Illustration redesigned by Devin Thorpe
Satoshi Nakamoto’s blockchain changed the world, and Bitcoin became the first proof of concept for this exciting technology. Bitcoin was a remarkable, world-changing invention, and it brought together previously niche technologies to create an entirely new way of doing things. It was a fully-functioning computer network capable of replacing the function of banks and maintaining a very popular cryptocurrency. It was open to anyone, permissionless, and secure while requiring no trust in any particular person or body. But its flaws were nearly as apparent as its features. For example, proof of work inherently solves several security problems otherwise foreseen in a peer-to-peer network.Miners are naturally incentivized away from processing invalid transactions. So the majority of the network will always beat out individual fraudulent entities. Most crucially, bitcoin is only valuable because people believe it to be.
The value of the coin itself would plummet if the network failed to block fraudulent activity. Therefore, the majority in the network will always seek to maintain the security and functionality of the mining process.
But what makes proof of work safe also makes it slow. It takes ten minutes to process a new block on the Bitcoin blockchain. You might wonder why, with the powerful computers of today, it takes so long to process transactions. The ten minute wait time–what we call “latency”–is a security feature of the blockchain; it is not an inherent flaw in the system. The proof of the work process is intentionally designed to take this long, so fraudulent transactions don’t rush through verification and get buried deep in the chain before anything can be done about it.
Additionally, the entire proof of the work process requires large amounts of energy. Thousands of miners operate mammoth computer systems. The Bitcoin network uses as much energy as the country of Singapore. All those miners compete to process the same transactions. For all of the security, it’s entirely inefficient, and a tax on the environment.
It’s fair to ask whether Bitcoin can ever be a legitimate worldwide currency on par with fiat currencies like the dollar when, even in its early stages, it requires the upkeep of an entire nation’s energy resources.
With all the flaws built into Bitcoin processing, there had to be a better solution to decentralize recordkeeping. Half a decade later, a Russian whizkid from Canada proposed a new paradigm: a broader blockchain, built for more practical use. This new blockchain would be a way to expand the powers of the technology and make Bitcoin appear small in comparison.
A Second Generation Blockchain
Vitalik Buterin first learned about Bitcoin from his father, at age 17. He started writing about cryptocurrency and, in 2013, co-founded Bitcoin Magazine. In 2013, while still a teenager, he proposed a new type of blockchain in a white paper. He named his blockchain: Ethereum. In 2014, he received $100,000 in grant money and dropped out of college to build it. The network went live on July 30th, 2015.
Vitalik’s insight was both simple in its concept and revolutionary in its implications. The heart of his proposal was a separation of the application from the infrastructure layer of the blockchain.
Consider a building. Its infrastructure consists of walls, windows, doors, a roof, and the rooms inside. Certain buildings like barns, government houses, and mansions are built for a specific purpose. You wouldn’t raise chickens in a courtroom, nor would you hold court hearings in a barn. In these cases, the infrastructure of the building accommodates a particular application. Other buildings, whether they be a house located on the Main Street of a small town or a tall city building in Manhattan, have more flexible uses. They are blank slates, applicable for living or work, business or pleasure, or both.
Satoshi built blockchain specifically for the operation of Bitcoin. Ethereum, on the other hand, was a building open for rent. Anybody could develop applications over the network, whether it be a cryptocurrency like Bitcoin, or something entirely different, like a social media platform. And it all happened on top of what we call “smart contracts”.
That historical data be unchangeable is essential to the security of Bitcoin-. This insight refers to Stuart Haber and W. Scott Stornetta’s 1992 white paper on timestamping digital documents. Any digital information that can be altered retroactively, without a paper trail, is inherently untrustworthy, especially when there’s no oversight body involved.
This principle applies equally to Bitcoin and Ethereum. For Bitcoin, the solution was cryptographic hashing and proof of work. But Ethereum requires another precaution to accommodate all of its various use cases: smart contracts.
Smart contracts are digital contracts–agreements held by two or more parties and manifested in code. Every piece of software operating over Ethereum is itself a smart contract. So when you purchase a cryptocurrency, you engage a smart contract.
Since blockchain does away with third parties–banks, companies, governments: the kinds of institutions that write and enforce rules–smart contracts are made to be entirely immutable. Not only is it nearly impossible for a hacker to alter a smart contract, but the same even applies to the contract’s creators. To understand why it must be this way, let’s consider a use case.
Imagine a digital wallet application, running over Ethereum. The program should operate as a bank for cryptocurrency investors: they can use it to purchase coins, store coins, transact with others, et cetera. And all these functions are written into the program’s smart contract code.
Now, consider if the smart contract were subject to change. After investors have begun using their wallets, the developers could update their program to change some of its features. For example, developers could institute a fee system and take a cut from every transaction. Or, they might renegue on the original agreement and take all the coin that has been stored in the program for themselves. Without a governing body, there’s nothing anyone else could do; there is no state to provide a legal framework for recourse, and there is no corporate entity offering insurance.
Blockchain is meant to be the solution against having to place your trust in strangers. Smart contracts are immutable for that reason. In fact, smart contract code is self-executing. If you deposit, transfer or withdraw money from an Ethereum wallet, the program itself will handle those commands without any human input. You can be sure of the outcomes based on certain actions because all the rules are written in the code.
Proof of Stake
Smart contracts solve security at the application layer of Ethereum. Like Bitcoin, Ethereum requires a security protocol for its infrastructure layer. Activity over the network manifests as it does in Bitcoin– miners validate actions and group them into blocks along a chain. But in Ethereum “miners” are “validators”, “mining” is referred to as “minting” or “forging”, and validators operate under a protocol called “proof of stake”.
Proof of stake was first proposed by a Bitcoin forum user on July 11th, 2011, as a way to resolve the energy and cost drawbacks in proof of work. Proof of stake employs an algorithm to randomly select one validator per transaction. The proof of stake algorithm takes a validator’s stake in the system as its likelihood of being chosen. Therefore, a validator with twice as much stake in a cryptocurrency as another validator will receive twice as many transactions to process.
You might note, at this point, that having miners compete with one another was the very feature that made Bitcoin so secure to malicious actors. But the proof of stake model disincentivizes malicious activity differently; it penalizes validators for minting fraudulent transactions. Because the penalty for doing so outweighs the reward earned for minting a fraudulent block, any miner will do well to check the validity of any transaction before acting upon it.
Ethereum ushered in a whole new era of blockchain: a technology for the masses, where anybody could come with an idea and use this infrastructure to make it happen. Some incredible applications have already been built on the platform.
Like Bitcoin before it, though, Ethereum’s many innovations came with some glaring drawbacks. Network congestion has become a problem when new, popular apps enter the network. High fees and slow transaction throughput have made it difficult for medium-to-large entities to enter the space. Proof of stake comes with baggage, like the increased inequality that comes with rewarding already-rich investors with more transaction rewards.
Already new mining models are being proposed, and platforms are billing themselves as third-generation evolutions of the blockchain form. Not only that, but blockchain is proliferating even further into the world. Today, industries as far apart as Wall Street, healthcare, and transportation are incorporating and experimenting with blockchain to increase security and efficiency. As blockchain technologies continue to advance, we can only hypothesize about the implications it will have on daily life in the future.