Blockchain was invented over a decade ago, and as Bitcoin got popular, it changed the way the world saw online transactions and digital currencies. And along with the Bitcoin blockchain, other Distributed Ledger Technologies (DLTs) emerged and saw use in various industries like finance, healthcare, real estate.
In this article, I’ll explain the different types of Blockchain and their fundamentals. And along with it, we’ll get into the different protocols used to reach consensus, so everyone is on the same page about which transactions are legit and which are from malicious actors.
What is DLT?
A DLT is a digital system for recording the transaction of assets in which the transactions and details are recorded in multiple nodes at the same time.
A DLT, unlike traditional databases, does not store information centrally. It is distributed, decentralized, spread out over multiple nodes, each containing the same information. This decentralization provides better security, transparency, and parties using it don’t need to trust each other, just the protocol.
A distributed ledger can be used to record data such as a registry, transactions, and more. A consensus algorithm is used to verify the data and make the decentralization work, thus making it often more secure than a centralized solution. We’ll soon get into the different mechanisms used to reach a consensus.
The terms DLT and blockchain are often used interchangeably, but blockchain is a type of implementation of DLT.
What is blockchain?
Blockchain is a shared, immutable ledger for recording transactions in a way that makes it difficult or impossible to change, hack, or cheat the system.
A blockchain is formed by blocks chained together. Each block bundles transactions together, along with the actual timestamp, the cryptographic hash of the previous and the current block. Each additional block reinforces the ones before it, as hacking a single block requires every subsequent block to be hacked as well.
How does a blockchain achieve consensus?
One of the challenges of blockchain is how to figure out which transactions are legitimate and should be added to the blockchain? This is called the “Byzantine Generals Problem.”
Now, imagine several generals, with their armies, surround a city, and to successfully conquer it, they need to attack together. To coordinate this attack, they have to send messengers between them and reach a consensus on when to attack. But which messengers are to be trusted? And how can you be sure your message arrived?
Blockchains do this using various consensus mechanisms. They are protocols that make sure all nodes are synchronized and validate legitimate transactions. Even if malicious and corrupt actors are trying to change the transactions, as long as they are not the majority, the consensus mechanism adopted by all the nodes takes care of the validation of legit transactions.
Different blockchain consensus mechanisms
The consensus mechanism adopted depends on the desired outcome for each specific blockchain. The biggest influence on deciding which consensus mechanism to pick is the “scalability trilemma.”
The Scalability Trilemma, a term coined by Vitalik Buterin (founder of Ethereum
), refers to a widely held belief that decentralized networks can only provide two of three benefits at any given time concerning decentralization, security, and scalability.
Proof of Work
Proof of Work (PoW) is the consensus mechanism Satoshi Nakamoto used to secure Bitcoin
and solve the “Byzantine Generals Problem.”
In a PoW-based blockchain, miners solve complex mathematical puzzles with huge amounts of computational power to add a new block to the blockchain. This puzzle has no other utility besides being proof that work has been done. So, to find the answer faster and have a higher chance to get the rewards for creating a new block, miners need more computational power. On the Bitcoin blockchain, depending on the speed on which the algorithms are solved, the algorithm automatically adjusts the difficulty so a block is created on average every 10 minutes.
The downside of PoW is how energy-intense it is. According to the University of Cambridge’s bitcoin electricity consumption index, bitcoin miners are expected to consume roughly 140 TWh of energy, which is roughly 0.6% of global electricity consumption.
A PoW blockchain tends to score high in decentralization and security, but low on scalability.
Proof of Stake
Proof of Stake (PoS)
is a consensus mechanism where only network actors who have a financial stake in the network could add the blocks in the blockchain. Users can stake their tokens to become a validator (someone who can produce blocks), which means they lock their tokens up for a certain time. After doing so they are eligible to produce blocks. As a reward, they also get tokens, just like mining in a PoW blockchain. They usually receive the transaction fees along with a fixed reward.
If a bad actor tries to manipulate the transactions, they risk losing everything they staked to become validators. So each validator has a vested interest in keeping the network secure.
It is also more environmentally friendly than PoW since instead of using computational power to validate transactions, validators must just hold the coins of the blockchain on which they are validating.
Delegated Proof of Stake (DPoS) is a very fast consensus mechanism. To reach increased scalability, it sacrifices some decentralization and security.
In a DPoS system, users can stake their coins to vote for a certain number of delegates. Delegates are voted to govern the system and to propose core changes. The delegates that receive the highest amount of votes get to produce blocks and are rewarded for creating these blocks. Just like with PoS, they are either paid from the transaction fees or they are paid a fixed amount of coins.
Electing delegates is a continuous process, so who the top delegates are can constantly change. If an elected node misbehaves or does not work efficiently, it will be quickly expelled and replaced by another one.
Alternative consensus mechanisms
The consensus mechanisms above are the most commonly used. Yet, depending on the demands, a blockchain may need a different consensus protocol. Here’s a list with alternative consensus mechanisms:
- Proof of Authority
- Proof of Capacity
- Proof of Elapsed Time
- Proof of Identity
- Proof of Authority
- Proof of Activity
- Practical Byzantine Fault Tolerance
- Asynchronous Byzantine Fault Tolerance
Consensus mechanism used by popular cryptos
|Proof of Work||Bitcoin, Ethereum, Litecoin, Dogecoin|
|Proof of Stake||Stellar, Ethereum 2.0|
|Delegated Proof of Stake||Tron, EOS|
|Proof of Authority||VeChain|
How to solve the scalability trilemma?
In the decentralized ecosystem, there is no solution to the trilemma for Layer 1 protocols yet. Layer 1 refers to blockchain protocols like Bitcoin, Litecoin, and Ethereum.
So far, the solution lies in Layer 2 protocols. They operate on top of the Layer 1 blockchain and are often built to improve scalability, transaction speeds, and efficiency. The Lightning Network is an example of a Layer 2 solution build on top of Bitcoin.
These solutions achieve decentralization, security, and scalability often through batching transactions, and periodically settling them on the Layer 1 blockchain. Thousands of transactions can be made, and only the final state gets passed along to a settlement layer like Bitcoin or Ethereum.
Different types of blockchains
Due to its adaptability and ease of use, various industries have started incorporating blockchain technology into their systems. And as each industry functions in its unique manner, different types of blockchain have evolved. It was the need to match the dynamic needs of various sectors which led to the introduction of different types of blockchain.
As the name suggests, a public blockchain is a non-restrictive, permission-less distributed ledger system.
It has no restriction on who can participate or be a validator or node. No one has complete control over the network. This ensures data security and helps immutability because a single person can not manipulate the Blockchain. Anyone is authorized to access the ledger, validate and verify transactions, and do mining.
Public blockchains are secure, transparent, and require no intermediaries. Because of their public nature, they are highly censorship-resistant.
A private blockchain, as the name suggests, is a restrictive system that cannot be accessed by everyone freely. Private blockchains are usually used within an organization or enterprises where only selected members are participants of a blockchain network. Only pre-chosen entities have permission to access the blockchain. These entities are chosen by the respective authority and are given permission by the blockchain developers while building the blockchain application.
Private blockchains are similar in use as a public blockchain but have a small and restrictive network. Private blockchain networks are deployed for voting, supply chain management, digital identity, asset ownership, etc.
Private blockchains are fast and more scalable. The downsides are the centralization, lower security, and trust required in the operator of the blockchain.
Examples: Ripple, Hyperledger Fabric, Corda
Consortium blockchains are governed by a group and not by a single entity. This is contrary to what we saw in a private blockchain, which is managed by only a single organization. More than one organization can act as a node in this type of blockchain and exchange information or do mining. Consortium blockchains are typically used by banks, government organizations, etc.
This approach has all the same benefits as a private blockchain and could be considered a sub-category of private blockchains, as opposed to a separate type of chain.
Examples: Energy Web Foundation (EWF), R3
A hybrid blockchain is a combination of the private and public blockchain. It combines the features of both because it lets one have a public permissionless system and a private permissioned system. With such a hybrid network, users can control who gets access to which data stored in the blockchain. Only a selected section of data or records from the blockchain can be allowed to go public, keeping the rest confidential in the private network.
The hybrid system of blockchain is flexible so that users can easily join a private blockchain with multiple public blockchains. A transaction in a private network of a hybrid blockchain is usually verified within that network. But users can also release it in the public blockchain to get verified.
Coins and tokens without blockchains
Many of the most popular tokens and coins don’t have their own blockchains. They are created on top of existing ones.
Tokens are different from traditional cryptocurrencies in that they're not intended to be used as general-purpose currency. They're also created as smart contracts
on top of existing blockchains, such as Ethereum, and do not exist as stand-alone systems. Blockchains like Polkadot and Cardano
will soon also have tokens being created on top of them.
As you might imagine, there are a wide variety of use cases for crypto tokens. They can be used to represent assets like NFTs, real estate, stocks, or bonds. Some are used as a payment method to use the project which launched the token.
Examples: Chainlink, Uniswap, Theta
As the name suggests, stablecoins are cryptocurrencies created for the sole purpose of providing reliable value storage. They came about because standard cryptocurrencies like Bitcoin and Ether can fluctuate wildly in value over a short span.
They have some mechanism to keep them stable, pegged to a specific value. Most keep reserves of those currencies as a guarantee of the token’s value.
Examples: USDT, USDC, BUSD
The bottom line
DLT is a new technology enabling us to build decentralized alternatives to the current status quo. The DLT and consensus mechanism used heavily depend on the requirements a project or company has.
As stated in the “scalability trilemma”, it is often a trade-off between scalability, security, and decentralization. Much like the college trilemma, where one must pick two between enough sleep, good grades, and social life.
Through the development and adoption of Layer 2 solutions, soon we might enjoy the benefits of having all three, scalability, security, and decentralization, opening the doors to a host of new possibilities.