Disclaimer: This is not financial advice. Anything stated in this article is for informational purposes only and should not be relied upon as a basis for investment decisions. Triton may maintain positions in any assets or projects discussed on this website.
TL;DR
Part V
What’s in a Name: Blockchain Networks and Cryptocurrencies
We shift our focus to the basics of blockchain technology for this post. The goal here is to offer simple clarifications about how these networks operate under the hood, and through that clarity, hopefully better contextualize how these are just emerging internet technologies that are going to add better functionality to the financial systems that exist today. Importantly, blockchains are not panaceas to all problems or immune to frictions, greed, or any other problems that generally exist in society.
Too often proponents ascribe far too much promise (e.g. if the US invests in Bitcoin it can unlock $100 trillion of economic activity) or critics ascribe far too much blame (e.g. the only use case is crime). Blockchain is a neutral technology that lives on the internet. It can unlock very powerful new use cases and reduce massive inefficiencies in payments while at the same time may provide another route through which criminals can conduct their business, as they have done throughout the entirety of human history. The internet offered similar advantages (global, free, instant information sharing) and disadvantages (phishing, ransomware, data hacks, viruses), but as it grew, we collectively developed ways to magnify the benefits while reducing the risks. This still very much needs to happen with blockchain technology, and it will. But in the meantime, unfortunately we can expect the inefficiencies to be exploited as is consistent with any new technology.
As we explained in our previous posts, blockchain networks like Bitcoin are best viewed as internet native value transfer networks. BTC, like gold, has value because it is scarce, safe, and an increasingly proven way for people to protect their wealth. Yes, it is largely reliant on people around the world collectively deciding that is the case, exactly as it has been with gold for thousands of years. Its level of adoption over its 16-year history suggests this might actually be the case, but it is by no means guaranteed and there obviously remains a significant level of speculation and risk in the asset. This also means that yes, many cryptocurrencies are not valuable in the same way that Bitcoin is, much like there are many, many commodities that are worth less than gold, from platinum and silver all the way down to river rocks worth just a few dollars per ton. There are millions of cryptocurrencies worth even less than that. Most are absolutely, undeniably, worthless. But not all.
The value lies in the collective adoption, utility and the network effects that any cryptocurrency is able to generate. BTC is the first to break through in a meaningful way, but there were many earlier attempts at ‘digital cash’ that failed, such as eCash, Bit Gold, and HashCash, with aspects of many of these ultimately incorporated into Bitcoin’s design. Though it seems like Bitcoin was simply invented one day out of thin air, it is actually the result of many years of development and failure. It just happens to be the first attempt that finally worked well enough to gain escape velocity. This is the same messy process behind the development of any successful technology.
Though not a perfect analogy (apologies to our CTO), one can simply think of blockchain networks as value transfer protocols that plug into the broader internet suite that includes things such as IP addressing and HTTPS. The internet is complex in practice and has been continuously under development since the 1950s, but in theory it all amounts to providing a way to move information from one computer to another, around the world, privately and efficiently. Blockchains are not replacements of any of the current internet stack and are entirely reliant on what already exists to enable their functionality. Blockchain protocols simply enable value exchange functionality to be added, extending what the internet can do.
Blockchains are not voodoo or rocket science, but they do include an impressive amount of mathematics and game theory to enable their functionality. For example, they elegantly solve what is known as the Byzantine General’s Problem: a problem in game theory that considers how decentralized groups can reach consensus when you cannot trust others in the group or rely on a central 3rd party. That is the secret sauce, and different blockchains implement different consensus mechanisms in order to solve that specific problem. Bitcoin uses its own ‘Nakamoto Consensus’ algorithm leveraging its Proof-of-Work mechanism. Ethereum uses its own ‘Gasper’ consensus algorithm based on a Proof-of-Stake mechanism. The actual algorithms are beyond the scope of this explanation, but by and large, they both enable a decentralized network of nodes to collectively agree on valid transactions, the correct block of valid transactions to add, and the correct chain of blocks to reference, while protecting against outside threats, such as Sybil attacks. A Sybil attack is where a malicious actor creates many fake identities to overwhelm a peer-to-peer network.
When we mention nodes on a blockchain network, we are typically referring to individuals or companies that have decided to help support the network, often in exchange for incentive rewards. Aside from a few chains, there are no restrictions around who can join and participate in a network. This is where the permissionless and decentralized aspects of these networks come from. Some networks have light enough requirements that anyone can run a node on their home computer, while others have more significant requirements and as such nodes are mostly handled by professional operating companies. Many have designs that enable a mix – some lightweight nodes can monitor, but full nodes are required to contribute to the core network functionality, for example. Regardless, these nodes are collectively responsible for keeping the networks running. Ethereum has ~6,000 nodes and ~1,000,000 active validators around the world, Bitcoin has ~22,000 reachable nodes, Solana has ~4,500 nodes and ~1,400 active validators.
Because these networks do not rely on any middlemen and are open to participation by anyone in the world, security and functionality guarantees have to be provided by math and code, rather than human coordination and legal agreements. The name ‘cryptocurrency’ stems from the use of cryptography to enable network functionality and security. Though often used interchangeably, cryptocurrencies are a subset of the broader blockchain technology paradigm. That is, a blockchain on its own is not a cryptocurrency, but a transferable asset that it enables is one (i.e. Ethereum is a general purpose blockchain network, Ether is that network’s native cryptocurrency). Cryptography broadly includes things like encryption and decryption, hashing and digital signature algorithms. Every blockchain utilizes its own mix of these to provide secure, peer-to-peer, and fully digital value transfer networks. For example, Bitcoin Core uses the same encryption algorithm to secure its wallet that the NSA uses to protect classified information.
Hashing and digital signatures are what enable the block continuity and verifiable validation that the network has not been tampered with. A hashing algorithm essentially just takes one input of data and produces a unique, irreversible output. These are simple yet powerful: you could run the entire Library of Congress’s collection through a hashing function and get one output, but if you removed just 1 period from one page somewhere in that collection and ran it through the same hashing function, you would get a completely different output. By comparing those two outputs, you would immediately know something was changed. And because blockchains utilize public ledgers where all of the data is available to see, it is immediately clear to the network what was changed if those hashes differ. With blockchains, the hash of the previous block of transactions is linked to the current block, and if something is tampered with anywhere in its history, the entire network knows immediately because a link within that chain of blocks would effectively break. Block-chain. Blockchain. These networks are thus append-only ledgers, meaning blocks can only ever be added to the existing chain, one cannot go back and change transactions that have already occurred.
Every entity (user, program, smart contract, etc.) interacting with a blockchain has an address. What this technically represents differs between networks, but it can be thought of exactly what it sounds like: your own network address. In practice, these are public-private ‘key pairs’ that provide native encryption and security for your address. Your address is the public piece of this key pair, and anyone can see that address and send funds to it whenever they want. It is usually an alphanumeric string of characters that looks like this on Bitcoin: 1A1zP1eP5QGefi2DMPTfTL5SLmv7DivfNa (this is one of Satoshi Nakamoto’s addresses and can be viewed at the provided link) and like this on Ethereum: 0x95222290DD7278Aa3Ddd389Cc1E1d165CC4BAfe5.
The second part of that key pair is your private key, which for all intents and purposes serves as the password to unlock access to that address. Only the holder of that private key can ‘unlock’ and send funds from the associated public address. A user must ‘sign’ the transaction with the correct private key showing proof of control and authentication, which is then validated by the network. The public key itself can be derived from the private key, and as long as you have the private key, you can access the public key address. But that function does not work in reverse; it is computationally impossible (currently) to derive a private key from an associated public key, hence why it is so secure. You need not worry about accidental duplicates either; there are 2^160 possible addresses or said another way: 1,460,000,000,000,000,000,000,000,000,000,000,000,000,000,000,000 possibilities.
Technically, private keys are 256-bit numbers, meaning they are defined by a binary set of 1s and 0s. But from this number, the 64-digit hexadecimal formats similar to what were shown above can be created mathematically. And from this, using a digital signature algorithm like ECDSA and a hashing function like Keccak-256, public key pairs can be deterministically generated.
The Golden Rule: Never share your private key with anybody.
Though secure, these key pairs are obviously unwieldy for an individual to use directly and new mechanisms are being developed to make things more user friendly, such as ‘Ethereum Name Service’, or ENS (note the similarity to DNS – the internet protocol that translates IP addresses between human readable addresses like google.com). In the current form, using these bare public keys is like sending an email directly to an IP address instead of a Gmail address. This is one of the major issues stopping broad consumer use cases. Most people do not want to deal with the frictions and added risk of interacting directly with their hexadecimal private keys. This experience is improving but is still not quite mature enough for seamless internet-scale consumer applications.
Wallets have been developed to help create and manage addresses and act as the main conduits through which users can interact with blockchains. Generally, wallets are secured through the use of seed phrases – a series of 12,18 or 24 words. These seed phrases act as a master password to the wallets and thus any keys stored within. Most wallet providers use seed phrases in a standardized way, meaning no matter which wallet provider one uses, the same seed phrase will unlock the same key pairs. That is, where a private key grants access to a single address, a seed phrase grants access to all of your addresses.
The More Golden Rule: Never share your seed phrase with anybody.
If this all makes it sound confusing or risky to manage one’s own keys, that is because it still is, and this is a major reason why one hears about so many losses or scams in crypto. Interacting directly with most blockchain networks today means that users have to store and manage their own seed phrases and private keys and try to parse what permissions any given transaction they sign is actually enabling and on what network. There is a significant amount of development effort going into better abstractions and user experience here, but this is still very much a clunky experience and for the marginal user just looking to try sending stablecoins to a family member, these frictions remain prohibitive.
In our next post, we will expand further on the state of the technology as it stands today before turning our attention to the actual networks and assets that are starting to emerge.
Exploring how blockchain disrupts money and trust.
Revisiting how Bitcoin offers a secure, transparent, and scarce asset to protect wealth
Revisiting the crypto revolution: empowering peer-to-peer payments with bitcoin