Behind the Curtain of Blockchain Transactions
Lesson 3: Or How to Know when a Transaction is Finalized
The “Platform Wars” involve competitors trying to achieve the trifecta of blockchain technology: decentralization, scalability, and security. These features are important on the user side of things since we need to know when a transaction we undertake on a blockchain is actually completed or finalized.
If it’s not, then we risk losing whatever the content of the transaction is — usually money!
So let’s take each desideratum in turn.
Decentralization and Transactions
The clarion call behind blockchain hype is that a decentralized system is much more democratic since the transfer and record-keeping of data is transparent and public. In other words, no one person, group, or institution controls how the data is presented (or not-presented); and certainly, no one can “cook the books” or dishonestly alter the record.
What is revolutionary about what the blockchain provides is open access to the record of transactions. In other words, each party to the transaction and the public can see “what” and “when” took place.
This is great in theory, but blockchains which are trying to reach a maximum level of decentralization often suffer when it comes to scalability. They simply do not have resources to process and verify transactions quickly. Why? Because decentralization involves having a lot of other people coming together to workout the task of verification, as opposed to it being located in the hands of one person or source.
The upside is that this form of consensus among many (as opposed to one) ensures a certain level of security since those involved in verifying a transaction need to come to agreement. This occurs typically through Proof-of-work or Proof-of-stake consensus mechanisms.
The take away here is that decentralization affects Transactions Per Second, or TPS. Why is TPS important?
Scalability and Transactions
For any processing platform to be efficient at facilitating transactions, it must be able to process user transactions at a rate that does not create a bottleneck or result in significant downtime or a crash. Ethereum’s Merge is a key but not a final part to solving this problem for its own network.
At the time of writing (Sept 10, 2022), some of the TPS stats for major blockchains:
- Solana — 2,825 TPS
- Ethereum — 45 TPS
- Cosmos — 10,000 TPS
- Polkadot — 1,000 TPS
Typically, a blockchain will have a foundational layer providing protocols, or a basic set of rules which allow data to be transmitted and shared between computers. This is referred to a “Layer 1 Protocol”.
Let’s take an analogue to the Internet of Things. The standard protocol enabling the transmission of data over the internet is TCP, or Transmission Control Protocol, which breaks down data into smaller packets. IP, or Internet Protocol, works with TCP so that when data is sent, a specific IP address can be acquired and used as the target to which the data is sent. “You’ve got mail!” (For those who can remember the AOL slogan).
Security and speed are both tied to the consensus mechanism innate to a Layer 1 protocol. As mentioned above, Proof-of-work and Proof-of-stake are two main mechanisms that provide security by ensuring that a willful breach of security is extremely costly in terms of capital and/or money.
To help with speed, sometimes Layer 1 protocols can delegate the validation process to a Layer 2 protocol. Or a blockchain can itself be segmented into smaller groups, with each group dealing with a specific set of data. This strategy for increasing the speed of processing is called sharding.
A Layer 2 Protocol is built “on top of” a main network protocol (e.g. Ethereum) that processes transactions in a slightly different, but faster way. An example of an Ethereum Layer 2 protocol is Polygon. Other examples include Bitcoin’s Lightning Network, Arbitrum (on Ethereum), and Optimism (on Ethereum).
Think of Layer 2s as separate blockchains doing work for the Layer 1 blockchain. Their main purpose is to make the main blockchain faster at processing transactions, without the compromise of security.
To achieve this, the main protocol is used for trust and verification, while the Layer 2 protocol processes everything on the side, it does not verify each transaction in the moment in the same way the main network would. To finalize the transactions, only the beginning and end amounts are recorded on the main protocol at a later time.
But speed isn’t all!
Security and Transactions
Transaction finalization is the event whereby a transaction occurring on the blockchain has been verified and completed. This may seem straightforward since we are used to financial transactions in the everyday world being completed and verified with the tap of a “buy” button or the tap or swipe of a credit card.
But remember that with such everyday (non-blockchain) transactions, there is a central authority–such as a bank–providing the verification. With blockchain transactions, the verification process must occur by a consensus of miners (Proof-of-work) or validators (Proof-of-stake).
What undermines the consensus process has to do with the nature of decentralized systems which need to mitigate or protect against the possibility of “bad actors” who might try to undermine the verification process. In this case, a bad miner or validator might try to reverse or change the transaction before it’s actually finalized.
The Proof-of-work and Proof-of-stake consensus mechanisms used by blockchains protect against such a scenario by requiring a tremendous amount of capital (either compute resource or money) to gain the kind of majority control (51%) needed to reverse or change a transaction for dishonest reasons.
A final note to help distinguish the features of transaction finalization.
Long-chain blocks
A general principle of blockchain verification is that the longest blocks are the ones which are the most secure. Why? Because they took the most effort (energy or capital) to build, longer blocks are those in which it is very difficult to replace any part of the chain. Remember that blocks in a chain are cryptographically linked. This is also referred to as “probabilistic finality” since it is more likely that a longer chain will be more secure.
Having said that, note that the “longest” chain does not always mean the one with the most blocks since a shorter series of blocks could have required more in the way of effort.
How To Apply This
When using any blockchain to undertake a transaction, be sure you are aware of the three features of decentralization, scalability, and security. They are all inter-linked at some level, and how they matter will depend on how quickly you want things done . . . and of course, in the longrun, how secure your assets are.
For example, if they are stored on a more centralized platform, centralized blockchains tend to be less secure since they have a single point of failure. In addition, more centralized projects might tend to hide their resources and collateral backing, which can have huge implications when liquidity in the wider market becomes an issue.
I am a reseacher and writer for 1.2 Labs and The Art of the Bubble.
This article is a part of the Crypto Industry Essentials educational program presented by The Art of the Bubble.
Though this article is credited to me, it contains some written material by Sebastian Purcell, PhD from his The Art of the Bubble education series on cryptocurrencies.
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