June 2017 - Blockchain

Blockchain - What's What?

How does a blockchain actually work? Stephan Zimprich, Leader of the Competence Group Blockchain in eco – Association of the Internet Industry, explains the key concepts and terms behind blockchain technology.

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Blockchain is currently a hype topic as a technical platform for digital innovations. It is a distributed technology for transparent and tamper-proof transactions without the need for a centralized authority. Below is a brief explanation of the most important blockchain terminology, in alphabetical order:

Blockchain

A blockchain is a database that is distributed throughout a network. As a result, all transactions are simultaneously saved in many different locations. Its integrity is ensured through the saving of the hash-value of each previous data set. It was created as the technical foundation for crypto-currencies like Bitcoin. In the meantime, numerous advancements have further developed the original blockchain technology. These enable a whole range of other applications aside from crypto-currencies, such as in the areas of license management, insurance, logistics, and ID management. For many experts, the strength of blockchain lies in simple transactions that validate the blockchain network – for example, in computationally intensive processes using proof of work (POW). The majority of computing resources decides which version of the blockchain is correct. This protects the blockchain against manipulation, and trusted intermediaries are no longer be needed for the processing of transactions.

Distributed Ledger 

The basis of a blockchain is a database of records distributed across all nodes of the network. This means that all data is shared between participants in a peer-to-peer network. All participants of this network have the same rights and the same information, and thus the same preconditions to be able to participate in the system and enter new information. Every node stores the entire database. This exhaustive redundancy protects the system against unilateral power, outage, and manipulation. The system is self-administering, and as a result could simplify processes for banks and stock exchanges, as well as in many other sectors.

Consensus Process

The consensus process is the decisive component for protecting a blockchain against manipulation. It prevents one participant from using a value more than once – so, for example, that a sum of money is transferred multiple times, even though it only exists as a single sum. The consensus process solves this “double-spending problem”: Only when the majority of the connected nodes are in agreement about the generation of a particular new block will this be validated and the previously generated blocks will be “chained” to it. 

Mining

All transactions are stored in blocks that are “chained” to one another – like a constantly-growing pile of sticky Post-it notes. The miners, the participants in the network, generate new blocks, by using computationally intensive process steps to aggregate and validate multiple transactions. During mining, a hash value – a kind of electronic fingerprint – is calculated for every new block on the basis of the previous block, and then the new block is chained to the previous one through the hash value. The blocks also contain a timestamp and a nonce, a randomly-generated string or set of characters. In order to calculate the current block’s hash values for the next block, blockchain systems use, for example, computationally intensive proof-of-work processes. Given that every newly-created block is chained to the previous one by means of the hash value of the previous one, a linear, chronological chain is created.

Nodes

Any computer can become a node, and thus a fully-fledged part of a blockchain network. This is because the database itself, in other words the blockchain, is distributed across many so-called nodes (or clients), and each of them stores the entire blockchain. Using specialized software, the nodes receive and examine every transaction and send it on. The software also contacts other nodes, in order to get or submit information and is itself a component of the network. Anyone can operate a node, because the different nodes do not need to trust one another in order to guarantee the consistency of the data.

Proof of Work (POW)

Instead of trusting in a central authority, a computationally-intensive proof of work (POW), for example, is required within the blockchain. In this process, new blocks are generated in computationally intensive process steps, the correctness of which is easy to ascertain for the other participants. Here, speed is essential: The first to generate the new block is rewarded. The new block will only be accepted by the rest of the network, if the majority of the computing resources in the network confirm the result. This is, at the same time, a trust mechanism, because no individual within the network can calculate faster than the complete network. A rogue participant would need to be faster than all the others combined and control more than 50 percent of the processing power, which is impossible, since the individual participants or nodes do not have basic mutual trust. Alongside the proof of work process, there are further processes, such as proof of stake and proof of burn.

Smart Contracts

Alongside simple transactions, blockchain also enables what are known as smart contracts to be generated. A smart contract is a program that emulates a contract or technically supports the settlement of a contract. Smart contracts are not actually intelligent, but they can automatically carry out specific actions if pre-defined conditions come into effect, making the settlement of the contract possible without human intervention. In this way, contract partners can determine in advance that, in the case of rain on a particular day in a particular location, a defined sum of money will be paid out – this would be an application in the form of a bad-weather insurance policy for filming. The smart contract can, for example, obtain the required weather information from an Internet-capable weather station without human intervention, and the payment of the insured sum would be done using a blockchain-based crypto-currency like Bitcoin – in this way, the contract can be settled completely without the need of a trusted central authority

Smart contracts also serve as the basis for more complex applications that no longer need human intervention. An example is decentralized autonomous organizations (DAO); autonomously acting and completely digital companies based on blockchain. Here also, activities are monitored and implemented completely without human judgement, but rather simply on the basis of algorithms. Such applications can be designed, for example, using the platform Ethereum. This blockchain with integrated programing language makes tools available to developers in an open platform, in order to develop their own smart contracts and to use them in a blockchain.

More information on the activities of the eco Competence Group Blockchain can be found here:  (in German) and here (in English). Early 2018, eco will host the Blockchain Masters conference in Frankfurt. More details will be online on blockchain.eco.de in a few weeks.

Stephan Zimprich is a lawyer in the intellectual property and media team of Fieldfisher's Hamburg office with six years of experience in advising clients ranging from start-up size to multinational market leaders in the fields of copyright, media and broadcasting regulation and data protection. The main focus of his work lies in the area of digital content distribution and data-driven business models such as targeted advertising and mobile advertising. He has a particular expertise in the online travel sector, where he advises international clients from Europe and the US in the fields of data protection, advertising and travel regulation as well as general commercial law, including cross-border co-operations.


Please note: The opinions expressed in Industry Insights published by dotmagazine are the author’s own and do not reflect the view of the publisher, eco – Association of the Internet Industry.