The Blockchain system — future or hype?

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With the increasing success of cryptocurrencies, such as Bitcoins, Blockchains are on everyone’s lips. Everyone wants to be part of it, scenting — driven by almost fabulous course jumps in the last few months — the chance of great wealth and investing the one or other Euro in the technology that digital money makes possible. While the Bitcoin is becoming more and more presentable and is on the news with new records almost daily, the functioning of a Blockchain is largely unknown to most people. This article provides a quick overview to understand the concept of Blockchains in general, their various solution approaches and their current problems.

Development

The development of the Blockchain-process dates back to the birth of Bitcoins in 2008. Under the pseudonym Satoshi Nakamoto, whose identity is more or less unclear, a white paper was published describing digital money on the basis of a peer-to-peer network, which is transferred directly from the sender to the recipient in a transaction without the use of third parties (so-called intermediaries). The security of the system is guaranteed by the decentralized nature of the network, the use of complex encryption and the transparent chaining of transactions in chronological order, which brought the technology the name Blockchain. In 2017, nine years after the beginning of the development of Bitcoin, the value of a Bitcoin, an abstract data set with no substantial value, is over 3800 EUR. Other cryptocurrencies, such as Ether and Litecoin, are entering the market. The total market capitalization of cryptocurrencies amounts to more than 123 billion USD. To put it this way: this is roughly equivalent to the gross domestic product of Hungary.

Disintermediation

One of the reasons why Blockchain technology is so promising and could one day be far more than digital money is the possibility of abandoning intermediaries. In our analogue and digital world, intermediaries are the guarantor for the trust between personally unknown parties in the execution and the value of a transaction. Intermediaries can be banks, insurance companies and other service providers. However, this advantage of trust protection is costly. On the one hand, the intermediary usually demands money for its use and on the other hand, verification is usually carried out by workers and therefore not in real time. Generally speaking it therefore costs two of the most important resources in economic life: time and money.

Transparency

If implemented appropriately, a Blockchain can establish such trust by combining cryptography and a predefined procedure in a network of anonymous and mutually unknown users. The individual transactions are irreversibly encrypted as hash values and linked in chronological order to the hash values of the immediately preceding transactions. Only if the majority of the network confirms the transaction it will be included in the current block of the chain. This verification ensures, among other things, that a transaction is not executed more than once (so-called double spending). A subsequent modification of the block chain is almost impossible. Once the transaction has been confirmed, it remains part of the chain forever and can be viewed by everyone anonymously.

Mining

The generating (so-called mining) of a new block is done using an artificially complicated mathematical calculation. This allows controlling the number and speed of generating new blocks. In order to encourage users to make their computing power available for these complex, hardware intensive and also energy consuming calculations, the one who generates a block is rewarded. For Bitcoin, this reward currently amounts to 12.5 Bitcoins (BTC) per block. A block is created every ten minutes. After 210.000 blocks, the reward is halved. This mechanism is called “Proof of Work” (PoW). It is one of the greatest achievements of the system and at the same time one of its greatest weaknesses.

Limitations

Due to the limited number of newly mined blocks and their capacity limits, the number of transactions stored in them is limited. This inevitably leads to a delay in the verification of each transaction when the global transaction volume grows and to an increase of transaction fees which can be used to prioritize the transaction. Both of these are actually against the principles of the Blockchain. In order to enforce changes in the Blockchain system, a majority of users is required, which otherwise can only be achieved by elections in autocratic states. If changes are not carried by such a predominant mass, the Blockchain may be divided. This is because different users no longer use compatible software. Only recently unbridgeable disagreements in the scaling debate of the Bitcoin-Blockchain have led to the division and creation of the Bitcoin Cash (BCH) currency.

Energy consumption

It is also questionable how long the energy-hungry PoW process will be acceptable in times of climate change and the targeted reduction of global CO2 emissions. A Bitcoin-transaction exceeds the power consumption of an average US family per day. It is estimated that Bitcoins’ electricity consumption in 2020 will be similar to that of Denmark as a whole. In theory, the last development stage of the Blockchain therefore provides for a “Proof of Stake” mechanism (PoS) which is supposed to make the generation of a new block independent of the computing power and dependent on the user’s share of the entire network. However, this technology is not yet operational and faces considerable and especially safety-relevant difficulties in the implementation.

Attack of the majority

As long as this is not yet the case, the merger into so-called mining pools, i. e. communities that bundle their computing power to increase the probability of calculating the next block, is likely to increase. It seems grotesque that a system with the objective of absolute decentralization ultimately leads to a merger and thus centralization through its conception. Apart from idealistic aspects, this bundling of capacities carries the risk of being targeted by a so-called 51 %-attack. By means of a relevant computing capacity — contrary to the irritating name not necessarily 51% — the Blockchain could theoretically be modified or manipulated in other ways afterwards. Realistically speaking, the danger of this is not so slight. A merger of the three largest mining pools at present would already suffice for the mathematically probable realization of such an attack. The danger is not particularly concrete, but it is an abstract possibility.

Recoverability

What the future holds in store through Bitcoins and other Blockchains is in the stars. However, certain tendencies can be deduced from the knowledge gained. On the one hand, there is now a significant monetary value behind the technology so that, at least for the moment, its relevance is beyond question. While critics want to compare the astronomical gains with the speculative bubble surrounding Dutch tulip bulbs in the mid-17th century, others see enormous potential. In many countries around the world the legal treatment with the topic Blockchain and the introduction of Bitcoin as a payment method have at least already been discussed by individual parties. The more this development progresses, the less likely it is to fall in absolute value. An increase in demand for Bitcoins, of which there will be no more than 21 million units due to technical limitations, would in this case more likely lead to further price increases in accordance with the laws of the market.

Wide range of application

It is likely that Blockchains will also find their way into other areas. The possibilities offered by Smart Contracts, small programs that run autonomously on the Blockchain, are almost unlimited. Many intermediaries are already pushing their knowledge towards this direction. Especially in the financial sector first projects for the realization of own Blockchains arise. In general, intermediaries and their employees are in danger of becoming completely unnecessary with their activities. According to experts, Blockchain technology can also make a decisive contribution to the Internet of Things (IoT). However, it would be important that standards are established which can be used effectively and which ensure a standardization of programming and communication.

Outlook

Ultimately, it is therefore important to observe carefully what developments are emerging here. Maybe only a few Blockchains are successful, maybe it is only the technology that prevails and a lot of Blockchains will exist side by side depending on the area of application. It is also important to bear in mind that new developments are being introduced almost daily. An example of this is the IOTA Blockchain which was only created at the end of 2015 and is characterized by the fact that there is not only one single main chain, but a large number of side chains. Its aim is to avoid technological limitations of other Blockchains. However, IOTA is mainly aimed at the IoT market.

Whether you are convinced of a long-term success of the Blockchains or believe, based on Bill Gates’ convictions of the Internet, that Blockchains are “just hype”, one thing can be said with great certainty: The development of Blockchain technology is still in its early stages