check for double spending within the single proposed block, while not having to deal with the timestamping conflicts if multiple blocks were allowed to be appended at the same time, which is impossibly difficult.

But what if this newest single page/block is nefarious? What if all the other “pages” of the ledger are correct, except the most recent block proposed?

This is where public-key cryptography saves the day again. Every crypto wallet/address has a private key—similar to a Social Security number or your fingerprint. Whenever a transaction is made outbound from the address/balance, the transaction must be “stamped” by this private key in order for the transaction to be accepted into the proposed block. Essentially, it’s mathematically impossible to get away with “stamping” an outbound transaction with a fake private key. The protocol verifies that the owner of the address signed the outbound transaction with a private key. If not, the proposed block is immediately ignored and tossed out. The bad actor loses money in the form of wasted expenditure on electricity and may become “white-listed” and ignored by the rest of the network: a permanent punishment dealt by miners who truly support the blockchain.

I should note that, within the consensus system, the modified SHA-256 puzzle algorithm creates a lottery dynamic in which someone who has one “vote” can absolutely solve the puzzle versus someone with ninety-nine “votes’” worth of computation power. This is simply to say the answer to the puzzle is randomly distributed using elliptic curve cryptography, and this randomness cannot be gamed. More computation will increase the frequency of winning, but the distribution of the solution to the puzzle is still random.

The proof-of-work consensus model to date has worked perfectly—534,500,000 transactions exist on Bitcoin’s blockchain, with over thirteen thousand new transactions appended per day to the Bitcoin ledger., The more individuals transact on a blockchain, the greater the native cryptocurrency of the respective blockchain is priced. A high price incentivizes more miners to attempt to solve the puzzle and be the miner that submits the new block to the ledger. The reason for this is twofold. Miners that solve a puzzle and publish the newest-appended block to the to-be-adopted ledger earn revenue in the following ways:

1.Rewarded the transaction fees from everyday people like you and me who want to trade, transact, or update the ledger in some capacity

2.Rewarded automatically by the protocol a certain amount of cryptocurrency for each puzzle solved and new block submitted

This creates ferocious competition among miners to be the selected miner. The more individuals compete to be the winning miner, the more decentralized the consensus becomes and the more secure the network is. A beautiful side effect of price increasing for any cryptocurrency is it encourages more miners to attempt to solve the puzzle, ultimately securing the ledger. This is because it becomes more expensive to game the system with more competition while simultaneously increasing the decentralization of the network by having more nodes with their redundant copy of the universal ledger sustaining the decentralized ledger.

Transaction

But what if I don’t want to pay these vast electricity costs to attempt to solve the puzzle and have my transaction posted to the blockchain? What if I just want to transfer or transact with my cryptocurrency like how I use PayPal?

This is precisely where “miners” come in handy! First, you submit your transaction to the “pending transaction pool.” This pool is where your transaction is verified as legal by the protocol’s definition. Along with your submission to this pool, you set a reward for any miner who publishes your transaction. Picture this as a pizza tip in which all the drivers in the area know how much you are going to tip (versus someone else). Those who submit higher “tips” are going to have their transactions published sooner.

Multiple miners will pick up your transaction if they deem your tip adequate and add it to the “block” of transactions that the individual miner is attempting to add to the ledger. A Bitcoin “block” can contain five hundred transactions. Different blockchains, such as Bitcoin Cash, have larger block sizes, allowing more transactions to be published to the ledger per block. If the miner solves the puzzle, the new set of records is appended to the currently agreed-upon chain of records, and the miner is automatically paid the “tips” as well as a protocol reward of cryptocurrency for solving the puzzle to compensate for computation costs. Voilà! Your transaction is now submitted and etched into history, and the miner walks away a happy camper.

You now have a firm grasp of how this complex but beautiful beast known as blockchain works. Other consensus models other than proof-of-work are used by different blockchains. Despite some trade-offs to these (proof-of-stake, proof-of-authority), ultimately all of these consensus models exist to give the blockchain the valuable attributes mentioned earlier.

Consensus, enhanced security, corruption resistance, distributed ledger (by design), decentralization of power, immutability, audibility, and permissionless in nature are what make cryptocurrency and blockchain valuable. As we eventually turn to cryptocurrency as an investment, these valuable principles of decentralized ledger technology will be used in various apps and businesses to solve the problems of the present and future.

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