In 2008 Bitcoin was launched, bringing blockchain to the mainstream for the first time. Through booms and busts, speculation and doubt, blockchain technology and the projects that use it have changed dramatically in the years since they first appeared. This article will introduce in brief three generations of blockchains and the key components of each.
What is a Blockchain?
Cryptocurrencies are founded on a distributed ledger or “blockchain” technology. As the name indicates, a blockchain is a chain of blocks. Each block contains a variety of information such as transactions and account details as well as a unique digital signature or “hash“. This unique digital signature contains the status of the blockchain, or “state” at that point in time, and is referenced by adjacent blocks in the chain. In this fashion, each block proves the information that is contained in adjacent blocks. The hash on a fraudulent block, that has been altered, will not match the hash that is referenced by adjacent blocks making it statistically impossible to alter information contained in the blockchain. While this is a simplification it can be inferred that blockchains offer security benefits over traditional ledgers.
A key component of the blockchain movement is decentralisation. Decentralisation aims to empower the users in a system rather than trust intermediary or central party in a network. New information that is added to a blockchain is validated by participating community members, or “nodes” using various consensus mechanisms, namely “proof of work” and “proof of stake“. In addition to new information being validated by the users, blockchains are also distributed in their storage and governance. Decentralised blockchains are stored in many copies across the user base. More than half the user base would have to agree in order for a fraudulent copy of the blockchain to be accepted. The users in most decentralised blockchains also control the direction of the project, by voting on important decisions.
First Generation Blockchain: Bitcoin
The first mainstream project to take advantage of blockchain technology and proof of work is Bitcoin. Bitcoin serves as a proof of concept for blockchain and may be considered the only “first generation” cryptocurrency worth mentioning. Bitcoin successfully uses blockchain to create a ledger of transactions. The Bitcoin protocol can successfully transfer ownership of “Bitcoins” and prove the ownership or state of bitcoins at any time. There is a maximum of 21 million bitcoins which are distributed gradually as rewards for “miners” who provide the necessary computing power to operate the bitcoin blockchain. While bitcoin was originally envisioned as a transactional currency for online transactions it has created value instead of as a transferable store of wealth. If you own a bitcoin it is indisputable that it is yours, nobody can take it from you or contest your ownership. Bitcoin has value because the community has a demand for this immutable asset. This differs from later cryptocurrencies which provide additional value-added services.
Second Generation Blockchains: Smart Contract and Third Party Applications
While bitcoin proved the technological feasibility of a disputed ledger, “second generation” projects were quick to realise the potential to use a distributed ledger to record and use information outside of transaction details. While there are many second-generation cryptocurrencies who leveraged additional functionality on the blockchain, the example we will discuss in length is Ethereum. Ethereum recognized that while there are many applications for a secure and decentralised ledger it would be inefficient for a new blockchain program to be built every time a new project wanted to take advantage of the security and decentralisation of public blockchain technology. They instead built a more advanced blockchain with an integrated programming language that would allow for projects to be constructed and run complex functions on the Ethereum blockchain. This meant that new projects could reap the benefits of blockchain without needing to create their own.
Many of the most popular cryptocurrencies that have been launched since the creation of Ethereum choose to use the Ethereum blockchain as their foundation rather than building their own. While projects built on Ethereum may have their own cryptocurrency tokens, the cost for running these projects is payable in Ether, Ethereum’s domestic cryptocurrency. This creates demand for the Ether token driving it to the number two most popular token by market capitalization after bitcoin. Other second-generation currencies created independently from Ethereum developed unique programs or offered competing solutions.
Perhaps the most innovative and game-changing concept introduced by Ethereum and other second-generation cryptocurrencies is “smart contracts”. A smart contract is a digital agreement detailing and automating actions given certain trigger criteria. A smart contract can be used to store tokens similar to an escrow account and later distribute them in a way that is predetermined by code. For example, a contract can be used to facilitate a transfer (action) between two different Ethereum based currencies where it will not release the funds to either party until it has received the predetermined amount of each currency (criteria).
While this smart contract example is relatively simple Ethereum is Turing complete meaning that any action or criteria that can be mathematically expressed can be built into a smart contract or program running on the Ethereum blockchain. Similar to how your computer can be programmed to recognize documents, check criteria, and complete all sorts of complex computations, Ethereum based smart contracts enable projects to build all the same functionality while leveraging the security and decentralisation of blockchain technology.
Smart contracts introduce the concept of “code is law” where terms of a contract, actions, and triggers are clearly defined within the code. Where the contract is integrated into the blockchain it takes on the same security characteristics. A smart contract is immutable meaning it cannot be changed or altered. While a well-written smart contract will execute its code without bias and without failure there is the risk that a contract is poorly written and contains gaps or flaws which can be exploited. Modern programs attempt to mitigate and negate these risks with smart contract auditing and smart contract insurance to protect assets that may be stored inside a smart contract.
Decentralised Applications (DAPPS)
Decentralised applications or “DAPPS” are exactly what they sound like. Just like developers can design useful applications or “apps” for your cell phone developers can also design applications to run on decentralised blockchains. Where you can download calculators, games, and banking interfaces to use on your phone, DAPPs add the same utility to the blockchain. A user interface on a DAPP may feel virtually the same as any other APP but behind the scenes, DAPPS run on open source code stored on a community governed blockchain. This code can benefit from peer review and the community can propose improvements or start competing projects. In addition to being open-source, all transactions which occur inside a DAPP are stored within the blockchain and benefit from the security inherent in blockchain technology. Programmers use DAPPS to create useful ways for users to interact with a blockchain whether it is a game with in-game collectibles such as crypto kitties or creating an exchange for tokens such as Uniswap. Where blockchain’s like Ethereum provide the framework for tools to be built on blockchain, these tools most often come in the form of DAPPS. Each of these DAPP’s will have its own value according to its usefulness, and many will introduce their own token to facilitate and incentivize the use of the application.
Third Generation Blockchains: Scaling and Interoperability
While second-generation blockchains introduced smart contracts and the framework for DAPP’s and their many cryptocurrencies to be built on a blockchain, they largely improved functionality while inheriting the relatively inefficient transaction speeds of bitcoin and build new independent, self-contained networks. Third-generation blockchains, such as Cardano, Polkadot, or Zilliqa, among many others, look to include the functionality of second-generation blockchains while improving scalability and introducing ways for distinct blockchains to communicate and work together.
scalability refers to the ability of a blockchain to grow. Common barriers to blockchain scalability include high costs, energy consumption, data requirements, and adaptability. Though there are many innovative approaches to scalability, the most common technology leveraged by third generations blockchains to improve both efficiency and speed is proof of stake. In brief, proof of stake uses a random subset of users to validate transactions reducing energy and data requirements of the system. by reducing the energy and data consumption, third-generation blockchains are most often more sustainable, more cost-effective, and faster than earlier blockchains. While second-generation blockchains like Ethereum may struggle to implement these upgrades, third-generation blockchains are often designed with future upgrades in mind.
Blockchains were originally envisioned as independent and self-sufficient systems. In the future, as blockchains are more widely adopted, it will become increasingly important for blockchains to communicate with each other to facilitate transactions and exchanges between systems and companies which may use different private and public blockchains. DAPP’s, such as Chainlink, has begun to create solutions for blockchains to interact with each other and with systems that exist outside of the blockchain. To enable transactions between blockchains, these DAPPs normally rely on centralised resources such as exchanges. While this solution creates new ways to use blockchains, centralisation at any level during a transaction is contrary to the end goal of most blockchain pioneers. Third-generation blockchains have been designed from inception with interoperability in mind and with new approaches to decentralised interoperability.
Blockchain is here to stay. Since Bitcoin was launched in 2009, more advanced blockchains have enabled smart contracts and DAPP’s to build a variety of functional interfaces for businesses and users to take advantage of the security inherent in blockchain. Now third-generation projects are building on existing technology to make systems more efficient and sustainable as well as introducing new ways for blockchains to communicate and interoperate with each other.
While this is only an introduction, with this you are well-positioned to learn more and to start getting involved whether it be buying your first cryptocurrency, or reading about other topics like decentralised finance or non-fungible tokens to discover new ways to generate a return on your digital assets.