How the Byzantine General Sacked the Castle: A Look Into Blockchain

Blockchain IS NOT Bitcoin

Blockchain is a distributed ledger of immutable digital records saved in a chain of units called blocks. This distributed ledger is a database which is a consensus of replicated, shared, and synchronized data spread over multiple sites, countries, and institutions. A new block contains cryptographically hashed data and is built upon the previous block in the chain, ensuring that the data in the blockchain cannot be compromised. Blockchain is the technology powering bitcoin (1BTC ~ $419) and should not be confused as bitcoin. However, throughout this article, we will use the bitcoin blockchain as an example of how the blockchain technology works. Recently, it has gained momentum in technology and banking sectors and promises the potential to power many organizations in the near future. For example, the Depository Trust & Clearing Corporation (DTCC), the organization that settles and clears all transactions for the U.S. stock market has asked the entire financial industry to collaborate on creating and adopting blockchain technology to monitor, manage, and record all U.S. stock market transactions. So if you trade stocks, blockchain could be the technology that ensures your transactions happen properly. The technology also extends beyond the financial industry. Recently, Deloitte published a report on potential use cases for blockchain that included examples for the public sector, media, and insurance industries[1]. While these are visions for the future, there are already non-financial companies using blockchain to operate businesses ranging from art to real estate. In fact, any instance requiring securely recorded and maintained transactions is a use case for blockchain. In 2015 alone, Wall Street and venture capitalists invested $488 million into blockchain technology. Netscape’s cofounder and prominent venture capitalist Marc Andreessen believes bitcoin’s blockchain protocol is the most important technological advancement since the internet itself. So what is blockchain and why is it so revolutionary? How big is the industry getting? Is the technology secure? What are its limitations? Though blockchain may not be on your radar yet, it will likely cross your path in the near future, whether you are focused on business or technology.

The Roots of Blockchain

Blockchain provides a solution to the Byzantine General’s Problem. In this problem, several army factions surround a castle they hope to sack. A general leads each faction and one general is the lead general (crown, figure 1). Only a simultaneous attack ensures victory. Also, since the factions surround the castle, they are dispersed, making centralized command difficult. The generals must send messages between the factions to relay the attack time. However, some generals are traitors and will not obey the command and worse, will relay the wrong attack time to the other generals. The generals do not know who is loyal and who is a traitor and there is no way to find out. So, how do the factions ensure a coordinated attack to sack the castle? Let’s apply this scenario to the blockchain. In a distributed ledger, any inputs (the messages) to the ledger (the agreed upon time of attack) must be trusted. Digital networks usually have millions of members (the generals) who are dispersed globally and there is no centralized command (no central governance), and it is impossible for you to know all the members. So how can you trust the other members of the network and ensure that the inputs to the distributed ledger are accurate and moreover, ensure that the ledger itself has the correct information? Blockchain solves this problem and in the case of our Byzantine general, ensures that he can send trusted messages and lead a successful coordinated attack.

Figure 1. The Byzantine General’s Scenario

Why is Blockchain revolutionary and how does it work?

How often have you wished you could, “get rid of the middleman”? Ideally, the middleman ensures a transaction is done honestly and one party receives the goods/services that another party pays for. Typically, the middleman requires some percentage of payment from the transaction to ensure a trusted exchange. Blockchain has the potential to remove the middleman while providing a trusted exchange. Therein lies the true power of blockchain:

  • Decentralized, self-governing network (no middleman)
  • Trusted network despite a lack of central governance

Since bitcoin is the most prominent use of blockchain, let’s examine the bitcoin protocol to help us understand blockchain. In fact, the decentralization and self-governance of bitcoin is only possible because of blockchain. Just as banks maintain a transaction ledger, the bitcoin blockchain maintains a digital ledger (imagine a database of all recorded transactions) that has recorded every single bitcoin transaction of every single bitcoin in history and updates this ledger whenever new transactions occur. A copy of the bitcoin ledger is distributed on a network of computers (nodes). In order for any updates to be made to the ledger, each node must agree on the proposed update. So how does this process happen?

If I want to pay you for a transaction using bitcoin, we both need to have a bitcoin wallet (software which connects to the bitcoin ledger). My bitcoin wallet tells the ledger to record the transaction of removing bitcoin from my wallet and adding the corresponding bitcoin into your wallet. For this update to take place, every network node (computer) examines the existing ledger to ensure the transaction is legitimate (i.e. do I actually have the bitcoin I want to give to you?). Once the node verifies the legitimacy of the transaction, it becomes part of a queue of other verified transactions and this queue forms the next potential block in the blockchain. In order for the new transactions to be approved by the network, the nodes try to solve a computational puzzle known as ‘the-proof-of-work’. Nodes that try to solve the puzzle are called ‘miners’. Once a miner solves the puzzle, it sends the solution to the rest of the network for verification. If the solution is verified, the new block is added to the blockchain. Figure 2 is a diagram of the process. Imagine transactions 1–6 are the latest transactions that will form a new block in the blockchain. Each individual transaction can be considered a string of characters and undergoes a cryptographic hash function generating a hash value. These individual hash values are then combined in a Merkle tree sequence and go through subsequent hash functions ultimately forming one hash value for the set of transactions that make the new block. The computational puzzle is then performed on a character string that is a combination of this new hash value, the hash value of the previous block, a timestamp, and a cryptographic nonce (more on this in the next section). When the solution to the puzzle is validated, it becomes the header of the new block in the blockchain. Since the new block must be approved by the entire network it is a trusted addition to the ledger and the header authenticates the accuracy of each block. The ledger itself is a chain of these trusted blocks, so the entire ledger is also trusted.

Figure 2. The Bitcoin Blockchain Protocol

Is the Blockchain Secure?

Blockchain security is essentially the security of the distributed ledger. Can the ledger be altered or ownership of the ledger items be changed? The key to blockchain’s security is reaching consensus across the blockchain network (in which the parties do not know or trust each other) through the process of mining. Mining is what makes blockchain nearly unhackable. Despite the several hacks on bitcoin, its ledger has never been hacked. What has been hacked are the websites or wallets exchanging bitcoin. For example, Mt. Gox, was one of the largest bitcoin sites ever hacked, but the bitcoin ledger remained intact. Once more, we’ll use the bitcoin blockchain to exemplify the process of mining. Bitcoin’s blockchain achieves consensus through sequential cryptographic hashing of the transactions and the final ‘proof-of-work’ validation. A cryptographic hash function takes a message (transaction value) and converts it into an alphanumeric value. Hash functions are nearly impossible to invert thus the input value of a hash function can never be determined from its output value. Also, a small change to the input dramatically changes the output. In a blockchain protocol, the header of the latest block is a combined hash value of the set of latest transactions. To this combined hash number is appended a random number called the nonce.

The goal for the miners is to find a nonce value that provides a hash output which fits the rules of bitcoin’s blockchain protocol (figure 3). Once a miner finds the nonce that satisfies the protocol, it sends the solution to the network for validation, upon which the block is added to the chain . The nonce is found through trial and error and requires tremendous computing power. For example, if the rule in the protocol is that the output hash must begin with ten zeros, it would take 10¹² trials before finding a nonce satisfying the rule. In fact, solving for the nonce requires so much computing power, the miners actually compete with each other to solve it and the winning miner is incentivized. When bitcoin was first introduced, the miner(s) solving the ‘proof-of-work’ was awarded 50 bitcoin. There are other safeguards to the bitcoin blockchain, but the sequential hashing protocol and the ‘proof-of-work’ make hacking it nearly impossible. There are other consensus protocols to alternative blockchains. None have yet achieved the scale of the bitcoin blockchain but these alternatives promise greater speed, larger data capacities, different consensus methods and more advanced functionality. Leading this charge of alternative blockchain protocols are Ethereum, Ripple, NXT, Open-Transactions, Steller, and Hyperledger.

Figure 3. Hash functions and the use of nonce in the bitcoin blockchain mining process

The Growing Presence of Blockchain

Blockchain Capital was founded in 2013 and is a fund dedicated to scouting and investing in blockchain technology companies. In its first three years, the firm has invested in 37 such startups. In 2015, bitcoin and blockchain companies received a total of $1 billion in funding and currently, there are more than 120 blockchain based startups. Funding is not only being offered by boutique investment firms like Blockchain Capital, but also by some of the most prominent names in venture capital and industry. Last year, Coinbase, a bitcoin wallet and exchange raised $75 million in series C funding led byDraper Fisher Jurvetson (DFJ), one of Silicon Valley’s most respected VC firms. Other notable VCs investing in the round were Andreessen Horowitz and Union Square Ventures. The institutional investors on the deal were perhaps even more significant. The New York Stock Exchange (NYSE) became the first traditional financial institution directly investing in a bitcoin related business. The round also included investments from banks including USAA and personal investments from financial industry luminaries such as Vikram Pandit, the former head of Citigroup. The Distributed Ledger Group (DLG), led by R3, a firm that designs and develops advanced distributed ledger systems for the financial sector, now includes 42 of the world’s largest financial institutions all collaborating to develop new uses for blockchain. This February, forty consortium members completed testing blockchain’s capabilities in executing ‘smart contracts’, or coded business rules enabling completion of transactions without human intervention. The main goal of the testing was to enable CIOs to develop the criteria needed to evaluate blockchain technologies offered by competing vendors. Amazon, Microsoft, and IBM provided the cloud infrastructure for the tests. IBM also offered its blockchain solution along with Eris Industries, Ethereum, Intel, and Chain. Beyond these efforts, several leading companies (figure 4) are participating in the open source Hyperledger Project to advance blockchain technology and reach consensus on important features for a cross-industry open standard for distributed ledgers.

Figure 4. The Hyperledger Project

Blockchain extends to other domains such as media and communication where it is seen as a way to support micropayments (payments less than $1, down to fractions of pennies). For example, digital content is usually paid through a subscription providing access to an entire library of content, including content not used (when you buy the newspaper, you pay for the entire paper, even though you may not read every article). With free digital content, ads often detract from the experience. Imagine if you could pay the price for only the fraction of content that you care about and not have to deal with advertisements? With wide scale adoption of blockchain, this type of transaction will be possible. Infinitesimal transaction amounts can already be processed with bitcoin (without fees) so micropayment transactions may be a reality in the very near future. Blockchain may also fuel another of today’s technological revolutions. IBM and Samsung are collaborating to create the Autonomous Peer-to-Peer Telemetry (ADEPT) concept, unveiled at the 2015 Consumer Electronics Show (CES). ADEPT will ideally serve as a ledger for IoT devices that autonomously broadcast transactions between each other. Envision a scenario where household appliances signal operational problems and retrieve software updates on their own. Factom, a blockchain-based record keeping company hopes to advance the healthcare industry by using its technology to store records such as medical bills and client-physician communications to claims and disputes, making the transactions more secure and efficient. The company is also partnering with the Honduran government to reduce corruption and fraud by replacing the centralized registry for land ownership (currently under the control of government officials) with a distributed digital ledger. Other governments are also exploring blockchain such as Australia, Russia, Korea, and the UAE. Figure 5 summarizes the variety of industry verticals exploring blockchain use cases. Clearly blockchain is a growing phenomenon and with huge investments being made, it should continue to grow.

Figure 5. Industries Focusing on Blockchain Technologies

No Technology is Free of Limitations

In the last few years there has been a huge spike in the number blockchain searches on Google (figure 6). Both the media and various enterprises are investing time and capital on it. However, blockchain technology as advertised has limitations both technically and practically.

Figure 6. Google Search Traffic for the term ‘Blockchain’

For example, the bitcoin blockchain can only process seven transactions per second and it takes ten minutes for a block to be added to the ledger. This volume is too small for the scale of transactions occurring at most financial enterprises. For enterprise level use, any blockchain protocol must handle a far greater number of transactions. Also, there is a small possibility of compromising the blockchain. Part of the security of bitcoin’s blockchain stems from the massive and expensive computing power required for any attempted hack but anyone controlling 51% of the computing power in bitcoin’s blockchain network can alter the ledger. In 2014, G. Hash mining group from China had gained 41% of the computing power in bitcoin before public outcry prevented them from acquiring anymore. However, the opposite scenario, where no miners attempt to solve the ‘proof-of-work’ is much more likely. Essentially, as bitcoin’s blockchain grows, the computing power and expense to solve the proof-of-work also increases and eventually this process becomes unsustainable. The hope is that the alternative blockchain protocols currently being developed will solve for the limitations apparent in the bitcoin blockchain.

Decentralization and self-government are two central tenets to the bitcoin blockchain, yet as it gets larger and requires more computing power, the process of mining can only be done by a handful of computers, and as noted with the reference to G. Hash, there are companies strictly devoted to mining blockchains, so bitcoin is trending towards creating centralization. The requirements of mining have even lead to the development of specialized hardware in the form of industrial grade and embedded mining chips. Computing costs are not the only issue with mining. A recent report calculated that the electricity consumption required for recording a single bitcoin transaction is equivalent to the daily consumption of 1.6 American households. Building off these calculations, a follow-up report determined that at the current rate of bitcoin’s growth, by 2020, the continuous electricity requirement would astonishingly equal the total power consumption of Denmark! Issues have also arisen from the shear size of the bitcoin blockchain which is currently 25GB making storage onto a personal device increasingly difficult. As this trend continues, fewer people will be able to store the bitcoin blockchain on their computers, limiting the ability of decentralization. Decentralization is fundamental to blockchain’s security since hackers cannot target an attack on any specific node or miner. Fewer of each, increases the ability to compromise the network. Self-governance may also go by the wayside, as enterprises will ultimately control the blockchain technologies they invest in, as the main goals become increasing efficiency and reducing costs. Self-governance will no longer be a primary driver. The public will see benefits from enterprise blockchains, but only as a secondary outcome. Finally, the shear migration to blockchain from legacy technologies is a monumental task and it may take years for enterprises to adapt to the new technology.

Reality Check to the Hype

Despite the challenges that exist, the hype surrounding blockchain increases daily. However, there are myriad examples of technological discoveries or trends that took years or decades to fulfill their promised revolution. ARPANET sent its first email in 1971. It took another 25 years (and the birth of the internet) for email to become mainstream. Similarly, Motorola’s Martin Cooper filed the patent for the ‘Radio Telephone System’ in 1973 and made the first mobile phone call that year. Yet most of us did not use a mobile phone until the mid-90’s. Remember the impending ‘nanotechnology revolution’? Just 15 years ago, nanotechnology was receiving even more press than blockchain is today. The nanotechnology hype is gone, but the science behind it has led to enhancements in technology. Like these examples, blockchain may not grow at the pace or achieve the potential being forecast by its recent press coverage. Seldom does any technology being touted to disrupt the entire industrial landscape evolve at the speed of its hype or match it but maybe blockchain will prove the rare exception? My hope is blockchain justifies all the investment and interest or at least serves as the predecessor to a technology that does become revolutionary. I am cautious of the hype, but I do believe blockchain will advance the technological framework of many industries and provide efficiencies not available or even thought of today. At the very least, blockchain is making very smart people dream big, which is usually a good thing.

[1] Blockchain: Enigma. Paradox. Opportunity; Grewal-Karr, V.; Marshall, S.; Deloitte LLP, 2016