Blockchain Applications (I): A Primer
Once upon a time
Bitcoin, the first e-currency to reach worldwide adoption, was introduced in 2008 with a paper by an anonymous researcher known with the pseudonym of Satoshi Nakamoto. Based on the concept of decentralised, peer-to-peer transactions, the digital currency was intended to facilitate the exchange of value between two entities, without the need for a third-party in the role of guarantor.
Since its launch (the first transaction dates to January 2009), with a handful of users and an exchange rate of approx. 40 USD per bitcoin, the network has grown enormously. In April 2017, blockchain.info (the core transaction ledger supporting the network) reports that:
- 1 bitcoin is worth 1,223.28 USD
- bitcoins are used worldwide for a market capitalisation of 19,349,213,565.00 USD
- an increasing number of transaction is performed every year, as seen in Figure 1 below:
Bitcoin is a virtual currency: it bears no intrinsic value (e.g. it’s not mandated by law or exchanged on a physical market), its value is only guaranteed by the trust that each participant holds on the network itself. On the brink of the Bitcoin success, other virtual currencies have emerged in the last five years, building and expanding on the original concept.
The basics
A common element to all virtual currencies and their source of trust, a blockchain is the shared ledger where transactions are recorded and cryptographically verified: the bitcoin blockchain is accessible at https://blockchain.info/ .
A blockchain system is composed of the following elements:
- Nodes: computers that participate to the network, they store the history of transactions (the ledger); each node replicates the entire ledger
- Users: humans or automated applications producing transactions, following a pre-determined business logic (which can also be embedded in the blockchain)
- Transaction: an element to be stored in the ledger. New transactions are always appended sequentially to the ledger: once appended, transactions cannot be removed or altered
- Miners: other participants to the network. When a new transaction is executed on the network, miners receive a task to verify its cryptographic consistency (a computationally intensive activity). Miners compete to verify the transaction: the first miner to solve the cryptographic task receives a reward
- Proof of work: once a miner solves its task, the solution is stored in the blockchain itself and constitutes the proof of the validity of the transaction
Evolution
Despite its relatively short history, blockchain technology evolution presents interesting challenges and can be summarised as in Figure 2:
1. Bitcoin: the introduction of the bitcoin network in 2008 can be considered the first step in the blockchain technology evolution. Virtual currencies have been developing quickly, as detailed above, in both number of users and transaction volume.
2. Blockchain: the underlying technology that supports the Bitcoin network is extracted and developed separately from eCurrencies, applying it to a wide scope of use cases and crating the current concept of shared ledger. The technology supports collaboration and cooperation between organizations, in a more integrated fashion
3. Smart contracts: The term “smart contract” was first popularised by computer scientist Nick Szabo in his 1997 paper “The Idea of Smart Contracts”. He suggested that computer code could be used in place of mechanical devices to facilitate far more complex transactions of digital property. Believed to be the very first use of blockchain technology, Smart Contracts add automation to the chain of trust provided by the blockchain.
Ethereum is an example of application development platform built on top of a blockchain: transactions can be automatically executed by software agents, once pre-determined conditions are met. An example could be an agent who automatically pays a fee to an account when another account receives a payment from a specific individual. These transactions are recorded and guaranteed by the underlying blockchain. The platform allows for custom code to be developed in a high-level language, and thus to easily build lean applications that exploit the power and the trust guaranteed by the blockchain
4. “proof-of-stake”: the trust mechanism for most blockchains is based on the concept of “proof-of-work”: blockchain nodes exploit their computing power to solve cryptographic problems tied to the transactions (recorded in “blocks”), which ensure the chain of trust in the network. The idea of “proof-of-stake” replaces the computing power required to support the network with complex financial instruments, based on cryptographic problems. This would introduce a less computing intensive mechanism to ensure trust between network participants. Proof-of-stake blockchains are still experimental and not ready for commercial use.
5. Scalable blockchains: in the current approach, each node in the blockchain network processes every transaction executed on the network. This is a required mechanism to validate transactions, but is highly inefficient and results in slow performance. The idea of scalable blockchain consists in splitting the workload needed to validate the transactions into packets and sharing packets on the network nodes, without impacting the security of the platform. This mechanism improves the performance of the network and is highly regarded as a foundation for Internet of Things applications.
Blockchain for business
Four principles can guide blockchain business applications (Figure 3):
- Shared ledger: the transaction ledger where all transactions are appended. It is immutable, its integrity being guaranteed and constantly verified by a cryptographic mechanism
- Smart contract: the ledger is used to record transactions, whose business logic is described in a symbolic form and embedded in the blockchain in the form of software agents
- Privacy: transactions are executed with verifiable credentials (even if the correspondence of such credentials to a human identity cannot be ensured without a third party), and are verifiable and secure
- Consensus: participants to the blockchain network accept to participate and establish trust based on the strength of the blockchain cryptographic mechanisms that support the ledger
Depending on the business model, the application of these principles can result in cost efficiencies, improved transaction execution performance and a simpler participation to the network (Figure 3, source: IBM study on blockchain use cases).
Blockchain per se is a potentially disruptive innovation, but it is not a consumer product: it’s more of a foundation technology, it creates the elements and supporting structure for new applications and new solutions to existing problems. The adoption of blockchain applications can result in advantages such as reduced costs, increased efficiency and improved participation.
In the second part of this article, we’ll look at a model to analyse blockchain adoption and its application to relevant business models.
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