Sample Chapter

CHAPTER 1:  A Gentle Introduction to the World of Blockchain

ABSTRACT

In this chapter, we begin our journey into understanding the world of blockchain. Blockchain is a mechanism to build trust between business actors. This mechanism is implemented using specific digital technology. To better understand the issue of trust in business relationships, we look at the design of means to regulate economic exchanges among people, i.e., different forms of money. We then introduce the basic ingredients of the blockchain recipe by discussing a simple example of an application in e-sports, clarifying that blockchain combines a network of business nodes with computational functions, a ledger of transactions distributed across these nodes, and a set of rules for these nodes to agree on the content of the ledger. We end this chapter by presenting the content of this book, discussing how it can be used by different profiles of learners, and giving an overview of the practical case studies that are discussed in this book.

Learning goals

1.A: The reader can discuss the notion of trust as a basic premise of asset and information exchange.

1.B: The reader can explain the fundamental elements of a blockchain and how these establish trust among business actors who do not trust each other.

1.C: The reader can demonstrate how blockchain can be used to support information exchange in a simple e-sport scenario.

1.D: The reader can explain the structure of this book and understands how it can be used by readers with different backgrounds and learning objectives.

1.1 What is Blockchain?

One of hardest questions that students ask to a teacher is actually a very simple one: “What is blockchain?”. In this initial chapter of this book, we answer this question in two steps. 

The first step (see Section 1.2) concerns understanding the concept of trust and how it underpins the exchange of assets among economic agents. The mechanisms supporting asset exchange can be designed in different ways to support varying levels of trust. Assets can be anything like money, goods, or valuable information. In a digital world, an asset is represented by data in a digital format that prove the characteristics of that asset. There are many kinds of characteristics, but ownership of an asset is obviously a very important one. The exchange of this kind of data represents business transactions, which require a basis for trustThe issue of trust and, more specifically, how it can be created and maintained, is one of the fundamental drivers of blockchain technology. It is also the reason why this technology has been considered revolutionary. To understand the concept of trust and how mechanisms can be designed to enable it, we use the example of different forms that money has assumed through history. 

In the second step (see Section 1.3), we move from the concept of trust to the mechanism to create and support it. To do so, we introduce a simple example system that is constructed using the basic functionality associated with blockchain. This is a fictitious online system for e-sports (online gaming). Online gaming is a booming industry attracting the interest of people of all ages and investors alike. The increasing economic interests around this industry call for mechanisms to improve the trust regarding the execution of games among the stakeholders, like gaming platforms, players, advertisers, and the audience. To keep the example understandable, we consider the game of chess, i.e., a game that everybody has played or at least has heard of at least once in their life. We call this system BC4C (Blockchain for Chess). Using this example, we show in depth what it means to build a blockchain or, in better terms, to design an application based on blockchain that addresses a specific (business) goal. This example also helps us to realize that blockchain implementation relies on several specific technologies, like networking and distributed systems, databases, and, most importantly, cryptography. 

1.2 Money, trust, and design choices

Markets, as the locus of economic exchange of goods or services, existed well before the emergence of what we call money today (see Fig. 1.1). In fact, in ancient times, but still even today in many niche scenarios, economic exchange took the form of bartering. A fisherman and a butcher, for instance, would meet on a Sunday morning on the market square of their village to exchange goods: the fisherman would bring fish, the butcher would bring meat. If they wanted and they agreed, they could exchange a fish for a steak. In this way, the butcher’s family could have fish stew on Sunday night, while the fisherman could enjoy a steak before the start of yet another week of hard work at sea.

The essence of such an exchange is the reciprocal trust in the value of the fish and the steak that are exchanged: both the fisherman and the butcher can inspect the fish and the steak that they are about to exchange (for instance, the weight, appearance and freshness) to establish that the fish and the steak have the same value and, therefore, can be exchanged for one another. Obviously, bartering only works well if two parties want each other’s goods and if these goods have the same value. If the butcher wants vegetables instead of a fish, the exchange is much harder: he must assume that he can find a farmer that wants to exchange the fish in return for vegetable produce (which puts the butcher in a bad negotiation position, as he obviously doesn’t want the fish).

To solve this issue, a more flexible way to regulate an exchange of goods and services emerged very early on in ancient times. It involved the invention of “money”. Money can be defined as any item or verifiable record generally acceptable as a form of payment [Dav02]. The initial common form of money is the so-called commodity money. The value of this money comes from the commodity – usually a precious metal - of which it is made. Typical examples of commodity money are the golden and silver coins coined by the Roman empire or sought by pirates across the seven seas. Also in this case, trust is what makes the commodity money a viable mechanism to regulate economic exchanges: the commodity of which money is made is universally trusted to be scarce and durable and, therefore, of a high value to whom owns it. Hence, golden or silver coins can be used to regulate an economic exchange of goods or services deemed of the same value. As everybody wants these coins, we do not have the problem discussed before of a butcher stuck with a fish that he does not want.

Finally, we get to modern times, in which we need even more flexibility to make economic exchanges. We are not used to carry around physical goods (like fish or steaks) to be exchanged for other ones, nor golden or silver coins. Rather, we carry with us paper notes that have an almost null intrinsic value (indeed, what is the actual value of the paper and ink used to print a US dollar note?), but that can still be used in economic exchanges. Or even more extreme, we carry with us cheap plastic cards with a small electronic chip that we do not exchange at all. We simply use these to provide evidence that we own the money required to purchase the goods or services in some bank account. These are the currently well-known debit and credit cards (which would highly confuse the fisherman and the butcher of our first example). While these cards are more convenient and safer to use, they introduce a problem that we do not have with fish, steaks, golden coins or banknotes: the authentication of the owner. Identifying the owner of a fish or a banknote is trivial: the owner is simply the one that has these assets with them when the economic exchange takes place (obviously these may have been stolen by their current owner, but hey, no system is perfect!). In the case of debit/credit cards, the challenge of authenticating the owner is however deeper. Since the cards are linked to a bank account, every time they are used there must be a mechanism in place to securely and reliably verify that the identity of the owner of the card matches the one of the owner of the bank account to which the card is linked. This obviously requires authentication by the carrier of a card and safe storage of the account details by a bank. 

What gives value to this modern form of money? Also in this case, it is the establishment of a trust mechanism. This modern form of money, in fact, is called “fiat” money. Fiat is a Latin word that we can roughly translate into “let it be”: money has value because some entity that is trusted by all people “lets this exist”. The entity that usually gives value to fiat money is a nation state (or a union thereof in the case of the European Union and the Euro currency). The state prints the notes and mints the coins via its central bank and establishes that these are so-called “legal tender”, i.e., they are accepted legally to regulate economic exchanges. In other words, money as legal tender means that a nation state always accepts this money from its citizen for paying taxes. This creates the circle of trust that is required for the circulation of this form of money. People accept to be paid for their labor by their employer using this money because they are able to use it to pay taxes; shops accept it from their customers because, again, they are able to use it to pay taxes; and so forth. Obviously, this mechanism can work only if the nation state issuing the money can be trusted. No one, in fact, is eager to own money issued by countries that are, for instance, politically unstable or engaged in long-standing wars with their neighbors. 

A similar trust-establishing mechanism is behind many other forms of ‘private’ currencies that we commonly use, possibly even on a daily basis. One such example are meal vouchers for a student cafeteria on a university campus. Meal vouchers have value as long as they are exchanged among actors who trust their value. A student may use a meal voucher to have lunch, but also to repay a debt that he has with a friend attending the same university. This works because this friend also trusts to be able to buy lunch with that voucher at the university’s cafeteria. However, the same voucher is of no value if used outside the university context. No restaurant outside the university campus accepts the voucher. Consequently, nobody trusts the voucher to have any value outside the university campus. In other words, the university is the ‘third party’ or the ‘central authority’ that, similarly to nation states in the case of fiat money, issues and guarantees the value of the meal vouchers.

The newest incarnation of money is that of cryptocurrencies, like Bitcoin. This kind of money does not need to be regulated by a third party, like a nation state or a university. Its value is instead established by the users of the money and by the technological platform that they use to exchange the money. To really understand this kind of money (e.g., its creation, ownership, and exchange), we need to understand more about blockchain. Hence, we will return to this kind of money later in this book. Blockchain is in fact the mechanism behind cryptocurrencies.

To summarize, what have we learned from this brief analysis of different forms of money?

1. That economic exchange depends on trust. Therefore, the value of the means used to regulate an economic exchange is established through a trust-based mechanism.

2. That different design choices can be made regarding the design of different forms of money to establish trust. 

We have discussed above four different ways through which people can trust the value of money: 

a. The trust in the goods that are physically exchanged in a barter trade (the goods are the money themselves).

b. The trust in the value of the commodity of which the money is made in the case of commodity money. 

c. The trust in the institution that issues the fiat money, such as nation states in the case of world currencies or the university in the case of meal vouchers.

d. The trust in the blockchain mechanism through which cryptocurrencies are implemented.

In Tab. 1.1 we show the development of the exchange mechanisms discussed above. It starts with (1) the physical exchange of valuable objects (like meat or fish) which does not need to be regulated by an authority. The development continues with (2) precious coins, which do have an intrinsic value (like the gold used to make them) but are often issued by an authority (like the Roman emperor) that vows for their status or quality, which we call semi-regulation here. The next step is that of (3) physical exchange of fiat money, which requires full regulation by a central authority. When we remove the physical exchange, we get to (4) exchange by credit/debit cards, which also requires full regulation. A development that we have not discussed before is that of (5) community virtual currencies (like currencies in virtual gaming worlds), which we characterize as semi-regulated: there is a regulator, but this is not a formal authority. The final step in the development is that of (6) cryptocurrencies, which do not need a regulation by a central authority nor any physical exchange.

In the next section, we generalize the issue of trust in regulating economic exchanges to the case of information exchanges. In the modern age, data and information are an extremely valuable asset [BWW+07], increasingly often available natively in digital form. Because of its value, citizens and organizations strive to protect their personal information. At the same time, the ownership of data and information can accrue immense profits to any organization (for instance for marketing, or generally to gain a competitive advantage). To be effective and efficient, a mechanism for information exchange should address the same issues that we have identified above for money, such as value determination, ownership, or ownership authentication. That is, business actors exchanging information should be supported by a trust mechanism. The most straightforward way to implement trust is again to rely on a central authority. However, the blockchain mechanism can help us to support business actors while exchanging information without relying on a central authority.  

As an example, the next section considers the scenario of e-sports, i.e., (professional) competitions using video games. E-sports can be abstracted as scenarios where a number of actors (the players) need to exchange valuable information (the moves that they want to play in a game) to achieve a business goal (winning a game).

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