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Fundamentals of Blockchain

Blockchain, originating from Bitcoin, has emerged as one of the most revolutionary technologies in recent years. Its decentralized nature enables the establishment of trust, making it highly disruptive across various industries including finance, and offering a wide range of applications. Consequently, it has garnered significant attention from governments, financial institutions, technology companies, enthusiasts, and the media worldwide.

1.1 Introduction to Blockchain

In September 2008, the financial crisis, triggered by the bankruptcy of the American investment bank Lehman Brothers, erupted in the United States and rapidly spread globally. In response, governments and central banks worldwide implemented unprecedented fiscal stimulus measures and expansive monetary policies, offering emergency assistance to major financial institutions that found themselves in turmoil due to their own missteps. However, these actions sparked widespread skepticism about the traditional financial system and eroded public trust in currency systems underpinned by national credit.

In October of the same year, a cryptographic researcher, pseudonymously known as "Satoshi Nakamoto," disseminated a paper (Nakamoto 2008) on Bitcoin with members of the enigmatic CypherPunk community through an email. The paper delineated a peer-to-peer electronic cash system that functioned without the need for a trusted third-party entity and introduced the concept of the blockchain for the first time. By November, Nakamoto released an initial version of the Bitcoin code. In January 2009, he mined Bitcoin's first block, known as the "genesis block," on a small server in Helsinki, Finland, marking the inception of Bitcoin. Nakamoto embedded the headline "Chancellor on brink of second bailout for banks" from The Times into the genesis block, symbolizing not only the dawn of a new era for decentralized currency but also a satirical jab at the old financial order.

Since its inception, Bitcoin has established itself as the most adopted system underpinned by blockchain technology. As the foundational technology derived from the Bitcoin system, blockchain is believed to possess the potential to revolutionize a myriad of sectors, including financial services, supply chain management, entertainment, smart manufacturing, public welfare, education, and employment.

By definition, a blockchain is a mechanism in a peer-to-peer networking environment that, through transparent and trustworthy rules, creates a chained data structure that is immutable, inalterable, and traceable, intended to execute and manage transactions. In a narrower sense, the blockchain is a sequential data structure where blocks of data are chronologically linked together and safeguarded cryptographically to ensure immutability and authentication. In a broader sense, it represents a novel distributed foundation and computing paradigm, utilizing a chained data structure to verify and store information. This approach employs distributed consensus algorithms to generate and update data, cryptographic methods to ensure secure data transmission and access, and smart contracts to program and manipulate data with automated script codes (Yuan and Wang 2016, pp. 481-494).

In the "Internet of Information" era, while online data was transparent and openly accessible, its credibility was questioned due to potential tampering, necessitating trusted third-party institutions to vouch for its authenticity. Should these intermediaries collapse, such trust evaporates, rendering the inherent value of Internet data insubstantial. However, with the advent of blockchain, data on the Internet has been imbued with a newfound trustworthiness. Stored across countless global machine nodes, data becomes "stable," "trustworthy," and "unalterable." Fundamentally, blockchain technology relies on a tamper-resistant, shared distributed ledger, maintained collectively by all network member nodes. Cryptographic technology, rather than external trust, ensures the integrity of this ledger as nodes work to validate incoming data and transactions. It records all transactional data comprehensively through a chained data structure. As a result, the blockchain is seen as the most promising driver in transitioning from the "Internet of Information" to the "Value of Information." The blockchain is characterized by three prominent features: decentralization, immutability, and trustlessness.

1. Decentralization: The network structure of blockchain adopts a peer-to-peer architecture, with equal status among nodes and no existence of a super administrative node, thus embodying the decentralized characteristic of blockchain. This is different from the centralized architecture of the client/server (C/S) service model. In a peer-to-peer network, each node is both a server and a client, relying on user groups rather than central servers to exchange information. All nodes collectively maintain the resources and services within the network, and the transfer of information and the provision of services are carried out directly between nodes, eliminating the need for intermediary nodes and servers. Since services are distributed among various nodes, an attack or damage to part of the network has minimal impact on other parts, making the entire system resilient and highly fault-tolerant. On the other hand, the middle cost of data value exchange in peer-to-peer networks is very low, reducing the resource and time costs induced by centralization.
2. Immutability: The data organization structure of the blockchain utilizes a chained data structure combined with pure mathematical encryption algorithms, ensuring its resistance to tampering and forgery. Blocks written later contain the identification information of those written earlier, and any data can be traced back through its chained structure for verification. Any change to data on the blockchain will result in a cascading effect on subsequent blocks, guaranteeing the accuracy of all stored information. Furthermore, cryptographic hashing algorithms are employed, leveraging its irreversible nature to render the forgery process unfeasible. Thus, this structure does not permit tampering or forging of data that's already confirmed on the blockchain, otherwise, it triggers a chain reaction that makes the on-chain data fail verification, ensuring the integrity, authenticity, and security of the entire blockchain.
3. Trustlessness: The trust mechanism of the blockchain is based on asymmetric cryptography. Asymmetric encryption, also known as public-key encryption, is a mathematical encryption method that utilizes two related but separate keys - a public key and a private key - to secure data and communications. This approach allows data to be encrypted with the public key and decrypted only with the corresponding private key, facilitating secure transmission without requiring the preshared secrets of symmetric encryption. For instance, when Alice initiates a transaction to transfer assets to Bob in the network, she encrypts the transaction using Bob's public key and then broadcasts this transaction to the entire network. Only the decryption using Bob's private key can access this information. When Bob decrypts the information using his private key, it verifies him as the asset recipient and gains the approval and recordation of the entire network. Rigorous encryption algorithms and a comprehensive authentication system ensure that one party in a transaction does not need to know the identity of the other node or require a third-party trust guarantee. They can conduct trusted transactions in an unfamiliar mode. All nodes in the network can act as "supervisors," safeguarding the personal privacy behind the transaction data.

1.2 Evolution of Blockchain

Blockchain technology originated from mature technologies such as peer-to-peer networks, asymmetric encryption, databases, and distributed systems. Through the combination and innovation of these existing technologies, unprecedented functionalities have been achieved. To date, the development of blockchain technology has roughly undergone three stages: programmable currency, programmable finance, and programmable society (Swan 2015), as illustrated in Figure 1.1. Subsequently, we will delve into how the value of blockchain applications evolved in each stage, providing readers with a comprehensive perspective on the profound impact of this technology.

Figure 1.1 Evolutionary trace of blockchain technology.

1.2.1 Value Evolution in Blockchain Applications

The initial stage of blockchain technology was characterized by the emergence of programmable digital currencies. During this period, the primary application scenarios revolved around cryptographic currencies facilitating secure transfers, remittances, and digital payments. Bitcoin serves as such a prominent exemplification.

In early 2009, the first version of the Bitcoin system officially went online. It painted an idealistic vision for people - a unification of global currency. The total supply of Bitcoin is confined by the consensus protocol within the network and no longer relies on central banks of various countries. No individual or institution can arbitrarily alter its supply or transaction records. Due to its limited supply, Bitcoin is...