Blockchain is a type of distributed digital ledger technology (DLT) in which chronological records (“blocks”) are mathematically configured to operate in an adversarial environment regarding requests for alteration originating from all the participating devices (“nodes”) of its network. In each case, read-only access to the data can be granted to all the participants, even in an adversarial environment. Permissionless or public ledgers are the best-known examples of blockchain and are the focus of this article.
The high level of security and privacy control in permissionless, or public, blockchain is attained by cryptographic hashing algorithms as well as encryption mechanisms using a combination of private and public “keys.” The nature of keys can be thought of in analogy to an email address: The address itself is public, but the password to access the contents of that address is private. The private key is a solution to a cryptographic hash, which in Bitcoin blockchain would have 64 digits, so the private key will be a specified factor in the 64-digit product.
Moreover, the blocks in a blockchain form an interlocking phalanx joined by the digits of interlocking encrypted data like the rings of a chain. That is, each block contains the cryptographic “hash” of the previous block. As a blockchain is used, blocks are added through transactions recorded as interlinked data, propagating the chain. These transactions could be the creation of a new unit of value, such as a Bitcoin, a transfer of such unit from one owner to another, or the memorialization of other information on the ledger, such as title to real estate. Because the ledger constituted by these blocks is held by each participating node, it is known as a distributed ledger network.
At the beginning of each chain is a “genesis block” that contains instructions and procedures for the operation of the chain. Such instructions could be rules on the creation of new assets and establishing consensus, code for smart contracts, or policy statements for the ledgers.
In a public or permissionless system such as Bitcoin, blocks are added to the chain by nodes completing a “proof-of-work” (PoW) mathematical puzzle to solve the hash, which requires considerable computing power and “hashes” each block against alternation (“mining”). A PoW puzzle requires calculating the hash of the block at a difficulty level set by the historical speed of solution, which at mid-2024 ranges from ten to 60 minutes for the Bitcoin blockchain. The rules for Bitcoin’s blockchain also provide for a consensus checking of each proposed solution so that a transaction initiated by a node broadcasting it to the blockchain network is only complete upon validation by the other nodes. These transactions remain “unconfirmed” and must be assembled with other unconfirmed transactions into a “candidate block,” which itself must be validated through PoW and consensus. The high latency arising from calculation of the hashed block header is perhaps the largest drawback for financial market use. The hashed block header, however, cannot be eliminated because it is the backbone of the PoW security model.
To grasp the network linkage among blocks, their durability against unintended replication, and the activity performed in PoW, a look at a block’s internal components is useful. As mentioned above, the genesis block is quite different from the others, as it can contain smart contracts specifying rules for node verification and validation or for the routine operations of the ledger ecosystem. A block contains a version number (4 bytes); a hash of the previous block (256 bytes); a time stamp in seconds (4 bytes); a “nonce,” which is a one-time password or key (4 bytes); the current difficulty level (4 bytes); and the Merkle Root hash of transactions. The Merkle Root is that segment of the hash that repeats the hash of related blocks and thus solidifies the chain.
The hash function is based on an algorithm that accepts any size data input but is restricted to a fixed size output known as the “hash value” or simply the “hash.” Creating a hash is simple, but deciphering the key input factors is impossible, even if the algorithm is known. A hash is non-reversible because changing even a single bit of the input data produces a completely different hash. Hash values are also known as “message digests” or simply “digests.” Once the genesis block and other protocols are written, the structure of a permissionless DLT network alone ensures that bookings on the ledger are authorized.
Users find the most attractive aspect of blockchain to be its distributed and autonomous nature. Once the genesis block establishes the encryption and transaction rules, the system of distributed ledgers can operate without supervision. This model brings with it the significant disadvantages of PoW—which are the use of enormous computing power and consequential energy consumption, together with latency. At ten to 60 minutes for each transaction, the Bitcoin blockchain lags significantly behind nearly every other type of financial transaction. A similar system created to allow execution of smart contracts by a distributed collection of users would face similar latency concerns.
This article draws its content from David C. Donald and Mahdi H. Miraz, Multilateral Transparency for Securities Markets Through DLT, 25 Fordham J. Corp. & Fin. L. 97 (2020). The author thanks Fordham University and Prof. Miraz for permission to use this content.
