August 26, 2022

Blockchain layers explained.

Your crypto assets will perish.


Since Satoshi #Nakamoto introduced the Bitcoin blockchain, the first #peer-to-peer #decentralized #network, in 2009, much has changed.

Satoshi, whose identity remains unknown to this day, transformed the world by developing the first functional mechanism for sending existing #digital #assets to anyone, anywhere in the world. Since then, many things have been written or stated regarding #blockchain, including “the future of finance,” “#cryptocurrencies are programmable money,” “the first non-manipulated #currency system,” and “the destroyer of central banks.” All of this, however, may be for nothing if critical breakthroughs are not made.

Despite this, many individuals are unaware of these restrictions and continue to spend a significant portion of their net worth on #cryptocurrency, while few actually understand even the most essential fundamentals of the #technology.

The real value of blockchain

The fundamental value of #blockchain originates from one true benefit: its inherent security. When it comes to #on-chain data, blockchains are incredibly safe.

The vast majority of security breaches in the news aren’t caused by the blockchain being hacked but rather by two main factors:

  • People being duped into handing over their wallet’s private key to a hacker — a phishing attack, for example
  • hackers exploiting smart contract bugs to attack DeFi protocols, such as the recent Crema Finance $6 million exploit.

So, what makes blockchains so secure?

Blockchains are so safe because they contain four layers of security.

For the first layer:

All data saved in a blockchain is encrypted and hashed. On the one hand, data encryption makes obtaining the actual data extremely difficult unless you have the secret key.

Hashes, on the other hand, are irreversible mathematical functions that generate ‘gibberish’ from a data set.

A hash is also unique to the data in that block. Suppose the data inside is changed, the hash changes, making it very effortless to determine if a block has been edited.

As a result, encryption strengthens the security of your data, and hashing acts as a tamper-proof technique because when the original data is updated, the hash changes and the change is easily identified.

In terms of the second layer:

Each blockchain block contains the previous block’s hash (which is where the concept of blockchain comes from).

The reason for this is that, as previously stated when a hacker tampers with a block, the hash of the block changes.

As the hash changes, all subsequent blocks become invalid since the hash of the tampered block no longer agrees with the hash contained in the next block.

As a result, the hacker must edit not only one block but all subsequent ones – we’re talking thousands of blocks here, 743.000 in the case of Bitcoin at the time of writing. I don’t think I need to explain how difficult that would be.

The third layer:

It is also known as the Sybil Control Mechanism.

This technique, known as Proof-of-Work in the case of #Bitcoin and #Proof-of-Stake in the case of blockchains such as #Avalanche, sets the rules of blockchain participation. In the former case, #miners must solve complicated mathematical problems to #mine the next #block.

As a result, a #hacker must carry out that #proof-of-work to tamper with the block and the proof-of-work for the subsequent blocks.

This significantly slows down the overall process, preventing supercomputers with massive hash rates from using their processing capacity to quickly predict the #hashes of the tampered block and the next ones.

In the latter case, validators — the equivalent of a miner in a proof-of-work blockchain – #stake their #currencies to participate in the #chain, with the danger of losing them if they violate the rules.

As a result, the Sybil Control Mechanism not only defines how to participate in the blockchain but also disincentivizes improper behavior, adding an extra layer of security.

There is a prevalent misunderstanding about control systems.

The Sybil Control Method outlined in the preceding paragraph is one thing, while the consensus process is another.

In other words, the techniques used by blockchains to create consensus are not #PoW and #PoS.

For example, in the case of #bitcoin, the “consensus mechanism” is the Nakamoto consensus, which solved the Byzantine Generals Problem.

On the other hand, they utilized Proof-of-Work, the “Sybil Control Mechanism” devised by Hal Finney, to prohibit frivolous or harmful uses of computational resources —Hal was also the first beneficiary of a bitcoin transaction, which led many to believe that he was the real Satoshi.

In summary, the Sybil Control Mechanism explains how to participate in the blockchain, whereas the consensus mechanism enables dispersed #networks, such as blockchains, to achieve consensus without using a central authority.

Decentralization is the final security layer:

There is a reason for this, and it isn’t the conventional pirate story of ‘fighting against #centralized entities like central #banks or #governments; #decentralization is crucial because properly decentralized networks are almost impossible to attack.

If a node tampers a block for malicious motives, unless the hacker owns more than 51 percent of the nodes in a blockchain, the rest of the network will reject the modified blockchain.

As a result, the hacker must not only tamper with a block and all subsequent ones, which is a significant effort in and of itself, but they must also control the vast majority of nodes in the network.

To put this in context, bitcoin now has over 14,000 nodes, which implies the hacker must control over 7,000 of them.

Bitcoin has never been hacked for a reason.

Bottom line, what distinguishes blockchain is its ability to create decentralized networks that achieve consensus without central entities and are so difficult to hack that it is the best #technology for securely storing #data while ensuring #traceability, #immutability, and, most importantly: trustless #proof-of-ownership.

These ideas are the cornerstone for all crypto applications (smart contracts, NFTs, SBTs, and so on).

Now that we understand the underlying value of blockchain, we need to grasp what the crypto industry is missing, which is scalability without #centralization.

The blockchain trilemma says that a blockchain cannot be #scalable, decentralized, and secure simultaneously. Let’s take Bitcoin as an example to grasp this better.

By far, the most decentralized blockchain is Bitcoin.

As a result, one could argue that it is also the most secure network.

However, this isn’t as clear as the decentralization part, which is undeniable.

It comes at a high cost, as Bitcoin is likely the least #scalable blockchain of all. In a word, this is the trilemma problem, a tradeoff in which the vast majority of initiatives focus on two of the three factors and ‘forget’ about the third.

Now we understand why Bitcoin can only handle seven transactions per second, why Bitcoin will never be a viable digital currency, and why Bitcoin’s narrative is no longer “Bitcoin is digital money” but “Bitcoin is digital #gold.”

Very decentralized Ethereum is another example of a blockchain that does not scale in its current configuration (going to be a lot more decentralized in the future with Eth 2.0).

So, how did the vast majority of other blockchains respond?

Said they went the other way because they knew they couldn’t compete with Bitcoin on its turf. That is, sacrificing decentralization in order to create scalable #blockchains. #Solana is an excellent illustration of this because it is both scalable and centralized (which explains the numerous exploits and outages).

Scalability concerns necessitated the deployment of other types of blockchains, known as L2s, that sit on top of the L1s (Ethereum, Solana, Avalanche) to assist minimize bottlenecks; nevertheless, this usually resulted in an even larger degree of centralization.

Other blockchains, such as the aforementioned Avalanche, are actively attempting to address the trilemma through the use of what they call subnets.

This extremely intriguing feature produces smaller blockchains within the main one, each with its own rules and #tokenomics and certified by a portion of the main chain’s #validators. The results are promising, but there isn’t enough data to conclude that the trilemma has been addressed.

What if blockchains never grow in size?

Scalability is both #crypto’s holy grail and its Achilles’ heel.

Proving that blockchains can scale would be a watershed moment in the crypto sector. As long as they don’t scale, no central banker in the world will consider crypto because, without scalability, there would be no DeFi, no NFTs, no nothing since adoption is fed by scalability.

It’s like a Ferrari with an empty tank; outstanding features and ultimate speed, but useless otherwise.

The question is whether blockchain has ever intended to scale.

Some people, such as #Twitter creator Jack Dorsey, believe that a truly decentralized, safe, and ultra-scalable blockchain is not viable, prompting the #development of #Web 5.0, which describes a #non-blockchain distributed network that uses Bitcoin’s blockchain as an identity #layer.

That is, returning to the original blockchain concept of a distributed ultra-secure network for data storage. The needed level of scalability in that scenario is substantially lower. Scalability is essential in situations like #Web 3.0, with things like #DeFi, and we as a space have yet to demonstrate that we can use blockchain at scale.

However, we must ensure scalability is achieved without jeopardizing #decentralization.

Decentralization is not only a key selling point of blockchain in and of itself but also an inherent security feature of blockchains.

I can’t seem to find scenarios where the world needs a centralized blockchain; it doesn’t offer anything substantial to justify the effort of building the future of the internet and finance.

We NEED truly decentralized and scalable blockchains to make this work, as people like Vitalik or Emin, founders of Ethereum and Avalanche, respectively, have demonstrated.

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