Intro to Blockchain: How Protocols Work

Internet Protocols The first question to ask is: what is a protocol? A protocol is the method by which data is sent from one computer to another over the internet. The three protocols that power the modern internet are the HyperText Transfer Protocol (“HTTP”), Transmission Control Protocol (“TCP”), and Internet Protocol (“IP”). The TCP and IP are the protocols that help to route information across the network and HTTP is an application-level protocol for web browsers. If you’re a little bit confused by what these terms mean, that’s totally understandable. Let’s break it down.

Proof of Work: The first consensus algorithm to be implemented in a blockchain protocol was the proof-of-work algorithm. It is the algorithm that powers a number of the top blockchain networks, including bitcoin and ethereum. The proof-of-work algorithm requires network participants to verify transactions through a computationally complex math puzzle and incentivizes them to verify transactions by providing a reward to the node that successfully completes that problem. This idea of computational complexity provides additional security to the system because it requires an enormous amount of time and energy to make any changes to the blockchain after consensus has been reached. Essentially, a hacker would need to have enough computing power to compete with the entire existing blockchain network if they wanted to make any retroactive changes. As always, I think it’s easiest to understand how the concept works by walking through an example. Let’s say that a number of bitcoin transactions have occurred and need to be validated. All of the nodes that are connected to the network (known as miners) will then compete to “mine” the block of transactions. They do this by taking a hash of a few different inputs, including (i) all of the transactions in the block, (ii) the timestamp of when the block was hashed, (iii) the difficulty of the block (don’t worry about this for now), (iv) the hash of the previous block of transactions, and (v) an extra number called a “nonce” (more on this later).

“Proof-of-stake: Proof-of-stake (“POS”) was first used by Peercoin in 2012 and has since gained in popularity. In fact, even Ethereum will be switching to it in the near-term. The benefit of using a proof-of-stake system is that it reduces the amount of energy and expensive hardware required to validate transactions. That makes it more environmentally friendly and further decentralizes the network as there are lower barriers to entry for becoming a validating node. Let’s break down how it works. In a proof-of-stake system, there is no math puzzle for nodes to compete to solve. Instead, validating nodes (known as “forgers”) are selected in a semi-random way, where the probability of being selected is based on a combination of the number of network tokens the forger owns and the amount of time he / she has owned those coins for. For a good description of these selection methods, check out this article. So how do you make sure that these forgers don’t validate fraudulent transactions? Proof-of-stake protocols solve this potential issue by forcing forgers to lock up their “stake” (aka their network tokens) in an escrow of sorts. If a forger validates a fraudulent transaction, it will lose the coins in the escrow account and will not be allowed to partake in the forging process in the future. Another key difference between POW and POS consensus mechanisms is how they financially incentivize network participants to validate transactions. Unlike proof-of-work, there are no block rewards in a proof-of-stake system. Instead, nodes receive transaction fees for validating transactions. What’s interesting is that the transaction fees are actually a way for proof-of-stake networks to regulate the number of forgers (aka validating nodes). If a network wants to encourage more forgers, it can increase the value of transaction fees and vice versa.”

"Another key difference between POW and POS consensus mechanisms is how they financially incentivize network participants to validate transactions. Unlike proof-of-work, there are no block rewards in a proof-of-stake system. "

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Integrated Blocks I know this has been a dense post but stay with me, we’re almost there. The final differentiating component of a blockchain protocol is how blocks of transactions are integrated to create an “immutable ledger”. This integration is done through hashing. The best way to understand how this works is to look at how blockchain networks initially get off the ground. The first block in a blockchain is known as the “genesis block”. The genesis block differs from other blocks because it is hardcoded into the network and details the initial parameters of the blockchain. When the transactions from this genesis block are validated, they are hashed to generate a unique value that identifies the block. When the second block is validated, the transactions from the second block, as well as the hash value of the first block, are used as inputs to create the second block’s unique hash value. This is then done for each subsequent block in the blockchain, effectively linking the blocks together. This linking feature is what makes the blockchain “immutable” because hackers cannot just hack one block. If a hacker tries to change the data stored in a validated block, it will change the hash of each subsequent block and cause a ripple effect throughout the rest of the chain. This will instantly be spotted by every other node, providing an additional level of security to the network.

Rest of the Story:

I know this piece covers a ton of dense information so thanks for taking the time to read it! Just to quickly sum it up (or…re-hash it if you will), blockchain protocols are an innovative way of sending information across a network. They sit on top of the TCP / IP protocol stack and incorporate several elements that make them a much more secure method for sending information and transferring value. These elements include distributed ledgers, encryption, consensus mechanisms, and integrated blocks. Original Article: https://medium.com/all-things-venture-capital/intro-to-vc-how-blockchain-protocols-work-750e9371b053