Fundamental issues that need to be addressed in e-cash systems are accountability and anonymity. David Chaum addressed both of these issues in his seminal paper in 1984 by introducing two cryptographic operations, namely blind signatures and secret sharing. These terminologies and related concepts will be discussed in detail in Chapter 3, Cryptography and Technical Foundations. At the moment, it is sufficient to say that blind signatures allow signing a document without actually seeing it and secret sharing is a concept that allows the detection of using the same e-cash token twice (double spending).

After this other protocols emerged such as Chaum, Fiat, and Naor (CFN), e-cash schemes that introduced anonymity and double spending detection. Brand's e-cash is another system that improved on CFN, made it more efficient, and introduced the concept of security reduction to prove statements about the e-cash scheme. Security reduction is a technique used in cryptography to prove that a certain algorithm is secure by using another problem as a comparison. Put another way, a cryptographic security algorithm is as hard to break as some other hard problem; thus by comparison it can be deduced that the cryptographic security algorithm is secure too.

A different but relevant concept called hashcash was introduced by Adam Back in 1997 as a PoW system to control e-mail spam. The idea is quite simple: if legitimate users want to send e-mails then they are required to compute a hash as a proof that they have spent a reasonable amount of computing resources before sending the e-mail. Generating hashcash is a compute intensive process but does not inhibit a legitimate user from sending the e-mail because the usual number of e-mails required to be sent by a legitimate user is presumably quite low. On the other hand, if a spammer wants to send e-mails, usually thousands in number, then it becomes infeasible to compute hashcash for all e-mails, thus making the spamming effort expensive; as a result this mechanism can be used to thwart e-mail spamming. Hashcash takes a considerable amount of computing resources to compute but is easy and quick to verify. Verification is performed by the user who receives the e-mail. Hashcash is popularized by its use in the bitcoin mining process. This idea of using computational puzzles or pricing functions to prevent e-mail spam was introduced originally in 1992 by Cynthia Dwork and Moni Naor. Pricing function was the name given to the hard functions that are required to be computed before access to a resource can be granted. Later, Adam Back invented hashcash independently in 1997, which introduced the usage of computing hash functions as PoW.

In 1998 b-money was introduced by Wei Dai and proposed the idea of creating money via solving computational puzzles such as hashcash. It's based on a peer-to-peer network where each node maintains its own list of transactions.

Another similar idea by Nick Szabo called BitGold was introduced in 2005 and also proposed solving computational puzzles to mint digital currency. In 2005 Hal Finney introduced the concept of cryptographic currency by combining ideas from b-money and hashcash puzzles but it still relied on a centralized trusted authority.

There were multiple issues with the schemes described in infeasible preceding paragraphs. These problems range from no clear solution of disagreements between nodes to reliance on a central trusted third party and trusted timestamping.

In 2009 the first practical implementation of a cryptocurrency named bitcoin was introduced; for the very first time it solved the problem of distributed consensus in a trustless network. It uses public key cryptography with hashcash as PoW to provide a secure, controlled, and decentralized method of minting digital currency. The key innovation is the idea of an ordered list of blocks composed of transactions and cryptographically secured by the PoW mechanism. This will be explained in more detail in Chapter 4, Bitcoin.

Looking at all the aforementioned technologies and their history, it is easy to see how ideas and concepts from electronic cash schemes and distributed systems were combined together to invent bitcoin and what now is known as blockchain.

This can also be visualized with the help of the following diagram:

The various ideas that helped with the invention of bitcoin and blockchain

Addresses are unique identifiers that are used in a transaction on the blockchain to denote senders and recipients. An address is usually a public key or derived from a public key. While addresses can be reused by the same user, addresses themselves are unique. In practice, however, a single user may not use the same address again and generate a new one for each transaction. This newly generated address will be unique. Bitcoin is in fact a pseudonymous system. End users are usually not directly identifiable but some research in de-anonymizing bitcoin users have shown that users can be identified successfully. As a good practice it is suggested that users generate a new address for each transaction in order to avoid linking transactions to the common owner, thus avoiding identification.

A transaction is the fundamental unit of a blockchain. A transaction represents a transfer of value from one address to another.

A block is composed of multiple transactions and some other elements such as the previous block hash (hash pointer), timestamp, and nonce.

As the name implies, this is a network topology whereby all peers can communicate with each other and send and receive messages.

This element performs various operations on a transaction. Transaction scripts are predefined sets of commands for nodes to transfer tokens from one address to another and perform various other functions. Turing complete programming language is a desirable feature of blockchains; however, the security of such languages is a key question and an area of important and ongoing research.

This is an extension of a transaction script. A virtual machine allows Turing complete code to be run on a blockchain (as smart contracts) whereas a transaction script can be limited in its operation. Virtual machines are not available on all blockchains; however, various blockchains use virtual machines to run programs, for example Ethereum Virtual Machine (EVM) and Chain Virtual Machine (CVM).

A blockchain can be viewed as a state transition mechanism whereby a state is modified from its initial form to the next and eventually to a final form as a result of a transaction execution and validation process by nodes.

A node in a blockchain network performs various functions depending on the role it takes. A node can propose and validate transactions and perform mining to facilitate consensus and secure the blockchain. This is done by following a consensus protocol. (Most commonly this is PoW.) Nodes can also perform other functions such as simple payment verification (lightweight nodes), validators, and many others functions depending on the type of the blockchain used and the role assigned to the node.

These programs run on top of the blockchain and encapsulate the business logic to be executed when certain conditions are met. The smart contract feature is not available in all blockchains but is now becoming a very desirable feature due to the flexibility and power it provides to the blockchain applications.

Distributed consensus is the major underpinning of a blockchain. This enables a blockchain to present a single version of truth that is agreed upon by all parties without the requirement of a central authority.

Any transactions posted from nodes on the blockchain are verified based on a predetermined set of rules and only valid transactions are selected for inclusion in a block.

A blockchain is a platform where programs can run that execute business logic on behalf of the users. As explained earlier, not all blockchains have a mechanism to execute smart contracts; however, this is now a very desirable feature.

Blockchain enables the transfer of value between its users via tokens. Tokens can be thought of as a carrier of value.

This is an optional feature depending on the type of blockchain used. A blockchain can generate cryptocurrency as an incentive to its miners who validate the transactions and spend resources in order to secure the blockchain.

For the first time it is possible to link a digital or physical asset to the blockchain in an irrevocable manner, such 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 it with a digital music file, for example, which can be copied many times without any control; on a blockchain, however, if you own it no one else can claim it unless you decide to transfer it to someone. This feature has far-reaching implications especially in Digital Rights Management (DRM) and electronic cash systems where double spend detection is a key requirement. The double spend problem was first solved in bitcoin.

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 has become a main barrier for its adaptability by financial institutions and other industries that need privacy and confidentiality of transactions. As such it is being researched very actively and there is already some good progress made. It could be argued that in many situations confidentiality is not really needed and transparency is preferred instead. For example, in bitcoin confidentiality is not really required; however, it is desirable in some scenarios. Research in this area is very ripe and already major progress has been made towards providing confidentiality and privacy on blockchain. A more recent example is Zcash, which will be discussed in more detail in later chapters. Other security services such as nonrepudiation and authentication are also provided by blockchain as all actions are secured by using private keys and digital signatures.

This is another key feature of blockchain: records once added onto the blockchain are immutable. There is the possibility of rolling back the changes but this is considered almost impossible to do as it will require an unaffordable amount of computing resources. For example, in much desirable case of bitcoin if a malicious user wants to alter the previous blocks then it would require computing the PoW again for all those blocks that have already been added to the blockchain. This difficulty makes the records on a blockchain practically immutable.

This feature of blockchain ensures that every transaction is unique and has not been spent already. This is especially relevant in cryptocurrencies where much desirable detection and avoidance of double spending are a key requirement.

Blockchain provides a platform to run smart contracts. These are automated autonomous programs that reside on the blockchain and encapsulate business logic and code in order to execute a required function when certain conditions are met. This is indeed a revolutionary feature of blockchain as it allows flexibility, programmability, and much desirable control of actions that users of blockchain need to perform according to their specific business requirements.

Steps 4 and 5 can be considered non-compulsory as the transaction itself is finalized in step 3; however, block confirmation and further transaction reconfirmations, if required, are then carried out in steps 4 and 5.

This was introduced with the invention of bitcoin and is basically used for cryptocurrencies. Also, as bitcoin was the first implementation of cryptocurrencies it makes sense to categorize Generation 1 of blockchain technology to only include cryptographic currencies. All alternative coins and bitcoin fall into this category. This includes core applications such as payments and applications.

Generation 2.0 blockchains are used by financial services and contracts are introduced in this generation. This includes various financial assets, for example derivatives, options, swaps, and bonds. Applications that are beyond currency, finance, and markets are included at this tier.

Generation 3 blockchains are used to implement applications beyond the financial services industry and are used in more general-purpose industries such as government, health, media, the arts, and justice.

This is a vision of blockchain singularity where one day we will have a public blockchain service available that anyone can use just like the Google search engine. It will provide services in all realms of society. This is a public open distributed ledger with general-purpose rational agents (Machina Economicus) running on blockchain, making decisions and interacting with other intelligent autonomous agents on behalf of humans and regulated by code instead of law or paper contracts. This will be elaborated in detail in Chapter 13, Current Landscape and What's Next.

This type of consensus mechanism relies on proof that enough computational resources have been spent before proposing a value for acceptance by the network. This is used in bitcoin and other cryptocurrencies. Currently, this is the only algorithm that has proven astonishingly successful against Sybil attacks.

This algorithm works on the idea that a node or user has enough stake in the system; for example the user has invested enough in the system so that any malicious attempt would outweigh the benefits of performing an attack on the system. This idea was first introduced by Peercoin and is going to be used in the Ethereum blockchain. Another important concept in Proof of Stake (PoS) is coin age, which is a derived from the amount of time and the number of coins that have not been spent. In this model, the chances of proposing and signing the next block increase with the coin age.

Delegated Proof of Stake (DPOS) is an innovation over standard PoS whereby each node that has stake in the system can delegate the validation of a transaction to other nodes by voting. This is used in the bitshares blockchain.

Introduced by Intel, it uses Trusted Execution Environment (TEE) to provide randomness and safety in the leader election process via a guaranteed wait time. It requires the Intel SGX (Software Guard Extensions) processor in order to provide the security guarantee and for it to be secure. This concept is discussed in more detail in Chapter 9, Hyperledger in the context of the Intel Sawtooth Lake blockchain project.

Nodes that wish to participate on the network have to put in a security deposit before they can propose a block.

This idea is important and different from Proof of Stake. Proof of importance not only relies on how much stake a user has in the system but it also monitors the usage and movement of tokens by the user to establish a level of trust and importance. This is used in Nemcoin.

Used in the stellar consensus protocol, nodes in this protocol keep a group of publicly trusted peers and propagates only those transactions that have been validated by the majority of trusted nodes.

As the name suggests, a leader is elected on the basis of the reputation it has built over time on the network. This can be based on the voting from other members.

Practical Byzantine Fault Tolerance (PBFT) achieves state machine replication, which provides tolerance against Byzantine nodes. Various other protocols, including but are not limited to PBFT, PAXOS, RAFT, and Federated Byzantine Agreement (FBA), are also being used or have been proposed for use in many different implementations of distributed systems and blockchains.