Blockchain Quick Start Guide: A beginner's guide to developing enterprise-grade decentralized applications

Blockchain technology initially caught people's attention due to the Bitcoin blockchain, an idea outlined by a white paper authored by Satoshi Nakamoto and published in October 2008 on the cryptography mailing list at metzdowd.com. It describes the Bitcoin digital currency (BTC) and was titled Bitcoin: A Peer-to-Peer Electronic Cash System. In January 2009, Satoshi Nakamoto released the first Bitcoin software, which launched the network and the first units of the Bitcoin cryptocurrency: BTC coins.

The creation of Bitcoin was right after the 2008 financial crisis, the most severe economic crisis since the Great Depression. This is not coincidental. The inventor of the Bitcoin cryptocurrency aimed at addressing people's disillusionment with financial institutions, whose epic failures in risk controls resulted in the 2008 financial crisis.

A fundamental role played by financial institutions is to be an intermediary entity and bring untrusting parties together to facilitate transactions. For example, a retail bank attracts residual money from individuals and lends to individuals or companies that need the money. The difference in interest paid to the money suppliers and borrowers is the fee a bank charges for providing the intermediary service. Financial institutions are very successful in providing these services and play a pivotal role in powering economies worldwide. However, there are many deficiencies associated with this business model. Here are some examples:

With blockchain technology, the preceding problems are resolved elegantly. In the case of the Bitcoin blockchain, the underlying asset to be transferred is the digital coin, BTC. A cross-border BTC transaction can complete in no more than 1 hour. No settlement is needed since transaction and settlement are in one action. The cost of this transaction is a tiny fraction of a transfer via a bank. For example, a recent report published by the Bank of America (BoA) claims a transfer via blockchain costs 1/6000 of what BoA charges. However, for some clients, waiting an hour is still too long. Ripple, a payment provider for sending money globally, completes in under 1 minute.

The word Bitcoin often causes confusion as people use the word interchangeably for three things: the cryptocurrency, the blockchain, and the protocol. To avoid this confusion, we use BTC to refer to the cryptocurrency, and Bitcoin to refer to the blockchain and the corresponding network that uses the distributed ledger. For the protocol, we will fully spell out Bitcoin protocol or simply protocol.

To explain how Bitcoin works, let's look at what steps are involved with the existing business model for completing a cross-border transaction:

Since there are multiple steps, entities, and systems involved, the preceding activities take days to complete.

A Bitcoin network connects computers around the world. Each computer is a node with equal status, except for a subset of nodes called miners, which choose to play the role of verifying transactions, building blocks and linking to the chain. With Bitcoin, the business model for completing a money transfer involves the following steps:

The Bitcoin transfer is a lot faster (in 1 hour, or minutes if using Ripple) for the following reasons:

In a case where a sender or receiver prefers to use a fiat currency such as USD, GBP, CNY, or JPY, a cryptocurrency market can be used for a conversion between BTC and a fiat currency. A website, CoinMarketCap, lists these markets: https://coinmarketcap.com/rankings/exchanges/. As of September 21, 2018, there are 14,044 markets. In terms of market capitalization, the top three are Binance (https://www.binance.com/), OKEx (https://www.binance.com/), and Huopi (https://www.huobi.pro).

A peer-to-peer network can connect nodes worldwide. However, a merely physical connection is not enough to make two untrusting parties trade with each other. To allow them to trade, Bitcoin takes the following measures:

With these measures, untrusting parties feel comfortable to trade due to these reasons:

Cryptography or cryptology is research on techniques for securing communication in the presence of adversaries. In the old days, cryptography was synonymous with encryption. Modern cryptography relies heavily on mathematical theory and computer science. It also utilizes works from other disciplines such as electrical engineering, communications science, and physics.

Cryptographic algorithms are designed around the assumption that with foreseeable computational hardware advances, it will not be feasible for any adversary to decipher encrypted messages based on these algorithms. In other words, in theory, it is possible to decode the encrypted message, but it is infeasible to do so practically. These algorithms are therefore defined to be computationally secure. Theoretical research (for instance, parallel or integer factorization algorithms) and computational technology advancements (for instance, quantum computers) can make these algorithms practically insecure and, therefore, encryption algorithms need to be adapted continuously.

Encryption is the process of converting plaintext into unintelligible text, called ciphertext. Decryption is the reverse, in other words moving from the unintelligible ciphertext back to plaintext.

The encryption algorithms used by Bitcoin mining are hash functions. A hash function is a function that maps data of any size to data of a fixed size. The values returned by a hash function are called hash values or simply hashes. A cryptographic hash function allows one to verify easily  that some input data maps to a given hash value. However, the reverse – when the input data is unknown—it is practically infeasible to reconstruct the input plaintext from a hash value. In other words, hashing is a one-way operation. Another notable attribute of a hashing function is that a minor change in the input plaintext will result in a completely different hash value. This feature is desirable for safeguarding information as any tiny change to the original data by a hacker results in a visibly different hash.

Two common hash algorithms are MD5 (message-digest algorithm 5) and SHA-1 (secure hash algorithm):

SHA-256 is a successor hash function to SHA-1. It is one of the strongest hash functions available and has not yet been compromised in any way. SHA-256 generates an almost unique 256-bit (32-byte) signature for a text. For example, My test string maps to 5358c37942b0126084bb16f7d602788d00416e01bc3fd0132f4458d d355d8e76. With a small change, the hash of My test strings is 98ff9f0555435 f792339d6b7bf5fbcca82f1a83fde2bb76f6aa95d66050887cc, a completely different value. SHA-256 produces 2^256 possible hashes. There is yet to be a case where two different inputs have produced the same SHA-256 hash, an issue called collision in cryptography. Even with the fastest supercomputer, it will take longer than the age of our universe to hit a collision. As a result, SHA-256 is used by Bitcoin for encryption.

At a financial institution, a ledger is a book for recording financial transactions. Similarly, Bitcoin maintains a ledger for bookkeeping BTC transactions and balances by address. One key difference is that a bank's ledger is centralized and Bitcoin's ledger is decentralized. Consequently, a bank's ledger is much easier to be cooked. On the other side, Bitcoin's ledger is very difficult to cook as one has to change the ledger at all nodes worldwide.

A user submits a transaction containing the following information:

As per the Wiki site, a transaction has a general structure shown as follows:

Both source and destination addresses are 64-character hashes. Here is an example of an address: 979e6b063b436438105895939f4ff13d068428d2f71312cf5594c132905bfxy1.

The term address is a bit confusing. A programmer may think it to be an address related to a disk or memory location. However, it has nothing to do with a physical location. Instead, it is a logical label for grouping BTCs that have been transferred from/to it. In a way, one can think of it as a bank account number, yet there are fundamental differences between them. For example, a bank has a centralized place where metadata on an account, for instance, owner name, account open date, and account type, is saved. In addition, the account balance is precalculated and saved. In Bitcoin, there is no metadata on an address and one has to query the entire ledger to find the balance of an address by counting the net BTCs being transferred in and out of the address.  Addresses are referred to only in Bitcoin transactions. When the balance of an address falls to 0, any future request for taking BTCs from the address will fail the transaction validation due to insufficient funds.

Bitcoin utilizes the UTXO model to manage its BTC transfer. The term was introduced by cryptocurrency, where it refers to an unspent transaction output. This is an output of a blockchain transaction that has not been spent and can be used as an input for a future transaction. In a Bitcoin transaction, only unspent outputs can be used as an input, which helps to prevent double spending and fraud. As a result, a committed transaction results in deleting inputs on a blockchain and creating outputs in the form of UTXOs. The newly created unspent transaction outputs can be spent by the owner holding the corresponding private keys. In other words, UTXOs are processed continuously and a committed transaction leads to removing spent coins and creating new unspent coins in the UTXO database.

Like an address, a BTC is not associated with any physical object such as a digital token file or a physically minted coin. Instead, it only exists in transactions in the distributed ledger. For example, if one wants to know the total number of BTCs minted so far, one has to go through all nonzero balance addresses on the blockchain and add up all the BTCs. Since every node of Bitcoin keeps a copy of the ledger, it is only a matter of taking computing time to find an answer.

When a user enters a BTC transaction request at a node, Bitcoin software installed at the node broadcasts the transaction to all nodes. Nodes on the network will verify the validity of the transaction by retrieving all historical transactions containing the input addresses and ensuring that BTCs from these addresses are legitimate and sufficient. After that, the mining nodes start to construct a block by collecting the verified transactions. Normally, a Bitcoin block contains between 1,500 to 2,000 transactions. A miner who wins the race to resolve a difficult mathematical puzzle gets the role to build and link a new block to the chain. On the Bitcoin blockchain, a new block is created around every 10 minutes. As of September 21, 2018, approximately 542,290 blocks have been created on Bitcoin. The structure of a Bitcoin block is shown as follows:

Here, the block header contains the following fields:

The concept of a nonce will be explained in the subsection on mining. hashPrevBlock is the same value as hashMerkleRoot. The Merkle tree hash root is essentially the hash of all transaction hashes in the block via a binary tree aggregation structure. The following diagram explains the idea:

A Bitcoin blockchain can diverge into two potential paths since miners do not necessarily collect transactions and contract block candidates in the same way, nor at the same time. Other reasons such as hacking or software upgrades can also lead to path divergence. The splitting patches are called forks. There are temporary forks and permanent forks.

If a permanent fork occurs due to, for example, malicious attacks, a hard fork occurs. Similarly, there is the concept of soft fork. Both hard fork and soft fork refer to a radical change to the protocol. Hard fork makes previously invalid blocks/transactions valid and a soft fork makes previously valid blocks/transactions invalid. 

To remove a temporary fork, Bitcoin protocol dictates that the longest chain should be used. In other words, when facing two paths, a winning miner will choose the longer chain to link a new block. As a result, the longer path continues to grow and the blocks on the losing (shorter) path becomes orphaned. Bitcoin nodes will soon discard or not take the orphaned blocks. They only keep the blocks on the longest chain as being the valid blocks.

In the case of a permanent fork, nodes on the network have to choose which chain to follow. For example, Bitcoin Cash diverged from Bitcoin due to a disagreement within the Bitcoin community on how to handle the scalability problem. As a result, Bitcoin Cash became its own chain and shares the transaction history from the genesis block up to the forking point. As of September 21, Bitcoin Cash's market cap is around $8 billion, ranking fourth, versus Bitcoin's $215 billion.

There is one more issue that needs to be resolved: how to maintain the new block building rate of 10 minutes. If nothing is done, the mining rate will change due to the following factors:

Bitcoin adjusts the difficulty level of the mathematical puzzle in order to keep the building rate at 10 minutes. The difficulty level is calculated from the rate at which the most recent blocks were added in. If the average rate of new blocks being added is less than 10 minutes, the difficulty level will be increased. If the average rate takes more than 10 minutes, it's decreased. The difficulty level is updated every 2,016 blocks. The following graph displays the historical trend in Bitcoin difficulty level.

We have yet to talk about the actual mining algorithm. Assume the current difficulty level is to find the first hash value with the leading character to be 0. In Bitcoin, the process of solving a puzzle, that is, mining, requires a miner to follow these steps:

The following is an example of how the plaintext and nonce work together. The original plaintext is input string and the nonce varies from 0 to 1:

In Bitcoin, adjusting difficult level largely refers to changing the required number of leading zeros. (The actual adjustment involves some other miner tuning to the requirement.) Each addition of a leading zero will increase the average number of tries significantly and therefore will increase the computing time. This is how Bitcoin manages to maintain the average rate of 10 minutes for new blocks being added in. The current Bitcoin difficulty level is 18 leading zeros.

Thanks to the rising price of BTC, the mining operation has become more attractive. Investments are rushing in and large mining pools involving thousands of rigs or more have joined the network in order to gain an advantage in the race to solve the puzzle first and get the reward. For players without large capital from investments, they have a choice to participate in a mining pool. When the pool wins a race, the award will be allocated to each participant based on the computational power contributed.

This ever-growing computational power of a pool poses a real threat due to the so-called 51% problem. This problem occurs when a miner manages to build up computational power to total at least 51% of the total computing power of the network. When this occurs, the miner will have a chance to outrun other miners. The miner can continue to grow the ledger with blocks containing bad transactions since this miner has more than a 50% chance of solving the puzzle first. Soon, the malicious miner's ledger will grow to be the longest path and all other nodes have to save this path based on Bitcoin's consensus protocol.

For a large and well-established network such as Bitcoin, the 51% problem is not as critical an issue, mainly due to the following reasons:

As discussed earlier, BTCs do not physically exist. The only evidence of their existence is when they are associated with addresses, which are referred to in transactions. When an address is initially created, a pair of public and private keys are generated with it. The public key is made known to the public and the private key is kept only by the owner of the address. When the owner wants to spend all or a portion of their BTCs, the owner provides a digital signature signed with the private key and sends the BTC request to the Bitcoin network. In other words, one has to know both the address and its private key to spend the BTC. 

If an owner loses a private key, its associated BTCs will be lost permanently. Therefore, it is advised to keep this information in a safe place. It is generally good practice to keep the address and private keys in separate places. To prevent a digital copy getting lost, an owner should maintain physical copies of printouts. To make conversion easier, an owner can print a QR code and later scan the QR code whenever it is needed.

Bitcoin wallet applications are available to help a user manage keys and addresses. One can use a wallet to do the following:

In Bitcoin, a private key is a 256-bit-long hash and a public key is 512 bits long. They can be converted into shorter lengths in hexadecimal representation. The following screenshot gives an example of a pair of public/private keys along with an address:

Bitcoin private keys can also be expressed in a string of 51 characters starting with a 5 and a public key in a string of 72 characters. A sample private key is 5Jd54v5mVLvyRsjDGTFbTZFGvwLosYKayRosbLYMxZFBLfEpXnp and a sample public key is BFCDB2DCE28D959F2815B16F81798483ADA7726A3C4655DA4FBFC0E1108A8FD17B448A68.

One can install the following development tools for programming Bitcoin operations:

After installing the preceding tools, one can execute the following operations:

Thanks to Bitcoin, blockchain technology has attracted worldwide attention. Like any new technology, it has its limitations. Many variations of Bitcoin were created to address a particular limitation of Bitcoin. Here, we mention a few of them:

Regardless of the efforts made from the steps-mentioned altcoins in addressing some part of the Bitcoin's limitations, there are several fundamental issues that are not being addressed yet:

In response to these problems, Vitalik Buterin, a Canadian cryptocurrency researcher and programmer, proposed the idea of Ethereum in late 2013. Funded by an online crowdsale, the system went live on 30 July 2015, with 11.9 million coins premined for the crowdsale.

The core idea for Ethereum was to build a general-purpose blockchain so users could solve a wide range of business problems not just limited to cryptocurrency transfer. Ethereum introduced a few new and critical concepts:

Solidity was initially proposed in August 2014 by Gavin Wood. The Ethereum project's Solidity team led by Christian Reitwiessner later developed the language. It is one of the five languages, (Solidity, Serpent, LLL, Vyper, and Mutan) designed to target the Ethereum virtual machine (EVM).

Nick Szabo, a programmer and lawyer, initially proposed the term smart contract in 1996. In his blog, Nick Szabo described it as the granddaddy of all smart contracts, the vending machine. A vending machine shares the exact same properties as a smart contract on a blockchain today. A vending machine is built with hardcoded rules that define what actions to execute when certain conditions are fulfilled, for example:

In other words, rules are defined and enforced by a vending machine physically. Similarly, a smart contract contains rules in program code that are run on the blockchain and triggered when certain conditions are met.

The introduction of the smart contract concept is significant: