Welcome to the introduction to blockchains

[Virtual Presenter] Welcome to the introduction to blockchains. If you followed the learning path, then you have already heard about the difference between DLT, digital ledger technology, and blockchains. In the following 7 to 8 minutes we will take a closer look at blockchains. We start with a very simple example:.

[Audio] Let's assume you have a file on your computer with all buy and sell transactions done. Consequently you know what you own or owe. Two other parties, a counterparty who you transacted with before and your accountant have the same file..

[Audio] Now you make a transaction and your computer sends an email to both the counterparty and the accountant to inform them..

[Audio] Both the counterparty and the accountant check their files to be sure that you can afford it. One will be the first one to reply to all that he's validated this and that it's ok. The other will follow up later with another email to all, also confirming that all is ok..

[Audio] Thus when everybody has agreed, the three files can be updated to include the latest transactions. And a transaction fee is paid to reward the efforts..

[Audio] Now let's look at this scenario using blockchain terms: The setup with 3 parties having the same file is a distributed setup. When you wrote the initial email, you acted as a so called node, one of many. The counterparty and the accountant proved with their work, their verification effort, that the transaction is legit. They consequently contributed to creating a new version of the file, which is why we call them miners. And the reward could be for example paid in Bitcoins. In other words, this actually simple concept is enabled by blockchains..

[Audio] While the previous example showed how blockchains such as for example Bitcoin work, let's now focus on what challenges are addressed that can be of value for users of such networks..

[Audio] The blockchain is a digital ledger that can be used not just for financial transactions but for many things, especially if the following key characteristics are of value: The blockchain is distributed as every node holds a full copy of all transactions done..

[Audio] The distributed nature and the fact that once a transaction is agreed and documented in the digital ledger, it cannot be edited or changed anymore, makes it immutable. This allows for transparency that can be traced back also over time, literally as long as the internet works..

[Audio] The blockchain is near real-time. As computers take the role of executing transactions and write them into blocks, execution is done in a short amount of time. This is a major difference especially compared to transaction settlement times in the traditional financial industry settlement which due to the many involved parties often take up to 2 or 3 days..

[Audio] The blockchain is peer to peer, interactions are between all participants directly, not via intermediaries. Which also means you don't need a trusted third party or middle man to execute transactions. The transactions are furthermore encrypted to protect the data in the blockchain. When a user sends a transaction, it is encrypted using the own private key and the public key of the recipient. This ensures that only the recipient can read and access the transaction data..

[Audio] Now let's look at an important element of trust in blockchain systems: The consensus mechanism..

[Audio] The consensus mechanism is here to ensure that all nodes on the network agree on the state of the ledger. Nodes are represented by computers or own networks that each maintain a full copy of the blockchain ledger. They are in charge of validating transactions, creating new blocks and ensuring consensus..

[Audio] There are several consensus mechanisms used in blockchains, with proof-of-work and proof-of-stake being the most popular. Let's have a look at those two now..

[Audio] Proof-of-work is the original consensus mechanism used in Bitcoin, the initial blockchain implementation and is still widely used today. In proof of work, nodes on the network compete to solve complex mathematical problems in order to validate transactions and add them to the blockchain..

[Audio] The first node to solve the problem is rewarded with newly minted cryptos, which is the incentive for nodes to participate in the network and perform their important roles. The individuals or companies who solve the puzzles with their computing power are called miners. Minting is the process of authenticating data, adding new blocks and creating new tokens, such as for instance one new bitcoin. In order to increase the odds to be the first one to solve the cryptographic puzzle and get a reward, minors can join together in mining pools. Rewards are then paid out according to the processing power brought into the pool..

[Audio] Proof of stake is a very secure consensus mechanism, the Bitcoin has never been hacked since it's going live many years ago. One potential threat scenario is the 51% attack. This means that a malicious party achieves control over more than 50% of the network's computational power also known as hash rate. When this is achieved, then the malicious party can control the validation process and manipulate transactions in their favor or jeopardize the overall integrity of the blockchain. Important is to understand is that the consensus mechanisms are designed such as to make it very difficult if not almost impossible to perform such attacks..

[Audio] Keeping up with the security by solving mathematical puzzles means that the validation method requires a significant amount of computational power, which makes it energy-intensive and rather expensive to operate. The high energy consumption of Bitcoin has repeatedly raised concerns about its environmental impact. The consumption is estimated to be equivalent to the energy consumption of a small country. However, efforts are being made to address the energy consumption. Any example are mining operations that are using renewable energy sources such as solar or wind power to reduce their environmental impact..

[Audio] Proof-of-stake is a newer consensus mechanism and addresses some of the issues with proof-of-work..

[Audio] In proof-of-stake, the validators secure the network by staking their cryptos as collateral and by validating transactions. The validators are chosen randomly. When one is selected, he must deposit a certain amount of cryptos as collateral which is called "staking". The collateral serves as a guarantee that the validator acts honestly and follows the rules of the network. Otherwise the collateral can be lost..

[Audio] Validators are rewarded with a portion of the transaction fees and newly minted crypto tokens, in proportion to the staked collateral. Validators who have more staked cryptos have a higher chance of being selected to validate transactions and earn rewards. Validators thus group in networks to increase their voting power and their odds to get rewarded..

[Audio] While proof of stake networks have proven secure, a similar type of threat scenario exists as with proof of work. A 51% attack would involve a single entity or group of entities controlling more than 51% of the network's computational power and being able to manipulate transactions in their favor. To prevent a 51% attack networks use mechanisms such as penalizing validators who act maliciously, random selection of validators, and requiring validators to stake a significant amount of cryptos to participate in the network..

[Audio] And finally, proof-of-stake is less energy-intensive than proof-of-work, as it does not require nodes to solve complex mathematical problems..

[Audio] In conclusion, DLT and blockchain technology have the potential to revolutionize the way we conduct transactions and manage data. The decentralized nature makes them more transparent and tamper-proof than traditional centralized systems. Consensus mechanisms like proof-of-work and proof-of-stake ensure that all nodes on the network agree on the state of the ledger, making it virtually impossible for any single entity to manipulate or alter the data stored on the blockchain. Yet one must also not forget, that these technologies continue to evolve, continue to mature. And given the number of applications that we see already today, we can expect that they're here to stay and that we will see more innovative applications emerge in the years to come. Thank you for staying with us in this module..