Module – 2

Fundamentals of Blockchain Technology

Blockchain – Definition, architecture, elements of blockchain, benefits and limitations, types of blockchain.
Consensus – definition, types, consensus in blockchain., Decentralization – Decentralization using blockchain,
Methods of decentralization, Routes to decentralization, Blockchain and full ecosystem decentralization.

1.Blockchain
Blockchain is a constantly growing ledger that keeps a permanent record of all the transactions that have taken
place in a secure, chronological, and immutable way. It can be used for the secure transfer of money, property,
contracts, etc. without requiring a third-party intermediary such as bank or government.

o Ledger: It is a file that is constantly growing.

o Permanent: It means once the transaction goes inside a blockchain, you can put up it permanently in the
ledger.
o Secure: Blockchain placed information in a secure way. It uses very advanced cryptography to make sure
that the information is locked inside the blockchain.
o Chronological: Chronological means every transaction happens after the previous one.
o Immutable: It means as you build all the transaction onto the blockchain, this ledger can never be
changed.

1.1Blockchain Architecture

Blockchain is a technology where multiple parties involved in communication can perform different
transactions without third-party intervention. Verification and validation of these transactions are carried
out by special kinds of nodes.
What are the Merkle trees? What is its importance in blockchain?
Merkle tree is a fundamental part of blockchain technology. It is a mathematical data structure composed of
hashes of different blocks of data, and which serves as a summary of all the transactions in a block. It also allows
for efficient and secure verification of content in a large body of data. It also helps to verify the consistency and
content of the data. Both Bitcoin and Ethereum use Merkle Trees structure. Merkle Tree is also known as Hash
Tree.

The Merkle tree plays a vital role in blockchain technology. If someone needs to verify the existence of a specific
transaction in a block, then there is no need to download the entire block to verify the transaction in a block. He can only
download the chain of block headers. It allows downloading a collection of a branch of the tree which contains this
transaction is enough. We check the hashes which are relevant to your transactions. If these hashes check out is correct,
then we know that this particular transaction exists in this block.

How do Merkle trees work?

A Merkle tree stores all the transactions in a block by producing a digital fingerprint of the entire set of
transactions. It allows the user to verify whether a transaction can be included in a block or not.

Merkle trees are created by repeatedly calculating hashing pairs of nodes until there is only one hash left. This
hash is called the Merkle Root, or the Root Hash. The Merkle Trees are constructed in a bottom-up approach.

Every leaf node is a hash of transactional data, and the non-leaf node is a hash of its previous hashes. Merkle
trees are in a binary tree, so it requires an even number of leaf nodes. If there is an odd number of transactions,
the last hash will be duplicated once to create an even number of leaf nodes.

How Does blockchain Work?

These are the core blockchain architecture components:

Node — Any computer or machine, which holds the complete copy of the blockchain ledger.

Transaction — Every data or information which we store on the block change is in the form of transactions.

Block — Block consists of Block Header, Hash of Previous Block Header, Merkle root of the transaction.

Chain — Sequence of blocks in a specific order.

Miners — The nodes who produce a block and perform the block verification process before adding anything
to the blockchain structure. Miners will compete with each other to solve the puzzle to earn rewards.

Consensus (consensus protocol) — ​ Consensus​ is a way of reaching an agreement in a group. Where a set of
rules and arrangements to carry out blockchain operations. Any transaction within the blockchain should follow
the rules and arrangement of Consensus.

How blockchain works?

1. Transaction is Initiated.

2. The Transaction is placed in a Block.

3. The block of a transaction is sent to every node in the network.

4. Miners validate the transaction using consensus mechanism Proof of Work

5. Miners who successfully crack the puzzle in “Proof of Work” will receive the reward.
 6. The Block is now successfully placed on the existing Blockchain.

7. The transaction is Successfully Completed.

1.3 Elements of Blockchain

Blockchain has many powerful components that play an excellent role in storing and securing data. Let’s discuss
the components of blockchain in a detailed way below:

Blocks: Basically, blocks are the backbone of blockchains. You can store data in blocks permanently but cannot
change or delete it after it is stored. Once a block is filled with the data of transactions, then it will be linked with
previous blocks. Every block will have information such as block size, transaction counter, block header, the
previous block's hash, timestamp, and transaction data.

Know that blocks are linked based on cryptographic methodology. Generally, blocks are identified with long
numbers that will have information about previous blocks as well as a new transaction. While creating new
blocks, data inside a block is verified by a blockchain network. After that, you can add new blocks to the
blockchain.

Hash Codes: It is one of the vital security features used in blockchain technology. In its basic form, a hash code
has a fixed length. It helps to ensure that no one can crack blockchains or alter block data. You can use Hash
codes to verify the integrity of transactions as well as authentication. You can add new blocks only after solving
hash codes. Note that it must generate the same output whenever you apply the hash function in data in a block.
If not, it means that the data in the block is modified.

Nodes: It is one. of the essential components of blockchains. Nodes are storage units that store vast amounts of
blockchain data. Nodes can be computers, servers, and laptops. All nodes are connected in a blockchain network.
If any change is made in the blockchain's data, nodes can detect it quickly. There are two types of nodes such as
full nodes and light nodes.

 Full Nodes: Generally, a full node stores the complete copy of a blockchain. In other words, once a full
node joins a blockchain, it stores copies of all the blocks. After the node is synchronized with all other
nodes in the network, it can add new blocks to the blockchain. Full nodes usually have more memory
than light nodes. They can accept, reject, and validate transactions.
 Light Nodes: They are also known as partial nodes. This is because they don't copy all the blocks in the
blockchain. Instead, they only store the recent blocks and access older ones only when users request the
same. They maintain the hash code of transactions. You can access data only after solving the hash code.
Unlike full nodes, they have only low computing power and memory.

Ledger: Essentially, this component of a blockchain resembles a record-keeping mechanism. There are three
types of ledgers: public, decentralized and distributed.
  Public Ledger: In this type, anyone can access ledgers since it is open to all blockchain network
participants. There is no central authority in this public ledger type. And it allows transactions only after
verifying the identity of users. At the same time, participants' identities are hidden until they make any
transaction.
 Distributed Ledger: In distributed type, all the nodes will have a copy of databases. A group of nodes
will manage the tasks, such as verifying transactions or adding blocks to a blockchain. You can
significantly reduce financial fraud and cyberattacks by using this ledger. You can access all the
information stored in this ledger using cryptographic signatures and keys.
 Decentralized Ledger: In this type, no participant needs to trust others or know their identities. The
stakeholders or partners can access real-time data from the ledgers anytime. This ledger lessens reliance
on specific authorities that manage the network. It brings consistency and improves performance by
decentralizing resources.

Nonce: Nonce is yet another vital component of blockchain. It refers to a ‘Number used only once. In its basic
form, a nonce is a 32-bit number randomly used only once. It is also a pseudo-random number that you can use
only once in a cryptographic communication. Generally, a nonce is created only once while creating a new block
or validating a new transaction. Once a perfect nonce is created, you can add it with the hashed blocks in a
blockchain. After that, the block's hash value is rehashed, eventually creating a difficult algorithm. With this
component of blockchain, you can make secured transactions because nonce verifies all the transactions along
with other data of blocks.

1.4 Benefits and limitations

Benefits:

1. Open: One of the major advantages of blockchain technology is that it is accessible to all means anyone
can become a participant in the contribution to blockchain technology, one does not require any permission
from anybody to join the distributed network.
2. Verifiable: Blockchain technology is used to store information in a decentralized manner so everyone can
verify the correctness of the information by using zero-knowledge proof through which one party proves
the correctness of data to another party without revealing anything about data.
3. Permanent: Records or information which is stored using blockchain technology is permanent means one
needs not worry about losing the data because duplicate copies are stored at each local node as it is a
decentralized network that has a number of trustworthy nodes.
4. Free from Censorship: Blockchain technology is considered free from censorship as it does not have
control of any single party rather it has the concept of trustworthy nodes for validation and consensus
protocols that approve transactions by using smart contracts.
5. Tighter Security: Blockchain uses hashing techniques to store each transaction on a block that is
connected to each other so it has tighter security. It uses SHA 256 hashing technique for storing
transactions.
6. Immutability: Data cannot be tampered with in blockchain technology due to its decentralized structure so
any change will be reflected in all the nodes so one cannot do fraud here, hence it can be claimed that
transactions are tamper-proof.
7. Transparency: It makes histories of transactions transparent everywhere all the nodes in the network have
a copy of the transaction in the network. If any changes occur in the transaction it is visible to the other
nodes.
8. Efficiency: Blockchain removes any third-party intervention between transactions and removes the mistake
making the system efficient and faster. Settlement is made easier and smooth.
9. Cost Reduction: As blockchain needs no third man it reduces the cost for the businesses and gives trust to
the other partner.

Limitations:

1. Scalability: It is one of the

biggest drawbacks of
blockchain technology as it
cannot be scaled due to the
fixed size of the block for
storing information. The
block size is 1 MB due to
which it can hold only a
couple of transactions on a
single block.
2. Immaturity: Blockchain is
only a couple-year-old
technology so people do not have much confidence in it, they are not ready to invest in it yet several
applications of blockchain are doing great in different industries but still it needs to win the confidence of
even more people to be recognized for its complete utilization.
3. Energy Consuming: For verifying any transaction a lot of energy is used so it becomes a problem
according to the survey it is considered that 0.3 percent of the world’s electricity had been used by 2018 in
the verification of transactions done using blockchain technology.
4. Time-Consuming: To add the next block in the chain miners need to compute nonce values many times so
this is a time-consuming process and needs to be speed up to be used for industrial purposes.
5. Legal Formalities: In some countries, the use of blockchain technology applications is banned like
cryptocurrency due to some environmental issues they are not promoting to use blockchain technology in
the commercial sector.
6. Storage: Blockchain databases are stored on all the nodes of the network creates an issue with the storage,
increasing number of transactions will require more storage.
7. Regulations: Blockchain faces challenges with some financial institution. Other aspects of technology will
be required in order to adopt blockchain in wider aspect.

1.5 Types of Blockchain

There are four types of blockchain structures:

1. Public Blockchains

Public blockchains are permissionless in nature, allow anyone to join, and are completely decentralized. Public
blockchains allow all nodes of the blockchain to have equal rights to access the blockchain, create new blocks of
data, and validate blocks of data.
To date, public blockchains are primarily used for exchanging and mining cryptocurrency. You may have heard
of popular public blockchains such as Bitcoin, Ethereum, and Litecoin. On these public blockchains, the nodes
“mine” for cryptocurrency by creating blocks for the transactions requested on the network by solving
cryptographic equations. In return for this hard work, the miner nodes earn a small amount of cryptocurrency.
The miners essentially act as new era bank tellers that formulate a transaction and receive (or “mine”) a fee for
their efforts.

2. Private (or Managed) Blockchains

Private blockchains, which may also be referred to as managed blockchains, are permissioned blockchains
controlled by a single organization. In a private blockchain, the central authority determines who can be a
node. The central authority also does not necessarily grant each node with equal rights to perform
functions. Private blockchains are only partially decentralized because public access to these blockchains is
restricted. Some examples of private blockchains are the business-to-business virtual currency exchange
network Ripple and Hyperledger, an umbrella project of open-source blockchain applications.

Both private and public blockchains have drawbacks - public blockchains tend to have longer validation times
for new data than private blockchains, and private blockchains are more vulnerable to fraud and bad actors. To
address these drawbacks, consortium and hybrid blockchains were developed.

3. Consortium Blockchains

Consortium blockchains are permissioned blockchains governed by a group of organizations, rather than one
entity, as in the case of the private blockchain. Consortium blockchains, therefore, enjoy more decentralization
than private blockchains, resulting in higher levels of security. However, setting up consortiums can be a fraught
process as it requires cooperation between a number of organizations, which presents logistical challenges as
well as potential antitrust risk (which we will examine in an upcoming article). Further, some members of supply
chains may not have the needed technology nor the infrastructure to implement blockchain tools, and those that
do may decide the upfront costs are too steep a price to pay to digitize their data and connect to other members of
the supply chain.

A popular set of consortium blockchain solutions for the financial services industry and beyond has been
developed by the enterprise software firm R3. In the supply chain sector, CargoSmart has developed the Global
Shipping Business Network Consortium, a not-for-profit blockchain consortium which aims to digitalize the
shipping industry and allow maritime industry operators to work more collaboratively.1

4. Hybrid blockchains

Hybrid blockchains are blockchains that are controlled by a single organization, but with a level of oversight
performed by the public blockchain, which is required to perform certain transaction validations. An example of
a hybrid blockchain is IBM Food Trust, which was developed to improve efficiency throughout the whole food
supply chain. We will discuss IBM Food Trust in more detail in an upcoming article in this series.
Real life application of blockchain :

Here is a list of real world problem where we can use blockchain :

1. In a secure and full-proof voting management system.
2. To supply chain management.
3. In healthcare management.
4. Real estate project.
5. NFT marketplace.
6. Avoid copyright and original content creation.
7. In the personal identity system
8. To make an immutable data backup.
9. Internet of Things

1.6 Blockchain Consensus

Definition: It's a method whereby peers agree to the current state of the ledger. It makes sure that all peers share the same
copy of the ledger. Fraudulent transactions are kept off the ledger. It also ensures that it records transactions in
chronological order.

Example: For example, a group of friends decides on a trip to Goa without conflicts. Here, reaching a decision to
visit Goa together is a state of consensus or mutual agreement.

However, getting a no-conflict decision agreement by each person in a group seems far-fetched. Maybe someone
wants to go to Manali instead. How could a group of friends possibly reach a consensus? Moreover, how can
numerous strangers achieve consensus in a network?

In order to avoid centralization and conflicts among members, the system requires a consensus mechanism
or algorithm.

What Are Consensus Mechanisms

Consensus is the process by which a group of peers – or nodes – on a network determine which blockchain
transactions are valid and which are not. Consensus mechanisms are the methodologies used to achieve this
agreement. It’s these sets of rules that help to protect networks from malicious behaviour and hacking attacks.

There are many different types of consensus mechanisms, depending on the blockchain and its application. While
they differ in their energy usage, security, and scalability, they all share one purpose: to ensure that records are
true and honest. Here’s an overview of some of the best known types of consensus mechanisms used by
distributed systems to reach consensus.

1.7 Types of Consensus

A consensus mechanism is a set of steps that are taken by all, or most, nodes in order to agree on a proposed state
or value. For more than three decades this concept has been researched by computer scientists in the industry and
Academia. Consensus mechanisms have recently come into the limelight and gained much popularity with the
advent of bitcoin and blockchain.
Types of consensus mechanism There are various types of consensus mechanism; some common types are
described as follows:

 Byzantine fault tolerance-based: With no compute intensive operations such as partial hash inversion,
this method relies on a simple scheme of nodes that are publishing signed messages. Eventually, when a
certain number of messages are received, then an agreement is reached.
 Leader-based consensus mechanisms. This type of mechanism requires nodes to compete for the
leader-election lottery and the node that wins it proposes a final value.

Consensus Protocol/ Algorithm

The consensus algorithm is the method of gaining consensus on a change of data over the system or distributed
network. Consensus algorithms are heavily used in blockchains as they enable the network of unknown nodes to
reach consensus on the data that is being stored or shared through the blockchain.
1. Proof of Work (PoW)

Used by Bitcoin, Ethereum, and many other public blockchains, proof of work (PoW) was the very first
consensus mechanism created. It is generally regarded to be the most reliable and secure of all the consensus
mechanisms, though concerns over scalability are rife. While the term ‘proof of work’ was first coined in the
early 1990s, it was Bitcoin founder Satoshi Nakamoto that first applied the technology in the context of digital
currencies.

In PoW, miners essentially compete against one another to solve extremely complex computational puzzles using
high-powered computers. The first to come up with the 64-digit hexadecimal number (‘hash’) earns the right to
form the new block and confirm the transactions. The successful miner is also rewarded ​ ​ with a
predetermined amount of crypto, known as a ‘block reward’.

As it requires large amounts of computational resources and energy in order to generate new blocks, the
operating costs behind PoW are notoriously high. This acts as a barrier of entry for new miners, leading to
concerns about centralisation and scalability limitations.

And it’s not just the costs that are high. The most common criticism of PoW is the impact the electrical
consumption has on the environment. This has led many to seek more sustainable, energy-efficient consensus
protocols, such as proof of stake (PoS).

2. Proof of Stake (PoS)

As the name suggests, this popular method of consensus revolves around a process known as staking. In a proof
of stake (PoS) system, miners are required to pledge a ‘stake’ of digital currency for a chance to be randomly
chosen as a validator. The process is not unlike a lottery whereby the more coins you stake, the better your odds.

Unlike in PoW where miners are incentivised by block rewards (newly generated coins), those who contribute to
the PoS system simply earn a transaction fee.

PoS is seen as a more sustainable and environmentally-friendly alternative to PoW, and one that’s more secure
against 51% attack. However, as the system favours entities with a higher number of tokens, PoS has drawn
criticism for its potential to lead to centralisation. Prominent PoS platforms include Cardano (ADA), Solana
(SOL), and Tezos (XTC).

3. Delegated Proof of Stake (DPoS)

A modification of the PoS consensus mechanism, delegated proof of stake (DPoS) relies upon a reputation-based
voting system to achieve consensus. Users of the network ‘vote’ to select ‘witnesses’ (also known as ‘block
producers’) to secure the network on their behalf. Only the top tier of witnesses (those with the most votes) earn
the right to validate blockchain transactions.
To vote, users add their tokens to a staking pool. Votes are then weighted according to the size of each voter’s
stake – so the more skin in the game, the more voting power. Elected witnesses who successfully verify
transactions in a block receive a reward, which is usually shared with those who voted for them.

Witnesses in the top tier are always at risk of being replaced by those deemed more trustworthy and who
therefore get more votes. They can even be voted out if they fail to fulfil their responsibilities or try to validate
fraudulent transactions. This helps to incentivise witnesses to remain honest at all times, ensuring the integrity of
the blockchain.

Though less prevalent than PoS, DPoS is regarded by many as being more efficient, democratic, and financially
inclusive than its predecessor. It is used by Lisk (LSK), EOS.IO (EOS), Steem (STEEM), BitShares (BTS), and
Ark (ARK).

4. Proof of Activity (PoA)

Proof of activity (PoA) is a hybrid of the PoW and PoS consensus mechanisms. It is used by the Decred (DCR)
and Espers (ESP) blockchain projects.

In PoA systems, the mining process begins like PoW, with miners competing to solve an elaborate mathematical
problem using immense computing power. Once the block is mined, however, the system switches to resemble
PoS, with the successfully generated block header being broadcast to the PoA network. A group of validators are
then randomly selected to sign off on the hash, validating the new block. Like with PoS, the more crypto the
validator holds, the higher their chances of being selected. Once every chosen validator has signed the block, it is
added to the blockchain network and ready to record transactions. The block rewards are then shared among the
miner and validators.

Though the PoA system was designed with the intention of combining the very best features of PoW and PoS,
while avoiding their shortcomings, it has drawn criticism for its energy-intensive mining phase and inherent
partiality towards validators holding a greater number of coins.

5. Proof of Authority (PoA)

Not to be confused with proof of activity (also ‘PoA’), proof of authority (PoA) works by selecting its validators
based on reputation. A modified version of PoS, it was proposed by Ethereum co-founder and former CTO Gavin
Wood in 2017.

In PoA, validators don’t stake coins. Instead, they must put their reputations on the line for the right to validate
blocks. This is very different from the majority of blockchain protocols which usually do not require you to
reveal your identity to take part.

As this mechanism requires almost no computing power, it is far less resource-intensive than some of its
predecessors, in particular PoW. It is also one of the less costly options, making it a heavily favoured solution for
private networks, such as JP Morgan (JPMCoin). Other PoA-based projects include VeChain (VET) and
Ethereum Kovan testnet.
Though highly scalable, where it compromises is in the decentralisation area, as only a select few can participate
in the network. Additionally, the requirement for the validators to be identifiable also increases the risk of
corruption and third-party manipulation.

6. Proof of Burn (PoB)

Another more sustainable alternative to Bitcoin’s PoW algorithm is proof of burn (PoB). In PoB, miners gain the
power to mine a block by ‘burning’ (destroying) a predetermined amount of tokens in a verifiable manner –
namely, sending them to an ‘eater address’ where they cannot be recovered or spent. The more coins burned, the
greater the chances of being randomly selected.

Unlike in PoS where miners are able to retrieve or sell their locked coins should they ever leave the network,
burned coins are irretrievably lost. This method of requiring miners to sacrifice short-term wealth in order to gain
the lifetime privilege to create new blocks helps to encourage long-term commitment from miners. The act of
burning coins also leads to coin scarcity, limiting inflation and driving up demand.

Cryptocurrencies that use the proof of burn protocol include Slimcoin (SLM), Counterparty (XCP), and Factom
(FCT).

7. Proof of Capacity / Proof of Space (PoC / PoSpace)

Unlike the majority of its predecessors which grant mining rights based on computational power or coins staked,
proof of capacity (PoC) – also known as proof of space (PoSpace) – bases its mining algorithm on the amount of
space available in a miner’s hard drive.

In PoC, miners generate a list of all the possible hashes beforehand in a process called ‘plotting’. These plots are
then stored on a hard drive. The more storage capacity a miner has, the more possible solutions. The more
solutions, the higher the chances of possessing the correct combination of hashes and winning the reward.

As it doesn’t require expensive or specialised equipment, PoC opens up opportunities for the average person to
participate in the network. As such, it is a less energy-intensive and more decentralised alternative to some of the
more prevalent consensus mechanisms covered in this guide. However, as of yet, not many developers have
chosen to adopt the system, and there are concerns about its susceptibility to malware attacks. The mechanism is
currently used by Signum (SIGNA) – formerly Burstcoin (BURST), Storj (STORJ), and Chia (XCH).

8. Proof of Elapsed Time (PoET)

Usually used on permissioned blockchain networks (those that require participants to identify themselves), proof
of elapsed time (PoET) leverages trusted computing to enforce random waiting times for block construction. It
was developed by Intel in early 2016 and is based on a special set of CPU instructions called Intel software guard
extensions (SGX).

A time-lottery-based consensus algorithm, PoET works by randomly assigning different wait times to every node
in the network. During the waiting period, each of these nodes goes to ‘sleep’ for that specified duration. The
first to wake up (that is, the one with the shortest waiting time) is awarded the mining rights. This randomisation
guarantees that every participant is equally as likely to be the winner, ensuring fairness within the network.

The PoET consensus mechanism is highly efficient, less resource-intensive, and scalable. It has been
implemented in Hyperledger’s Sawtooth.

9. Proof of History (PoH)

As the name suggests, proof of history (PoH) provides proof of historical events. Developed by Solana,
PoH allows for ‘timestamps’ to be built into the blockchain itself, verifying the passage of time between
transactions without having to rely on other nodes.

This timestamping method is enabled by what’s known as a SHA-256, sequential-hashing verifiable delay
function (VDF). It works by taking the output of a transaction and using it as input for the next hash, which
enables everyone to clearly see which event took place in a particular sequence. As the VDFs can only be solved
by a single CPU score, PoH severely reduces the processing weight of the blockchain, making it faster and more
energy-efficient than many of his contemporaries.

As PoH is only employed by Solana, it has yet to be tested on a large scale.

10. Proof of Importance (PoI)

First introduced by NEM (XEM), proof of importance (PoI) selects its miners based on certain criteria in a
process called ‘harvesting’. Common factors include the number and size of transactions in the last 30 days,
amount of vested currency, and network activity. It’s based on these factors that an importance score is attributed
to nodes. The higher the score, the higher the probability of being chosen to harvest a block and receive the
accompanying transaction fee.

Though similar to PoS, PoI’s use of additional metrics does away with the former’s tendency to inherently
reward the rich by taking into account participants’ overall support of the network. As such, simply staking high
in POI does not necessarily guarantee a chance of winning the block.

Basis Centralisation Decentralisation

The evenly and systematic

The concentration of authority at the top distribution of authority at all levels
Meaning level is known as Centralisation. is known as Decentralisation.

There is no delegation of authority as all

Delegation of the authority for taking decisions is vested There is a systematic delegation of
authority in the hands of top-level management. authority at all levels.
Suitability It is suitable for small organisations. It is suitable for large organisations.

Freedom of
decision There is no freedom of decision-making at There is freedom of decision-
making the middle and lower level. making at all levels of management.

Flow of There is an open and free flow of

Information There is a vertical flow of information. information.

Employee Employees are demotivated as compared Employees are motivated as

Motivation to decentralisation. compared to centralisation.

There are least chances of any conflict in There are chances of conflict in
Conflict in decision as only top-level management is decision as many people are
Decision involved. involved.

The burden of work is not shared and only The burden of work is shared
Burden one group carries the burden. amongst all levels.

1.8 Decentralization using Blockchain

Decentralized blockchains are designed to be unalterable, and once the data is entered it is irreversible. New data
can be tacked on, but the old data can't be edited or changed in any way. For Bitcoin, this means transactions are
permanently recorded and viewable by anyone. Think of it as feedback on eBay taken to the next level.

Not all digital currency is decentralized. There are also cryptocurrencies that use private, centralized systems,
where only a select few people have the power to add new blocks and check the validity of transactions. These
tend to be used in privacy-oriented industries like healthcare and finance.

1.9 Methods of decentralization in blockchain

A blockchain usually exhibits one of the following levels of decentralization:
 Fully centralized. Entirely controlled and managed by a single, central authority.
 Semi-decentralized. Controlled and managed by multiple authorities.
 Fully decentralized. No middlemen or central authorities to manage or administer the network.

There are several subcategories of decentralization, including the following:

 Physical decentralization involves the geographical dispersion of blockchain servers across the globe as
much as possible, so no single party will own the network, and the loss of physical servers -- for whatever
reason -- won't impact the network.
 Transactional decentralization is specifically to improve the efficiency and transparency of B2B networks.
Through the use of unalterable ledgers and smart contracts, a decentralized transactional system can provide
a more secure, consensus-based environment for executing, verifying and recording transactions.
 Political decentralization is more concerned with how many people or organizations control the system
rather than the number of servers. The fewer people or organizations controlling the network, the less
decentralized it is.

Who is building blockchain applications leveraging decentralization

Every blockchain protocol, decentralized Application (dApp), Decentralized Autonomous Organization (DAO),
or other blockchain-related solution adopts varying levels of decentralization. The adoption level is typically
based on the maturity of the solution, the time-proven reliability of its incentive models and consensus
mechanisms, and the ability of the founding team to strike the right balance. For example, many DAOs have
various components at different stages of decentralization: oracles (i.e., third-party services that provide smart
contracts with external information) may be partly decentralized, smart contracts might be fully centralized,
while the governance process for adjusting parameters is community-driven and decentralized.

On a broader scale, decentralized blockchain solutions are being explored and adopted by organizations of every
type, size, and industry. Some notable examples include applications that provide immediate foreign or
emergency aid to those who need it most, without the mediation of a bank, government or third-party entity. Or
applications that give people the ability to manage their own digital identities and data. Today, social media
platforms, companies, and other organizations sell this information without the individual seeing any benefit. A
decentralized approach would help make it equitable for all.

Benefits of decentralization
The benefits of decentralization are numerous. They include the following:

 Trust is a given. From a bank to an eBay seller, knowing and trusting the other party in a transaction is
essential. But no one needs to know or trust the other party in a decentralized blockchain network because
the distributed ledger technology used to record the transaction can't be tampered with, in theory. If anyone
tries, the majority of network members will reject it.
 Increased data accuracy. Businesses frequently silo their data, and it often has to be reconciled one way or
another. Every time data is manipulated, there is the possibility of an invalid entry or data loss. In a
 decentralized blockchain, data isn't siloed and is copied from one ledger to the next, thus ensuring its
integrity.
 Downtime is reduced. Decentralization can help to mitigate failures because there is no single point of
failure. Everything is distributed, so if one source is unavailable or there is a system bottleneck, others can
pick up the slack.
 Transparency. Decentralized blockchains are available to the public, so they are transparent and everyone
can see them.
 Full control. The blockchain's members or users -- not a central, sometimes faceless authority -- are in
control of their information and who can see or access it.
 Immutability. This is the common term used to describe the fact that data contained in a decentralized
blockchain is hard to alter because each alteration must be confirmed by each node in the blockchain network.
 Security. Proponents say decentralized blockchains are far more secure than centralized blockchains because
they employ encryption to protect data. They use either symmetric (secret key) encryption or asymmetric
(public key) encryption.


Downsides of decentralization
Everything has a downside, and that includes decentralized blockchains. The negatives include the following:

 Cost. A decentralized network can often be more expensive than a centralized one because of the need for
more systems and people to run them.
 Lack of consensus. There's something to be said for a single voice of authority. In a decentralized
blockchain, anyone can have their say on an issue, and they often do. The democratic process can be a messy
one and consensus hard to reach sometimes.
 Lack of clarity. This goes hand in hand with the consensus problem. When many people have their say on
an issue, it is important that they are clear and articulate their position. A lack of clarity can lead to paralysis.
 Lack of discipline. It is easy to get lazy when you don't have a boss to report to, which is often the case in a
decentralized network. These networks operate somewhat on an honor system where everyone involved is
expected to do their job. If they don't, the network can suffer.

1.10 Routes to decentralization

Even though there are systems that existed before bitcoin or blockchain that can be classed as decentralized to
a certain degree, such as BitTorrent or Gnutella file sharing, with the advent of the blockchain technology
many initiatives are being taken in order leverage this new technology for decentralization. Usually, the bitcoin
blockchain is the first choice for many as it has proven to be the most resilient and secure blockchain with a
market cap of almost 12 billion dollars. An alternative approach is to use other blockchains, such as Ethereum,
which is currently the tool of choice of many developers for building decentralized applications.

How to decentralize
A framework has been proposed by Arvind Narayanan and others that can be used to evaluate the
decentralization requirements of a variety of things in the context of blockchain technology. The framework
basically proposes four questions that, once answered, provide a clear idea as to how a system can be
decentralized. These questions are listed as follows:

1. What is being decentralized?

2. What level of decentralization is required? 3. What blockchain is used?

4. What security mechanism is used?

The first question simply asks what system is being decentralized. This can be any system. for example an
Identity system or trading. The next question can be answered by specifying the level of decentralization
required by looking at the scale of decentralization discussed earlier. It can be full disintermediation or partial
disintermediation. The third question is quite straightforward, where developers can make a choice as to which
blockchain is suitable for a particular application. It can be bitcoin blockchain, Ethereum blockchain, or any
other blockchain that is deemed fit for a specific application. Finally, a key question needs to be answered
about the security mechanism as to how the security of a decentralized system can be guaranteed. It can be
Atomicity, for example, whereby either the transaction executes in full or does not execute at all. In other
words, it is all or nothing. This ensures the integrity of the system. Other mechanisms can include reputation,
which allows varying degrees of trust in a system

Examples

In this section, an example of the application of the aforementioned framework is provided.

In the first example, a money transfer system is selected, which is required to be decentralized. In this case, the
four questions mentioned earlier can be answered in order to evaluate the decentralization requirements. The
answers are shown as follows:

1. Answer 1: Money transfer system. 2. Answer 2: Disintermediation.

3. Answer 3: Bitcoin.

4. Answer 4: Atomicity.

By answering these four questions, it can be shown how a payment system can be decentralized. Based on the
preceding answers, it can be stated that the money transfer system can be decentralized by removing the
intermediary and will be implemented on the Bitcoin blockchain with security guarantee provided via
Atomicity.

Similarly, this framework can be used for any other system that needs to be evaluated for

decentralization. By answering these four simple questions, it becomes quite clear as to what approach can be
taken to decentralize the system.
1.11 Blockchain and full ecosystem

Decentralization

In order to achieve complete decentralization, it is necessary that the environment around the blockchain is
also decentralized. Blockchain itself is a distributed ledger that runs on top of conventional systems. These
elements include storage, communication, and computation. There are other factors, such as Identity and
Wealth, that are traditionally based on centralized paradigms and there's a need to decentralize these aspects
too in order to achieve a fully decentralized ecosystem

Storage

Data can be stored directly in a blockchain, and with this, it does achieve decentralization, but a major
disadvantage of this approach is that blockchain is not suitable for storing large amounts of data by design. It
can store simple transactions and some arbitrary data but is certainly not suitable for storing images or large
blobs of data, as is the case in traditional database systems. A better alternative is to use distributed hash tables
(DHTS). DHTs were originally used in peer-to-peer file sharing software, such as BitTorrent, Napster, Kazaa,
and Gnutella. DHT research was made popular by CAN, Chord, Pastry, and Tapestry projects. BitTorrent turns
out to be the most scalable and fast network, but the issue is that there is no incentive for users to keep the files
indefinitely. Users do not usually keep files permanently, and if nodes leave the network that has data required
by someone, there is no way to retrieve it except having the required nodes rejoin the network again so that the
files become available once more. Two main requirements here are high availability and link stability, which
means that data should be available when required and network links should also always be accessible. Inter
Planetary File System (IPFS) by Juan Benet possesses both of these properties and the vision is to provide a
decentralized World Wide Web by replacing the HTTP protocol. IPFS uses Kademlia DHT and merkle DAG
(Directed Acyclic Graph) to provide the storage and searching functionality, respectively
Communication

It is generally considered that the Internet (the communication layer in blockchain) is decentralized. This is
true to some extent as the original vision of the Internet was to develop a decentralized system. Services such
as e-mail and online storage are all now based on a paradigm where the service provider is in control and users
trust them to give them access to the service when required. This model is based on the trust of the central
authority (the service provider) and users are not in control of their data; even passwords are stored on trusted
third-party systems. There is a need to provide control to individual users in such a way that access to their
data is guaranteed and is not dependent on a single third party. Access to the Internet (the communication layer)
is based on Internet service providers (15Ps) that act as a central hub for Internet users. If the 15P is shut down
for political or any other reasons, then no communication is possible in this model. An alternative is to use
mesh networks. Even though they are limited in functionality as compared to the Internet, they still provide a
decentralized alternative where nodes can talk directly to each other without a central hub such as an ISP.

Now imagine a network that allows users to be in control of their communication, no one can shut it down for
political or censorship reasons. This could be the next step toward decentralizing communication networks in
the blockchain ecosystem. It must be noted that this model may only be required in a jurisdiction where the
Internet is censored and controlled by the government.

As mentioned earlier, the original vision of the Internet was to build a decentralized network; however, over
the years, with the advent of large-scale service providers such as Google, Amazon, and eBay, the control is
shifting toward the big players. For example, e- mail is a decentralized system at its core, anyone can run an e-
mail server with minimal effort and can start sending and receiving e-mails, but there is a better alternative
available that is already providing a managed service for end users, so there is a natural inclination toward
selecting a centralized service as it is more convenient and free. Free services, however, are being offered at
the cost of valuable personal data and many users are not aware of this fact. This is one example that shows
how the Internet has moved toward centralization. Blockchain has once again given this vision of
decentralization to the world and now concerted efforts are being made to harness this technology and gain the
benefits that it can provide.

Computation

Decentralization of computing or processing is achieved by a blockchain technology such as Ethereum, where

smart contracts with embedded business logic can run on the network. Other blockchain technologies also
provide similar processing layer platforms where business logic can run over the network in a decentralized
manner.

The following diagram shows the decentralized ecosystem overview where, on the bottom layer, Internet or
Meshnets provides a decentralized communication layer, then a storage layer uses technologies such as IPFS
and BigChainDB to enable decentralization, and finally, you see the blockchain that serves as a decentralized
processing layer. Blockchain can, in a limited way, provide a storage layer too, but that seriously hampers the
speed and capacity of the system; therefore, other solutions such as IPFS and BigChainDB are more suitable to
store large amounts of data in a decentralized way. At the top, the Identity and Wealth layers are shown,
Identity on the Internet is a very big topic and systems such as bitAuth and OpenID have provided
authentication and identification services with varying degrees of decentralization and security assumptions.

Blockchain is capable of providing solutions to various problems. A concept relevant to Identity known as
Zooke's Triangle requires that a naming system in a network protocol be secure, decentralized, and meaningful
to humans. It is conjectured that a system can have only two of these properties simultaneously, but with the
advent of blockchain, in the form of Namecoin, this problem was resolved. This, however, is not a panacea and
comes with its own challenges, such as reliance on users to store and maintain private keys securely. This
opens up other general questions about the suitability of decentralization. Perhaps decentralization is not
appropriate in every scenario. Well-reputed centralized systems tend to work better in many cases.

Smart contract

A smart contract can be thought of as a small decentralized program. Smart contracts do not necessarily need a
blockchain to run; however, due to the security benefits that the blockchain technology provides, it is now
becoming almost a standard to use blockchain as a decentralized execution platform for smart contracts. A
smart contract usually contains some business logic and a limited amount of data. Actors or participants in the
blockchain use these smart contracts or they run autonomously on behalf of the network participants.

These small programs reside on the blockchain and execute business logic if some specific criteria are met.
More information on smart contracts will be provided in Chapter 6, Smart Contracts, which is dedicated to a
detailed discussion of smart contracts.

Decentralized organizations Decentralized organization (DOS) are software programs that run on a blockchain
and are based on the idea of real human organizations with people and protocols. Once a DO, in the form of a
smart contract or a set of smart contracts, is added to the blockchain, it becomes decentralized and parties
interact with each other based on the code defined within the DO software.

Decentralized autonomous organizations

Just like DOs, a Decentralized autonomous organization (DAO) is also a computer program than runs on top of
a blockchain and embedded within it are governance and business logic rules. DAO and DO are basically the
same thing, but the main difference is that DAOS are autonomous, which means that they are fully automated
and contain artificially intelligent logic, whereas DOs lack this feature and rely on human input in order to
execute business logic. Ethereum blockchain led the way with the introduction of DAOs for the first time. In
DAO, the code is considered the governing entity rather than humans or paper contracts. A Carator, however,
is a human entity that participates as someone who maintains this code and acts as a proposal evaluator for the
community. DAOS are capable of hiring external Contractors if enough input is received from the token
holders (participants). The most famous DAO project is The DAO (https://dacnub.org) as it raised 168 million
US dollars in its crowd-funding phase. The DAO project was designed to be a venture capital fund which was
aimed at providing a decentralized business model with no single entity as an owner. Unfortunately, this was
hacked due to a bug in the DAO code and millions of dollars' worth of Ether currency (ETH) were siphoned
out of the DAO into a child DAO created by the hackers. It required a hard fork on the Ethereum blockchain to
reverse the impact of the hack and initiate the recovery of the funds. This incident opened up a debate on the
security, quality, and the need for thorough testing of the code in smart contracts in order to ensure integrity
and adequate control. There are projects underway, especially in Academia, that are looking to formalize smart
contract coding.

Currently, DAOS do not have any legal status even though they may contain some intelligent code that
enforces some protocols and conditions, but these rules have no value in the current real-world legal system.
One day, perhaps an autonomous agent that is commissioned and permissioned by a law enforcement agency
or a regulator containing rules and regulations could be embedded in a DAO, to ensure the integrity of the
DAO from a legal and compliance perspective. An Autonomous Agent (AA) is a piece of code that runs
without human intervention. The fact that DAOs are purely decentralized entities makes it possible to run them
in any physical jurisdiction. Therefore, they raise a big question as to how a current legal system would work
with such a varied mix of different jurisdictions and geographies,

Decentralized autonomous corporations

DAOS, Decentralized autonomous corporations (DACs) are a similar concept but are considered a smaller
subset of DAOs. The definitions of DACS and DAOS can sometimes overlap, but a general difference is that
DAOs are usually considered to be nonprofit, whereas DACs can make money via shares offered to the
participants and by paying dividends. These corporations can run a business automatically without human
intervention based on the logic programmed within them.

Decentralized autonomous societies

Decentralized autonomous societies (DASs) are a concept whereby entire societies can function on a
blockchain with the help of multiple complex smart contracts and a combination of DAOs and Decentralized
applications (DAPPs) running autonomously. This model does not mean an outlaw approach, nor is it based on
a totally libertarian ideology; instead, many services that a government offers can be delivered via blockchain,
such as Government Identity Card systems, passport issuance, and records of deeds, marriages, and births.
Another theory is that, if a government is corrupt and central systems do not provide the satisfactory levels of
trust that a society needs, then the society can start its own virtual society on a blockchain that is driven by
decentralized consensus and is transparent. This might be seen as a libertarian or cypherpunk dream but is
entirely possible on a blockchain.

Decentralized applications

All ideas mentioned earlier come under the larger umbrella of decentralized applications All DAOS, DACs,
and DOs are basically decentralized applications that run on top of a blockchain in a peer-to-peer network.
This is the latest advancement in technology with regard to decentralization. Decentralized applications or
DAPPs are software programs that can run on their own blockchain, use another already existing established
blockchain, or use only protocols of an existing blockchain solution. These are called Type I, Type II, and
Type III DAPPS

Requirements of a decentralized application

In order for an application to be considered a decentralized application, it must meet the following criteria.
This definition was provided by David Johnston and others in their whitepaper called The General Theory of
Decentralized Applications, Dapps:

1. The DAPP should be fully open source and autonomous and no single entity should be in control of a
majority of its tokens. All changes to the application must be consensus-driven based on the feedback given by
the community.

2. Data and records of operations of the application must be cryptographically secured and stored on a public,
decentralized blockchain in order to avoid any central points of failure.

3. A cryptographic token must be used by the application in order to provide access and rewards to those who
contribute value to the applications, for example, miners in bitcoin,

4. The tokens must be generated by the decentralized application according to a standard cryptographic
algorithm. This generation of tokens acts as a proof of the value to contributors (for example, miners).

Operations of a DAPP

Establishment of consensus by a DAPP can be achieved using consensus algorithms such as Proof of Work
and Proof of Stake. So far, only PoW has been found to be incredibly resistant to 51% attacks, as is evident
from bitcoin. Furthermore, a DAPP can distribute tokens (coins) via mining, fundraising, and development.

Questions???

1. Illustrate the blockchain based decentralized system.

2. Explain how proof of Stake can achieve consensus among peers.

3. Illustrate and explain how blockchain works using a neat diagram

4. Explain the benefits, features and limitations of blockchain.

5. Explain consensus mechanisms used in blockchain. List out any six consensus

algorithms used in the context of blockchain.

6. Define blockchain. Explain how decentralization of computing or processing power is

achieved by a blockchain.