Crypto unchained - chapter 2

Chapter 2:

A new world

Crypto-assets are sketching a new world — painted as a triptych.

The inner workings of crypto-assets are the results of successful interplay of tools from cryptography and network organization combined with economic incentives. To understand crypto-assets we can rely on three building blocks:

the blockchain technology
network organization
trusted third parties.

Blockchain technology

The foundation of any crypto is the blockchain. While this term is omnipresent in the discussion, few are fully familiar with its mechanics and purpose.

What’s so special about it?

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How does it work?

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In short, the blockchain is nothing but a USB stick, a space for digital storage. The defining feature stems from the immutability.

Once content is added to blockchain it cannot be removed or altered in any way.

As we will see shortly, this immutability feature is key for the workings of crypto-assets.

Network dynamics

Now that we have seen how the data is stored, we can look at who is behind data management.

There are three types of network organizations to consider:

Centralised

Central authority that controls everything :

Hierarchical, one decision-maker
Efficient, fast decision
E.g. banks, governments

Decentralised

Decisions are spread across multiple centers

Multiple decisions nodes
Joined governances
E.g. European Union

Distributed

No single authority, everyone is equal

Flat hierarchy
More democratic
E.g. Crypto-assets

Every system, whether it’s a company or a government, relies on a network to function. But not all networks work the same way. While centralized and decentralized systems require permission to join or leave, distributed networks, like those powering crypto-assets, are completely open. We say that centralized and decentralized networks are “permissioned” networks. In line with our illustration, to get a job or to join the EU, one must apply and be accepted. Similarly, leaving isn’t always easy meaning quitting a job or leaving the EU (Brexit), requires up front notice and/or negotiations.

Distributed networks on the other hand are described as “permissionless” networks. This means that anyone is free to join and leave the network at will. The “peer-to-peer” quality of distributed networks stems exactly from the permissonlessness feature. In other words, everyone is equal and there are no gatekeepers.

This implies a high level of trust. If there’s no single entity in charge, how can people trust the crypto-asset ecosystem, let alone crypto transactions? This brings us to our final building block: trusted third parties.

Trusted third-parties

Trusted third parties (TTPs) are all around us and allow us to seamlessly interact with strangers. Every transaction, whether it’s buying coffee or sending money, relies on an intermediary which provides trust. An example of how third parties facilitate interactions looks as follows:

For Alice and Bob to transact, they rely on a third party which will ensure that Bob receives the funds Alice owes him. Third parties – such as banks – provide trust which allows individuals, who do not know and trust each other, to interact.

Crypto-assets follow the same principle, acting as a trust provider. Unlike traditional third parties, which are centralized, the third party in case of crypto-assets is distributed. Other than that, Alice and Bob may interact in the same way as they would with a centralized third party.

The motivation of distributed third parties is twofold:

Centralized trusted third parties often charge considerable fees, making transactions costly. For instance, Visa and Mastercard charge fees of roughly 2%, while transactions fees on the Bitcoin network amount to 0,05% for most of its existence.

Centralized third parties may not always qualify as trustworthy entities. The Lehman Brothers’ case is a notorious example. The bank collapsed during the 2008 financial crisis. Before filing for bankruptcy, the bank was suspected of hiding and manipulating financial records. Such example highlight a risk of relying on centralized models of trust.

In a nutshell:

With traditional banking:

The bank is the middleman
Your account & transaction data is stored on the bank’s server
The bank holds all the power over your account (e.g. blocking access, freeze funds, etc.)

With crypto transactions:

The blockchain itself is the middleman
Data is stored across multiple nodes within the distributed network, not just one server
Every participant holds a full copy of the blockchain
The immutability of the blockchain ensures no one can temper with the data

Crypto-assets provides a framework which allows users to move away from a world of centralized third parties and enjoy the peer-to-peer interactions provided by a distributed network. As opposed to centralized networks – in which data is stored and controlled in a centralized fashion – in the distributed networks system allows the data to be stored across a multiplicity of nodes. Every node holds a complete version of the blockchain and is in charge of updating it with newly validated blocks of transactions. To ensure that nodes do not temper with the data, it is stored on a blockchain. The immutability of the blockchain ensures no one can alter the data in any way.

The next big question is: how does this network of individual nodes come into existence and what motivates every single node to contribute to the system?

Chapter 3:

Money rules the world

Digital or not, what drives crypto — like everything else — is still a matter of money.

Read chapter 3

Into the wild

A new world

Money rules the world

From Wallets to Smart Contracts

The rise of DApps

Heads or tails, Coins & Tokens

Risks and scams

Outlook

Crypto’s Decentralization Dilemma

A new world

Blockchain technology

Network dynamics

Centralised

Decentralised

Distributed

Trusted third-parties

Money rules the world

Stay tuned