Blockchain

In 2008, a groundbreaking paper, entitled Bitcoin: A Peer-to-Peer Electronic Cash System, was written on the topic of peer-to-peer e-cash under the pseudonym of Satoshi Nakamoto.

This paper is available at https://bitcoin.org/bitcoin.pdf.

It introduced the term chain of blocks. No one knows the actual identity of Satoshi Nakamoto. After introducing Bitcoin in 2009, he remained active in the Bitcoin developer community until 2011. He then handed over Bitcoin development to its core developers and simply disappeared. Since then, there has been no communication from him whatsoever, and his existence and identity are shrouded in mystery. The term "chain of blocks" evolved over the years into the word "blockchain."

As stated previously, blockchain technology incorporates a multitude of applications that can be implemented in various economic sectors. Particularly in the finance sector, significant improvement in the performance of financial transactions and settlements manifests as highly desirable time-and-cost reductions. Additional light will be shed on these aspects of blockchain in Chapter 19, Blockchain – Outside of Currencies, where practical use cases will be discussed in detail for various industries. For now, it is sufficient to say that parts of nearly all economic sectors have already realized the potential and promise of blockchain, and have embarked, or will do so soon, on the journey to capitalize on the benefits of blockchain technology.

Blockchain defined

A good place to start learning what blockchain is would be to see its definition. There are some different ways that blockchain may be defined; following are two of the most widely accepted definitions:

Now, let's examine things in some more detail. We will look at the keywords from the technical definition one by one.

Peer-to-peer

The first keyword in the technical definition is peer-to-peer, or P2P This means that there is no central controller in the network, and all participants (nodes) talk to each other directly. This property allows for transactions to be conducted directly among the peers without third-party involvement, such as by a bank.

Distributed ledger

Dissecting the technical definition further reveals that blockchain is a "distributed ledger," which means that a ledger is spread across the network among all peers in the network, and each peer holds a copy of the complete ledger.

Cryptographically secure

Next, we see that this ledger is "cryptographically secure," which means that cryptography has been used to provide security services that make this ledger secure against tampering and misuse. These services include non-repudiation, data integrity, and data origin authentication. You will see how this is achieved later in Chapter 4, Public Key Cryptography, which introduces the fascinating world of cryptography.

Append-only

Another property that we encounter is that blockchain is "append-only," which means that data can only be added to the blockchain in time-sequential order. This property implies that once data is added to the blockchain, it is almost impossible to change that data and it can be considered practically immutable. In other words, blocks added to the blockchain cannot be changed, which allows blockchain to become an immutable and tamper-proof ledger of transactions.

However, remember that it can be changed in rare scenarios wherein collusion against the blockchain network by bad actors succeeds in gaining more than 51 percent of the power. Otherwise, the blockchain is practically immutable.

However, those are individual cases that need to be handled separately and that require an elegant technical solution. For all practical purposes, blockchain is indeed immutable and cannot be changed.

Updatable via consensus

The most critical attribute of a blockchain is that it is updateable only via consensus. This is what gives it the power of decentralization. In this scenario, no central authority is in control of updating the ledger. Instead, any update made to the blockchain is validated against strict criteria defined by the blockchain protocol and added to the blockchain only after a consensus has been reached among all participating peers/nodes on the network. To achieve consensus, there are various consensus facilitation algorithms that ensure all parties agree on the final state of the data on the blockchain network and resolutely agree upon it to be true. Consensus algorithms are introduced later in this chapter, and then in more detail in Chapter 5, Consensus Algorithms.

Blockchain architecture

Having detailed the primary features of blockchain, we are now in a position to begin to look at its actual architecture. We'll begin by looking at how blockchain acts as a layer within a distributed peer-to-peer network.

Blockchain by layers

Blockchain can be thought of as a layer of a distributed peer-to-peer network running on top of the internet, as can be seen in the following diagram. It is analogous to SMTP, HTTP, or FTP running on top of TCP/IP:

Figure 1.5: The architectural view of a generic blockchain

Now we'll discuss all these elements one by one:

• In the preceding diagram, the lowest layer is the Network, which is usually the internet and provides a base communication layer for any blockchain.
• A peer-to-peer network runs on top of the Network layer, which consists of information propagation protocols such as gossip or flooding protocols.
• After this comes the Cryptography layer, which contains crucial cryptographic protocols that ensure the security of the blockchain. These cryptographic protocols play a vital role in the integrity of blockchain processes, secure information dissemination, and blockchain consensus mechanisms. This layer consists of public key cryptography and relevant components such as digital signatures and cryptographic hash functions. Sometimes, this layer is abstracted away, but it has been included in the diagram because it plays a fundamental role in blockchain operations.
• Next comes the Consensus layer, which is concerned with the usage of various consensus mechanisms to ensure agreement among different participants of the blockchain. This is another crucial part of the blockchain architecture, which consists of various techniques such as SMR, proof-based consensus mechanisms, or traditional (from traditional distributed systems research) Byzantine fault-tolerant consensus protocols.
• Further to this, we have the Execution layer, which can consist of virtual machines, blocks, transaction, and smart contracts. This layer, as the name suggests, provides executions services on the blockchain and performs operations such as value transfer, smart contract execution, and block generation. Virtual machines such as Ethereum Virtual Machine (EVM) provide an execution environment for smart contracts to execute.
• Finally, we have the Applications layer, which is composed of smart contracts, decentralized applications, DAOs, and autonomous agents. This layer can effectively contain all sorts of various user level agents and programs that operate on the blockchain. Users interact with the blockchain via decentralized applications. We will discuss more about decentralized applications in Chapter 2, Decentralization.

All these concepts will be discussed in detail later in this book in various chapters. Next, we'll look at blockchain from more of a business-oriented perspective.

Blockchain in business

From a business standpoint, a blockchain can be defined as a platform where peers can exchange value/e-cash using transactions without the need for a centrally trusted arbitrator. For example, for cash transfers, banks act as a trusted third party. In financial trading, a central clearing house acts as a trusted third party between two or more trading parties. This concept is compelling, and, once you absorb it, you will realize the enormous potential of blockchain technology. This disintermediation allows blockchain to be a decentralized consensus mechanism where no single authority is in charge of the database. Immediately, you'll see a significant benefit of decentralization here, because if no banks or central clearing houses are required, then it immediately leads to cost savings, faster transaction speeds, and more trust.

We've now looked at what blockchain is at a fundamental level. Next, we'll go a little deeper and look at some of the elements that comprise a blockchain.

Generic elements of a blockchain

Now, let's walk through the generic elements of a blockchain. You can use this as a handy reference section if you ever need a reminder about the different parts of a blockchain. More precise elements will be discussed in the context of their respective blockchains in later chapters, for example, the Ethereum blockchain. The structure of a generic blockchain can be visualized with the help of the following diagram:

Figure 1.6: Generic structure of a blockchain

Elements of a generic blockchain are described here one by one. These are the elements that you will come across in relation to blockchain:

• Address: Addresses are unique identifiers used in a blockchain transaction to denote senders and recipients. An address is usually a public key or derived from a public key.
• Transaction: A transaction is the fundamental unit of a blockchain. A transaction represents a transfer of value from one address to another.
• Block: A block is composed of multiple transactions and other elements, such as the previous block hash (hash pointer), timestamp, and nonce. A block is composed of a block header and a selection of transactions bundled together and organized logically. A block contains several elements, which we introduce as follows:
  • A reference to a previous block is also included in the block unless it is a genesis block. This reference is the hash of the header of the previous block. A genesis block is the first block in the blockchain that is hardcoded at the time the blockchain was first started. The structure of a block is also dependent on the type and design of a blockchain.
  • A nonce is a number that is generated and used only once. A nonce is used extensively in many cryptographic operations to provide replay protection, authentication, and encryption. In blockchain, it's used in PoW consensus algorithms and for transaction replay protection. A block also includes the nonce value.
  • A timestamp is the creation time of the block.
  • Merkle root is a hash of all of the nodes of a Merkle tree. In a blockchain block, it is the combined hash of the transactions in the block. Merkle trees are widely used to validate large data structures securely and efficiently. In the blockchain world, Merkle trees are commonly used to allow efficient verification of transactions. Merkle root in a blockchain is present in the block header section of a block, which is the hash of all transactions in a block. This means that verifying only the Merkle root is required to verify all transactions present in the Merkle tree instead of verifying all transactions one by one. We will elaborate further on these concepts in Chapter 4, Public Key Cryptography.
  • In addition to the block header, the block contains transactions that make up the block body. A transaction is a record of an event, for example, the event of transferring cash from a sender's account to a beneficiary's account. A block contains transactions and its size varies depending on the type and design of the blockchain.

The following structure is a simple block diagram that depicts a block. Specific block structures relative to their blockchain technologies will be discussed later in the book with greater in-depth technical detail:

Figure 1.7: The generic structure of a block

• Peer-to-peer network: As the name implies, a peer-to-peer network is a network topology wherein all peers can communicate with each other and send and receive messages.
• The scripting or programming language: Scripts or programs perform various operations on a transaction in order to facilitate various functions. For example, in Bitcoin, transaction scripts are predefined in a language called Script, which consists of sets of commands that allow nodes to transfer bitcoins from one address to another. Script is a limited language, in the sense that it only allows essential operations that are necessary for executing transactions, but it does not allow for arbitrary program development.

To facilitate arbitrary program development on a blockchain, a Turing complete programming language is needed, and it is now a very desirable feature to have for blockchains. Think of this as a computer that allows the development of any program using programming languages. Nevertheless, the security of such languages is a crucial question and an essential and ongoing research area. We will discuss this in greater detail in Chapter 6, Introducing Bitcoin, Chapter 10, Smart Contracts, and the chapters on Ethereum Development, later in this book.

• Virtual machine: This is an extension of the transaction script introduced previously. A virtual machine allows Turing complete code to be run on a blockchain (as smart contracts); whereas a transaction script is limited in its operation. However, virtual machines are not available on all blockchains. Various blockchains use virtual machines to run programs such as Ethereum Virtual Machine (EVM) and Chain Virtual Machine (CVM). EVM is used in the Ethereum blockchain, while CVM is a virtual machine developed for and used in an enterprise-grade blockchain called "Chain Core."
• State machine: A blockchain can be viewed as a state transition mechanism whereby a state is modified from its initial form to the next one by nodes on the blockchain network as a result of transaction execution.
• Smart contracts: These programs run on top of the blockchain and encapsulate the business logic to be executed when certain conditions are met. These programs are enforceable and automatically executable. The smart contract feature is not available on all blockchain platforms, but it is now becoming a very desirable feature due to the flexibility and power that it provides to blockchain applications. Smart contracts have many use cases, including but not limited to identity management, capital markets, trade finance, record management, insurance, and e-governance. Smart contracts will be discussed in more detail in Chapter 10, Smart Contracts.
• Node: A node in a blockchain network performs various functions depending on the role that it takes on. A node can propose and validate transactions and perform mining to facilitate consensus and secure the blockchain. This goal is achieved by following a consensus protocol (most commonly PoW). Nodes can also perform other functions such as simple payment verification (lightweight nodes), validation, and many other functions depending on the type of the blockchain used and the role assigned to the node. Nodes also perform a transaction signing function. Transactions are first created by nodes and then also digitally signed by nodes using private keys as proof that they are the legitimate owner of the asset that they wish to transfer to someone else on the blockchain network. This asset is usually a token or virtual currency, such as Bitcoin, but it can also be any real-world asset represented on the blockchain by using tokens. There are also now standards related to tokens; for example, on Ethereum, there are ERC20, ERC721, and a few others that define the interfaces and semantics of tokenization. We will cover these in Chapter 12, Further Ethereum.

A high-level diagram of blockchain architecture highlighting the key elements mentioned previously is shown as follows:

Figure 1.8: Generic structure of a blockchain network

The preceding diagram shows a four-node blockchain network (top), each maintaining a chain of blocks, virtual machine, state machine, and address. The blockchain is then further magnified (middle) to show the structure of the chain of blocks, which is again magnified (bottom) to show the structure of a transaction. Note that this is a generic structure of a blockchain; we will see specific blockchains structures in detail in the context of Ethereum and Bitcoin blockchains later in this book.

How blockchain works

We have now defined and described blockchain. Now, let's see how a blockchain actually works. Nodes are either miners who create new blocks and mint cryptocurrency (coins) or block signers who validate and digitally sign the transactions. A critical decision that every blockchain network has to make is to figure out which node will append the next block to the blockchain. This decision is made using a consensus mechanism. The consensus mechanism will be described later in this chapter. For now, we will look at how a blockchain validates transactions and creates and adds blocks to grow the blockchain.

We will look at a general scheme for creating blocks. This scheme is presented here to give you a general idea of how blocks are generated and what the relationship is between transactions and blocks:

1. Transaction is initiated: A node starts a transaction by first creating it and then digitally signing it with its private key. A transaction can represent various actions in a blockchain. Most commonly, this is a data structure that represents the transfer of value between users on the blockchain network. The transaction data structure usually consists of some logic of transfer of value, relevant rules, source and destination addresses, and other validation information. Transactions are usually either a cryptocurrency transfer (transfer of value) or smart contract invocation that can perform any desired operation. A transaction occurs between two or more parties. This will be covered in more detail in specific chapters on Bitcoin and Ethereum later in the book.
2. Transaction is validated and broadcast: A transaction is propagated (broadcast) usually by using data-dissemination protocols, such as Gossip protocol, to other peers that validate the transaction based on preset validity criteria. Before a transaction is propagated, it is also verified to ensure that it is valid.
3. Find new block: When the transaction is received and validated by special participants called miners on the blockchain network, it is included in a block, and the process of mining starts. This process is also sometimes referred to as "finding a new block." Here, nodes called miners race to finalize the block they've created by a process known as mining.
4. New block found: Once a miner solves a mathematical puzzle (or fulfills the requirements of the consensus mechanism implemented in a blockchain), the block is considered "found" and finalized. At this point, the transaction is considered confirmed. Usually, in cryptocurrency blockchains such as Bitcoin, the miner who solves the mathematical puzzle is also rewarded with a certain number of coins as an incentive for their effort and the resources they spent in the mining process.
5. Add new block to the blockchain: The newly created block is validated, transactions or smart contracts within it are executed, and it is propagated to other peers. Peers also validate and execute the block. It now becomes part of the blockchain (ledger), and the next block links itself cryptographically back to this block. This link is called a hash pointer.

This process can be visualized in the diagram as follows:

Figure 1.9: How a block is generated

This completes the basic introduction to blockchain. In the next section, you will learn about the benefits and limitations of this technology.

Benefits, features, and limitations of blockchain

Numerous advantages of blockchain technology have been discussed in many industries and proposed by thought leaders around the world who are participating in the blockchain space. The notable benefits of blockchain technology are as follows:

1. Decentralization: This is a core concept and benefit of blockchain. There is no need for a trusted third party or intermediary to validate transactions; instead, a consensus mechanism is used to agree on the validity of transactions.
2. Transparency and trust: As blockchains are shared and everyone can see what is on the blockchain, this allows the system to be transparent. As a result, trust is established. This is more relevant in scenarios such as the disbursement of funds or benefits where personal discretion in relation to selecting beneficiaries needs to be restricted.
3. Immutability: Once the data has been written to the blockchain, it is extremely difficult to change it back. It is not genuinely immutable, but because changing data is so challenging and nearly impossible, this is seen as a benefit to maintaining an immutable ledger of transactions.
4. High availability: As the system is based on thousands of nodes in a peer-to-peer network, and the data is replicated and updated on every node, the system becomes highly available. Even if some nodes leave the network or become inaccessible, the network as a whole continues to work, thus making it highly available. This redundancy results in high availability.
5. Highly secure: All transactions on a blockchain are cryptographically secured and thus provide network integrity. Any transactions posted from the nodes on the blockchain are verified based on a predetermined set of rules. Only valid transactions are selected for inclusion in a block. The blockchain is based on proven cryptographic technology that ensures the integrity and availability of data. Generally, confidentiality is not provided due to the requirements of transparency. This limitation is the leading barrier to its adoption by financial institutions and other industries that require the privacy and confidentiality of transactions. As such, the privacy and confidentiality of transactions on the blockchain are being researched very actively, and advancements are already being made. It could be argued that, in many situations, confidentiality is not needed and transparency is preferred. For example, with Bitcoin, confidentiality is not an absolute requirement; however, it is desirable in some scenarios. A more recent example is Zcash (https://z.cash), which provides a platform for conducting anonymous transactions. Other security services, such as non-repudiation and authentication, are also provided by blockchain, as all actions are secured using private keys and digital signatures.
6. Simplification of current paradigms: The current blockchain model in many industries, such as finance or health, is somewhat disorganized. In this model, multiple entities maintain their own databases and data sharing can become very difficult due to the disparate nature of the systems. However, as a blockchain can serve as a single shared ledger among many interested parties, this can result in simplifying the model by reducing the complexity of managing the separate systems maintained by each entity.
7. Faster dealings: In the financial industry, especially in post-trade settlement functions, blockchain can play a vital role by enabling the quick settlement of trades. Blockchain does not require a lengthy process of verification, reconciliation, and clearance because a single version of agreed-upon data is already available on a shared ledger between financial organizations.
8. Cost-saving: As no trusted third party or clearing house is required in the blockchain model, this can massively eliminate overhead costs in the form of the fees, which are paid to such parties.
9. Platform for smart contracts: A blockchain is a platform on which programs can run that execute business logic on behalf of the users. This is a very useful feature but not all blockchains have a mechanism to execute smart contracts; however, this is a very desirable feature. It is available on newer blockchain platforms such as Ethereum and MultiChain, but not on Bitcoin.

   Smart contracts

   Blockchain technology provides a platform for running smart contracts. These are automated, autonomous programs that reside on the blockchain network and encapsulate the business logic and code needed to execute a required function when certain conditions are met. For example, think about an insurance contract where a claim is paid to the traveler if the flight is canceled. In the real world, this process normally takes a significant amount of time to make the claim, verify it, and pay the insurance amount to the claimant (traveler). What if this whole process were automated with cryptographically-enforced trust, transparency, and execution so that as soon as the smart contract received a feed that the flight in question has been canceled, it automatically triggers the insurance payment to the claimant? If the flight is on time, the smart contract pays itself.

   This is indeed a revolutionary feature of blockchain, as it provides flexibility, speed, security, and automation for real-world scenarios that can lead to a completely trustworthy system with significant cost reductions. Smart contracts can be programmed to perform any actions that blockchain users need and according to their specific business requirements.

10. Smart property: It is possible to link a digital or physical asset to the blockchain in such a secure and precise manner that it cannot be claimed by anyone else. You are in full control of your asset, and it cannot be double-spent or double-owned. Compare this with a digital music file, for example, which can be copied many times without any controls. While it is true that many Digital Rights Management (DRM)schemes are being used currently along with copyright laws, none of them are enforceable in the way a blockchain-based DRM can be. Blockchain can provide digital rights management functionality in such a way that it can be enforced fully. There are famously broken DRM schemes that looked great in theory but were hacked due to one limitation or another. One example is the Oculus hack: http://www.wired.co.uk/article/oculus-rift-drm-hacked. Another example is the PS3 hack; also, copyrighted digital music, films, and e-books are routinely shared on the internet without any limitations. We have had copyright protection in place for many years, but digital piracy refutes all attempts to fully enforce the law. On a blockchain, however, if you own an asset, no one else can claim it unless you decide to transfer it. This feature has far-reaching implications, especially in DRM and e-cash systems where double-spend detection is a crucial requirement. The double-spend problem was first solved without the requirement of a trusted third party in Bitcoin.

As with any technology, some challenges need to be addressed in order to make a system more robust, useful, and accessible. Blockchain technology is no exception. In fact, much effort is being made in both academia and industry to overcome the challenges posed by blockchain technology. The most sensitive blockchain problems are as follows:

• Scalability: Currently, blockchain networks are not as scalable as, for example, current financial networks. This is a known area of concern and a very ripe area for research.
• Adoption: Often, blockchain is seen as a nascent technology. Even though this perspective is rapidly changing, there is still a long way to go before the mass adoption of this technology. The challenge here is to allow blockchain networks to be easier to use so that adoption can increase. In addition, several other challenges such as scalability (introduced previously) exist, which must be solved in order to increase adoption.
• Regulation: Due to its decentralized nature, regulation is almost impossible on blockchain. This is sometimes seen as a barrier toward adoption because, traditionally, due to the existence of regulatory authorities, consumers have a certain level of confidence that if something goes wrong they can hold someone accountable. However, in blockchain networks, no such regulatory authority and control exists, which is an inhibiting factor for many consumers.
• Relatively immature technology: As compared to traditional IT systems that have benefited from decades of research, blockchain is still a new technology and requires a lot of research to achieve maturity.
• Privacy and confidentiality: Privacy is a concern on public blockchains such as Bitcoin where everyone can see every single transaction. This transparency is not desirable in many industries such as the financial, law, or medical sectors. This is also a known concern and a lot of valuable research with some impeccable solutions has already been developed. However, further research is still required to drive the mass adoption of blockchain.

All of these issues and possible solutions will be discussed in detail in Chapter 21, Scalability and Other Challenges.

You now know the basics of blockchain and its benefits and limitations. Now, let's take a look at the various types of blockchain that exist.

Types of blockchain

Based on the way that blockchain has evolved over the last few years, it can be divided into multiple categories with distinct, though sometimes partially overlapping attributes. You should note that the tiers described earlier in the chapter are a different concept, whereby the logical categorization of blockchain, based upon its evolution and usage, is presented.

In this section, we will examine the different types of blockchains from a technical and business use perspective. These blockchain types can occur on any blockchain tier, as there is no direct relationship between those tiers mentioned earlier and the various types of blockchain.

In this section, we'll examine:

• Distributed ledgers
• Distributed Ledger Technology (DLT)
• Blockchains
• Ledgers

Distributed ledgers

First, I need to clarify an ambiguity. It should be noted that a distributed ledger is a broad term describing shared databases; hence, all blockchains technically fall under the umbrella of shared databases or distributed ledgers. Although all blockchains are fundamentally distributed ledgers, all distributed ledgers are not necessarily blockchains.

A critical difference between a distributed ledger and a blockchain is that a distributed ledger does not necessarily consist of blocks of transactions to keep the ledger growing. Rather, a blockchain is a special type of shared database that is comprised of blocks of transactions. An example of a distributed ledger that does not use blocks of transactions is R3's Corda (https://www.corda.net). Corda is a distributed ledger that is developed to record and manage agreements and is especially focused on the financial services industry. On the other hand, more widely known blockchains like Bitcoin and Ethereum make use of blocks to update the shared database.

As the name suggests, a distributed ledger is distributed among its participants and spread across multiple sites or organizations. This type of ledger can be either private or public. The fundamental idea here is that, unlike many other blockchains, the records are stored contiguously instead of being sorted into blocks. This concept is used in Ripple, which is a blockchain- and cryptocurrency-based global payment network.

Distributed Ledger Technology

It should be noted that over the last few years, the terms distributed ledger or DLT have grown to be commonly used to describe blockchain in the finance industry. Sometimes, blockchain and DLT are used interchangeably. Though this is not entirely accurate, it is how the term has evolved recently, especially in the finance sector. In fact, DLT is now a very active and thriving area of research in the financial sector. From a financial sector point of view, DLTs are permissioned blockchains that are used by consortiums. DLTs usually serve as a shared database, with all participants known and verified. They do not have a cryptocurrency and do not require mining to secure the ledger.

Public blockchains

As the name suggests, public blockchains are not owned by anyone. They are open to the public, and anyone can participate as a node in the decision-making process. Users may or may not be rewarded for their participation. All users of these "permissionless" or "un-permissioned" ledgers maintain a copy of the ledger on their local nodes and use a distributed consensus mechanism to decide the eventual state of the ledger. Bitcoin and Ethereum are both considered public blockchains.

Private blockchains

As the name implies, private blockchains are just that—private. That is, they are open only to a consortium or group of individuals or organizations who have decided to share the ledger among themselves. There are various blockchains now available in this category, such as Kadena and Quorum. Optionally, both of these blockchains can also run in public mode if required, but their primary purpose is to provide a private blockchain.

Semi-private blockchains

With semi-private blockchains, part of the blockchain is private and part of it is public. Note that this is still just a concept today, and no real-world proofs of concept have yet been developed. With a semi-private blockchain, the private part is controlled by a group of individuals, while the public part is open for participation by anyone.

This hybrid model can be used in scenarios where the private part of the blockchain remains internal and shared among known participants, while the public part of the blockchain can still be used by anyone, optionally allowing mining to secure the blockchain. This way, the blockchain as a whole can be secured using PoW, thus providing consistency and validity for both the private and public parts. This type of blockchain can also be called a "semi-decentralized" model, where it is controlled by a single entity but still allows for multiple users to join the network by following appropriate procedures.

Sidechains

More precisely known as "pegged sidechains," this is a concept whereby coins can be moved from one blockchain to another and then back again. Typical uses include the creation of new altcoins (alternative cryptocurrencies) whereby coins are burnt as a proof of an adequate stake. "Burnt" or "burning the coins" in this context means that the coins are sent to an address that is un-spendable, and this process makes the "burnt" coins irrecoverable. This mechanism is used to bootstrap a new currency or introduce scarcity, which results in the increased value of the coin.

This mechanism is also called "Proof of Burn" and is used as an alternative method for distributed consensus to PoW and Proof of Stake (PoS). The example provided previously for burning coins applies to a one-way pegged sidechain. The second type is called a two-way pegged sidechain, which allows the movement of coins from the main chain to the sidechain and back to the main chain when required.

This process enables the building of smart contracts for the Bitcoin network. Rootstock is one of the leading examples of a sidechain, which enables smart contract development for Bitcoin using this paradigm. It works by allowing a two-way peg for the Bitcoin blockchain, and this results in much faster throughput.

Permissioned ledger

A permissioned ledger is a blockchain where participants of the network are already known and trusted. Permissioned ledgers do not need to use a distributed consensus mechanism; instead, an agreement protocol is used to maintain a shared version of the truth about the state of the records on the blockchain. In this case, for verification of transactions on the chain, all verifiers are already preselected by a central authority and, typically, there is no need for a mining mechanism.

By definition, there is also no requirement for a permissioned blockchain to be private, as it can be a public blockchain but with regulated access control. For example, Bitcoin can become a permissioned ledger if an access control layer is introduced on top of it that verifies the identity of a user and then allows access to the blockchain.

Shared ledger

This is a generic term that is used to describe any application or database that is shared by the public or a consortium. Generally, all blockchains fall into the category of a shared ledger.

Fully private and proprietary blockchains

There is no mainstream application of these types of blockchains, as they deviate from the core concept of decentralization in blockchain technology. Nonetheless, in specific private settings within an organization, there could be a need to share data and provide some level of guarantee of the authenticity of the data.

An example of this type of blockchain might be to allow for collaboration and the sharing of data between various government departments. In that case, no complex consensus mechanism is required, apart from simple SMR and an agreement protocol with known central validators. Even in private blockchains, tokens are not really required, but they can be used as a means of transferring value or representing some real-world assets.

Tokenized blockchains

These blockchains are standard blockchains that generate cryptocurrency as a result of a consensus process via mining or initial distribution. Bitcoin and Ethereum are prime examples of this type of blockchain.

Tokenless blockchains

These blockchains are designed in such a way that they do not have the basic unit for the transfer of value. However, they are still valuable in situations where there is no need to transfer value between nodes and only the sharing of data among various trusted parties is required. This is similar to fully private blockchains, the only difference being that the use of tokens is not required. This can also be thought of as a shared distributed ledger used for storing and sharing data between the participants. It does have its benefits when it comes to immutability, tamper proofing, security, and consensus-driven updates but is not used for a common blockchain application of value transfer or cryptocurrency. Most of the permissioned blockchains can be seen as an example of tokenless blockchains, for example, Hyperledger Fabric or Quorum. Tokens can be built on these chains as an application, but intrinsically these blockchains do not have a token associated with them.

All the aforementioned terminologies are used in literature, but fundamentally all these blockchains are distributed ledgers and fall under the top-level category of DLTs. We can view these different types in the simple chart as follows:

Figure 1.10: DLT hierarchy

This ends our examination of the various types of blockchain. We'll now move on to the next section to discuss the concept of consensus.