Understanding the Technology

Blockchain. Everyone is talking about it. Hardly anyone understands it. Lauded as transformational technology in fields ranging from financial services to agricultural supply chains, blockchain promises to create and secure value across industries. But what if you care about more than financial return on investment? Can blockchain technology also solve problems for society?

Yes. Blockchain technology has the potential to recontour civic landscapes. It can safeguard data, simplify service delivery, clarify outcomes, and ensure accountability. Simply put, blockchains help build and sustain trust. Harnessed strategically, blockchain-based solutions can do much more than widen profit margins; they can also improve lives and society.

Spoiler alert: A blockchain may not be the answer to all (or any) of your problems. Blockchain is a powerful tool, but it's not a substitute for decent leaders or well-designed processes. This report endeavors to equip readers with a working knowledge of the technology so you can perform an informed assessment of the technology’s potential relevance in your field. Education and collaboration offer the best foundation for successful blockchain solutions that create real value. This paper provides a framework for realizing that goal.

In a sentence, blockchain is a record keeping system with two important attributes: it is distributed (with copies of the record stored on multiple computers) and permanent (easy to update, but exceptionally difficult to modify). You likely have a spare house key or backup photo storage; at its core, blockchain functions on a similar principle. It’s a single cache of important information, typically digital records or financial transactions, stored securely by multiple sources. The idea of a decentralized or distributed ledger¹ isn’t new, but blockchain architecture applies the concept in innovative ways.

Blockchain is a frontier technology, but it’s built on a foundation of proven innovations that have existed for decades. Blockchain combines established technologies to create accountable, secure, efficient platforms for exchanging data.

Identity and Trust

Identity is the essential ingredient of an effective, secure blockchain. Each blockchain solution will have its own identity requirements for first-time users; these may include verification through government identification, personal information, or biometric data such as fingerprints or iris scans. However, once a user’s identity has been successfully established on a blockchain, the need to re-share personal data is eliminated. The system takes over, affording participants unprecedented convenience and security via a process called “public key cryptography” (PKC).

PKC uses a series of digital keys to simultaneously verify identity and protect privacy on blockchains. Traditionally, institutions like banks act as trust-brokers, allowing strangers to transact with a high degree of confidence. These third-party intermediaries often work well, but they can come with high barriers to entry, substantial costs, and inconvenient procedures that limit their utility for much of the world’s population. Blockchains remove the need for third party intermediaries and enable trusted, peer-to-peer² transactions through PKC.

Public key cryptography identifies parties to each other via public keys.³ This key functions like a P.O. Box—publicly visible, alterable, and pseudonymous,⁴ with the primary goal of facilitating transactions.⁵ PKC then validates their identities via private keys⁶ before executing any exchange. A private key unlocks the proverbial P.O. Box, providing its owner exclusive access to any materials stored inside. Public key cryptography facilitates accountability for blockchain users while protecting individual data.

Blockchain combines established technologies to create accountable, secure, efficient platforms for exchanging data.

Data

A person at a grocery store can exchange money for a loaf of bread. But what if you’re operating in an entirely virtual space? Blockchain transactions can include a wide variety of sensitive data transfers: financial transfers, identity confirmations, inspection certifications, land receipts, and more. Data can represent tangible assets, like currency, records, identity details, or ownership titles. Information can be unencrypted (plain), encrypted (hidden), or a representative digital signature⁷ (a hash) for goods stored off-chain.⁸

No matter the type of data being exchanged, it’s imperative that it is accurate and high-quality. Blockchain’s stringent protocols make logged information exceptionally difficult to alter or expunge, so if you start off with poor data, you may be stuck with it forever.

Several types of blockchain exist, but generally they involve a basic three-step process:

• Encryption-facilitated data exchanges occur between blockchain participants.
• A series of these transactions are grouped together to produce a locked data “block.”
• New blocks are linked to previous ones via a cooperative validation⁹ protocol, thus forming a “blockchain.”

Blockchains are like trees, becoming stronger as they grow larger. Like a new ring in a tree trunk, a new block on a blockchain records a specific moment in the entire chain’s history; the block does not exist independently, but is a development of the entire chain, inseparably grafted onto the blocks preceding it by complex algorithms, ensuring validity and accuracy over time.

The addition of each new data block makes it increasingly difficult for unauthorized changes to occur. Just as you can’t remove a single tree ring without compromising the entire trunk, the information recorded on a single block cannot be isolated or altered without affecting the entire blockchain. Each new block grows from the blocks preceding it, and in turn helps to secure and inform all subsequent blocks added to the chain.

Individual blocks¹⁰ are made up of groupings of unique transactions, or record updates. These occur constantly over a distributed network, and a blockchain system usually has multiple computers, or nodes,¹¹ that constantly process new updates.

Record updates are added to a pool as they occur, and nodes within the network sequence them according to a timestamp. These “miner” nodes create a new block of record updates, which then awaits verification and addition to the chain. When enough data is added to the block, a checksum or “hash” is added that is unique to the records it contains. This hash functions like a fingerprint for each block of data in the chain. If a single character of a single record update is altered, the final hash will change dramatically. A block can only be added to the chain once a majority of nodes in the blockchain agree that its record update data is valid. If over half of a blockchain’s nodes cannot verify a block’s data, the block is rejected.

Reaching Consensus

The rules that determine how to validate new entries on the chain are known as consensus mechanisms.¹² They allow all nodes in a blockchain system to collectively agree on new additions to the chain, ensuring network integrity. An effective consensus mechanism will incentivize validators to confirm legitimate blocks quickly and reliably.

Consider just one of the myriad consensus mechanisms currently in use to illustrate the concept: In a Proof of Stake¹³ protocol, validators (certain nodes of the blockchain) place stakes. These stakes act as part bet, part security deposit. If a validator is chosen and confirms a legitimate block, she receives compensation and the block is added to the chain. However, if the validator confirms a fraudulent block, her stake is forfeited and a new validator is selected. The protocol’s forced buy-in offers both a carrot and a stick to validators, promising rewards for correctly validated blocks and while penalizing specious validations with the loss of a stake.

Each breed of consensus mechanism has its own challenges and strengths and can be adopted dependent on a particular blockchain’s goals, security considerations, and network type. Other examples include Proof of Work,¹⁴ Proof of Burn, Proof of Authority,¹⁵ Practical Byzantine Fault Tolerance, Proof of Importance.

The information recorded on a single block cannot be isolated or altered without affecting the entire blockchain.

Lengthening a Chain

Once a block of data has been validated by consensus, it’s ready to be connected to the rest of the chain. The new block not only incorporates data from the transactions it represents, but also a digital fingerprint of every block preceding it—firmly securing it to the entire chain. Now the block is largely tamper-proof; retroactive edits to any part of the chain will produce code divergent from that stored on every block previously appended to the chain, invalidating any new block and assuring that the record remains secure.

A blockchain protocol¹⁶ connects different computers in the network. Programmers can alter frameworks around this protocol to suit specific use-cases. There are two basic questions at the foundation of most blockchain protocols:

Public vs. Private: This refers to the openness¹⁷ of a blockchain to outside users. Public blockchains, like Bitcoin¹⁸ and Ethereum,¹⁹ are completely open, allowing anyone to interact with the network. A private blockchain like IBM’s Hyperledger²⁰ has a governing group that determines which and to what degree users can access a blockchain.

Private and public blockchains can assign different privileges, or “permissions,"²¹ to users. A permissionless blockchain gives every computer an equal amount of authority to operate on a blockchain. Permissioned blockchains assign different capabilities to each computer on the blockchain, such as reading data, writing data, or verifying data and storing copies of a blockchain. A consortium of banks may appoint an administrator to control who can access their private blockchain, even though, once accepted, all computers on a blockchain can interact with it. Conversely, governments seeking to be transparent with their citizens may use a public permissioned blockchain to provide full visibility of certain records, but only allow government administrators to create entries on a blockchain.

Open Source²² vs. Proprietary: This distinction refers to the level of transparency and accessibility in a blockchain. To qualify as open source, a platform must be distributed for free and function with transparent and modifiable source code.²³ Open source blockchains spur innovation, fortify security, and facilitate accountability and transparency in data infrastructures. They’re ideal for refreshing antiquated infrastructure like voting systems or healthcare services. Alternatively, proprietary systems are typically leveraged for monetization or to protect market share in competitive landscapes; they can unintentionally lead to vendor lock-in.

Token Economics

For a blockchain to function effectively, there must be incentives for users, programmers, and other actors in the system. Developers accomplish this with tokens.²⁴ Digital tokens exchange real value by a method unique to their particular blockchain ecosystem. The most popular use of tokens is as currency, such as Bitcoin or Ether,²⁵ but they can fill a number of roles. They may signify ownership over assets like land titles or carbon credits, be exchanged for services, earned by curating digital content or spent by consuming that content. Tokens could even represent a vote in a municipal election or board meeting. The possibilities are expansive.

Blockchain-based token economies are new and the rules that govern them are as adaptable as the code that dictates their behavior. This flexibility has the potential to enable innovative forms of value distribution and creation, potentially uprooting assumptions about traditional market behavior and providing fertile ground for business models that were previously impractical due to, for example, high transaction costs.

Smart Contracts

“Smart contracts,"²⁶ can be programmed to facilitate binding exchanges with specific conditions executed from a blockchain. Once rules and penalties are agreed to by parties, a smart contract becomes a self-executing and self-enforcing contract—all without intermediaries²⁷ like banks, brokers, or lawyers.

For example, say a farmer needs to collect insurance after losing crops to drought. A smart contract could cross-reference the farmer’s land records with local weather reports. If the report showed that the farmer lived in a drought-affected region, the smart contract would automatically execute and provide him or her with aid. This is just one example of the many ways in which smart contracts could increase efficiency, reduce misallocation, and eliminate bureaucratic friction.

Artificial Intelligence

Blockchain and artificial intelligence²⁸ (AI) could prove to be a powerful pairing in a twenty-first century economy, providing security and accountability to the machines that will increasingly guide human decision-making. Each week brings new stories of the promises and perils of AI. One day it’s forecasting outbreaks of infectious disease, the next it’s going on Twitter rants. Blockchain technology offers stable data infrastructure that may not only help manage potential challenges of AI, but also distribute the gains possible through AI more equitably across the future digital economy. Blockchain-based data wallets could decentralize and democratize ownership of the data that powers AI systems. As AI steers cars and predicts weather, a blockchain could clarify and fortify the link between machines and the algorithms determining their choices, reducing vulnerability to exogenous threats like hackers.

Blockchain and AI could be a powerful pairing, providing security and accountability to the machines that will increasingly guide human decision-making.

Conclusion

There are many different flavors of blockchain. Some facilitate greater openness and flexibility, while others prioritize privacy and proprietary access. Some blockchain solutions may utilize complimentary technologies. Others won’t require it. While determining which features to include in a potential blockchain solution, an organization must carefully consider the context within which that blockchain will function. The “best” blockchain does not exist, only the best blockchain for your organization and the goals you’re aiming to achieve.