BlockShots: Blockchain Simplified

Latest Episodes:

Episode 36 - Anatomy of a Blockchain Node Jul 25, 2022

Show notes

Blockchains are peer to peer network of nodes. These nodes connect with each other and come to consensus on the state of the blockchain. All these nodes are basically computers running the blockchain node software. Let’s look at all the components of a blockchain node that come together to make it all possible.

* Storage: This is the most basic component of the blockchain node. This is where the state of the blockchain is stored. In general, this is simply a database optimized for blockchain use-cases. All the Merkle tree logic and related functions are implemented in the storage component of the blockchain node.

* Networking: Using the networking component, the nodes connect with each other and pass messages. Without the networking component, there would be no network, and there would be no consensus. This component is mainly comprised of two sub-components — discovery and message passing. Using discovery, the nodes find and connect with their close peers, and using messaging they pass information required for sharing state and voting on consensus.

* Consensus: The consensus engine is responsible for getting agreement on the state of the blockchain among all the nodes. All the logic about PoW, PoS, etc. is implemented in the consensus algorithm. In general, the consensus algorithm is responsible for finding which node would produce the next block of whose block would be accepted, and getting the votes from all peers on the validity of the block.

* Transaction Queue: When a user submits a transaction to a blockchain node, and before this transaction is included in a block, it is temporarily stored in the transaction queue on the node for initial validation checks. The nodes also share these transactions with other nodes, so that any node could propose them in the next block as per the rules. Transaction queue is also knows as the mem-pool.

* Node API: The node API is the user facing API that is used by users and applications to interact with the blockchain nodes. When the users submit a transaction, they use this API. The API is also used for several other purposes like reading the state, etc. Without an API, the users and apps won’t be able to interact with the blockchain.

* State Transition Function (STF): The STF of a blockchain is the most important component and it represents the core business logic of the blockchain. In the STF, all the rules about processing of transactions and their execution are implemented. The state of the blockchain is updated based on these rules written in the STF. For example, in the Bitcoin blockchain, the STF implements the logic about transfer of bitcoins from one account to other(s) when the users submit transactions.

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit podcast.blockshots.net

Episode 35 - What are Oracles? Jul 18, 2022

Show notes

Blockchains form consensus when all the nodes agree on the data they process. This depends on the condition that the computation at each node should be deterministic. That means each node should arrive at the same output, for a particular set of inputs, no matter what hardware they are using.

The deterministic nature of blockchain logic ensures strong consensus. For this reason, blockchains work on the data that is already on the chain or supplied by the transactions from the users as input. By design, blockchain don’t depend on external data sources when executing transaction logic.

However, in several use cases, external data is needed to be supplied to smart contracts to execute the end to end logic. Let’s take an example. Let’s say we have an insurance use-case implemented using smart contracts on a blockchain. The insurance amount is held in the smart contract as an escrow, and it would be paid to the user/customer only when certain conditions are met. The data about these conditions and their status is in an off-chain database. How would the smart contract know if the condition is met?

This is where oracles come in. An oracle is a service that provides external data to the blockchains. Using oracles blockchains can query data from external services or databases for consuming in the on chain logic. In the example I shared about, if an oracle is used, it would provide the data about the insurance payout conditions to the smart contract, and based on that the amount would transferred to the recipient.

Oracles generally work in an asynchronous manner. That means they are not directly called by the smart contract just like any other code. Instead, oracles are configured to listen to specific events from the smart contracts. When the smart contracts need data from the off-chain databases, they emit certain events and the oracle is triggered to fetch the data. Once the oracle gets that data from the data source, it then submits it to the smart contract as a transaction input.

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Episode 34 - On-Chain vs. Off-Chain Data Jul 11, 2022

Show notes

Blockchains are decentralized systems and are relatively slower than the centralized distributed systems. This is because decentralized systems have each node processing all the data so that they could not be hacked or influenced by a single point of control or failure. Processing all the data by all the nodes also makes things slow.

In order to still make use of blockchains and decentralized systems in real world use-cases, where millions of users could use them in spite of their low throughput, we have to follow certain best practices. One of these best practice is about what kind of data should be stored on and processed by the blockchains.

This definitely depends on the use-case we are using blockchains for, but it is an important design decision to make blockchains scale. For example, in use-cases like supply chain and data reconciliation among several parties, we should only put that data on blockchain which is critical for verification and consensus. All other data should be off the chain.

By off the chain data or off-chain data, I mean to say the data that could be stored or processed by conventional services and databases, outside the blockchain network. And the data that must go on the blockchain for consensus is generally referred to as on-chain data.

When a blockchain-based application or solution stores and sends less data to the blockchain, it performs more efficiently. This is directly related to the fact that if we put less data on the chain, the nodes of the blockchain network have do less work in getting consensus and the system performs faster as a whole.

In most cases, to make sure blockchains perform efficiently, they are used as verification machines and not as databases. The data is stored on conventional distributed databases, but it is verified on the blockchain.

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit podcast.blockshots.net

Episode 33 - Distributed vs. Decentralized Systems Jul 04, 2022

Show notes

Decentralized systems are fundamentally different from distributed systems. While in distributed systems we can add more servers to handle more load, we cannot do that in decentralized systems. Also, because distributed systems have a single point of control and failure because they process the data only at a single node. Decentralized systems don’t have that shortcoming because all nodes in the network verify the data. This makes decentralized systems much more secure.

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit podcast.blockshots.net

Episode 32 - Decentralized Autonomous Organizations (DAOs) Jun 27, 2022

Show notes

Blockchains allow seamless and transparent distribution of tokens and these tokens can represent pretty much anything. It can be something of a financial value, identity, or right to vote that can be tokenized on the blockchain.

Recall that to update the state of a blockchain, users send signed transactions, and based on the validity of these transactions the updates are applied to the blockchain. When an update requires multiple users to approve it, we use multi-signature transactions and wallets.

Now let’s combine these two concepts and imagine an organization’s entire governance based on a blockchain, where users have the right to vote by sending transactions. We can design an organization by programming the decision-making logic in the smart contracts. This logic can then be used to govern the finances, strategy, and other important aspects of an organization in a fully transparent and decentralized manner.

Users can have voting rights based on the tokens they own. The voting can be done using any of the popular approaches — a majority, supermajority, delegation, etc. The decisions made using this process can be applied automatically by distributing funds in specific account, or approving strategy and in many other ways.

These organizations that could function autonomously based on the business logic or governance rules programmed in blockchains are called Decentralized Autonomous Organizations (DAOs).

It is also worth pointing out that while the governance process of DAOs is more inclusive and transparent, it is still a challenge to apply the decisions made by a DAO in the outside world in a legal and enforceable manner.

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit podcast.blockshots.net

Episode 31 - Non-Fungible Tokens (NFTs) Jun 20, 2022

Show notes

If we look at the dictionary definition of the term fungible, it says “being of such nature or kind as to be freely exchangeable or replaceable, in whole or in part, for another of like nature or kind.”

https://www.dictionary.com/browse/fungible

Let’s take an example. If you have a 1 dollar bill, you can exchange it for another 1 dollar bill. When we deposit cash in a bank and then withdraw some or all of it, we don’t get back the same currency notes that we deposited. But we still accept that money because these notes have the same total value. Hence, fiat currencies are fungible.

The same applies to cryptocurrencies, a bitcoin can be easily exchanged for another bitcoin because all bitcoins have the same value.

Non-fungible would then mean that something cannot be exchanged for another thing of the same kind. Let’s take an example — an original painting from a painter cannot be exchanged for another painting of the same kind because there is only one original and it has it’s value. Think Mona Lisa. You cannot exchange one Mona Lisa with another because another doesn’t exist.

The same concept applies to Non-Fungible Tokens. NFTs are used to represent unique assets on the blockchain. These unique assets could be anything — a painting, a gif, a piece of land, etc. This is important to note that NFTs are only representing physical or digital assets on a blockchain. Just like we represent the ownership of a piece of land using registry papers, we can represent the ownership of something unique by using an NFT.

NFTs make sense because they represent assets that have some specific context associated with them. This context makes these assets unique and hence non-fungible. Examples of such context are — a particular art by a specific artist, a piece of land with coordinates on Earth or Mars or Moon, the original manuscript of a particular book, etc.

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit podcast.blockshots.net

Episode 30 - Crypto Exchanges Jun 13, 2022

Show notes

Exchanges allow users to buy, sell, and exchange cryptocurrencies. Just like we have stock and forex exchanges for buying and selling shares and foreign currencies, similarly we have exchanges for cryptocurrencies.

In general, crypto exchanges allow buying and selling of cryptocurrencies using fiat currencies or stablecoins or other cryptocurrencies. For example, you can buy bitcoin using USD and sell bitcoin for USD. You can also convert bitcoin into ether and vice versa, using a crypto exchange.

Crypto exchanges are of two kinds — centralized and decentralized.

Centralized exchanges are basically order book based platforms that manage keys for the users, and make blockchain transactions on behalf of the user. All trades go through a central server. They allow exchange of crypto with fiat and accept fiat payments and withdrawals. Centralized exchanges generally provide custody services to users for their purchased tokens. This means the users don’t have control on their wallets when transacting using centralized exchanges.

Decentralized exchanges are implemented using smart contracts (or logic on a blockchain) and allow users to directly make trades on the blockchain. They are more secure and allow full control of keys to the users, but they only work within the blockchain network and do not allow exchange with fiat currencies. The smart contract logic acts as automated market maker and matches the demand-supply for making token swaps. The market making and swapping of tokens is based on liquidity pools.

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit podcast.blockshots.net

Episode 29 - What are Stablecoins? Jun 06, 2022

Show notes

Cryptocurrencies are generally volatile. There are several reasons for that — low liquidity, speculation, and several other factors. There could be more reasons, but generally speaking, cryptocurrencies have been relatively more volatile compared to fiat currencies.

This volatility does not help with the value transfer use cases of cryptocurrencies. If the price is not stable, the value transferred or committed may not represent the services provided in return. For example, if a buyer and seller agree to transact using a cryptocurrency for a service or product, and by the time it is delivered if the value of that cryptocurrency changes too much then the entire trade could be unfair or undervalued, or overvalued.

To avoid these volatility issues and to still use the features of cryptocurrencies (decentralization, middlemen-less transfers, security, etc.), stablecoins are used.

Stablecoins are cryptocurrencies backed by or pegged to other currencies or commodities that have relatively stable prices. Generally, stablecoins are pegged to fiat currencies (USD, EUR, etc.), precious metals (Gold, etc.), and a combination of other cryptocurrencies.

Stablecoins are of two types — reserve-based and algorithm-based. Reserve-based stablecoins are minted based on the off-chain reserve maintained by the issuer. For example, if an issuer maintains a reserve of X USD in a bank then they can mint the same quantity of USD pegged stable coin on a blockchain. Algorithm-based stablecoins are less popular and work based on an algorithm that mints and burns coins based on the demand and supply, maintaining the stability of the price.

While providing a stable price, stablecoins also provide most of the benefits of cryptocurrencies like secure and trust-less transfers, pseudo-anonymity, etc. Hence, they are preferred as a value transfer mechanism.

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit podcast.blockshots.net

Episode 28 - Central Bank Digital Currency (CBDC) May 30, 2022

Show notes

Central bank digital currencies broadly refer to the digital versions of fiat currencies.

The fiat currencies are issued by the central banks of respective countries. These currencies are issued based on the economic conditions and needs for trade and commerce in a country. Previously, the fiat currencies were issued based on gold reserves. The process of minting and maintaining these currencies requires quite a bit of work in terms of printing, logistics, transfers, reserves, etc. There is a lot of paperwork and many of layers of bureaucratic processes in currency management at the central bank level.

On the other hand, digital/crypto currencies like bitcoin are issued on a decentralized network and are relatively easy to manage considering they are governed via code and consensus rather than via bureaucratic processes. This brings in a ton of efficiency.

Inspired by the idea of crypto currencies, some of the fiat currency issuers have been experimenting with the idea of issuing digital versions of fiat currencies using decentralized systems. This could allow more liquidity, more security, and faster digital payments while simplifying processes and overheads.

CBDCs would also allow increased efficiency in cross-border payment settlements where the processes take quite a bit of time at in the current system.

How open and transparent CBDCs would be? Would they all follow the same practices and would they all have their blockchain? Would they even use blockchain or just be a sufficiently efficient centralized digital payment system? These and many more questions are still unanswered while the idea of CBDCs is still in the exploratory stage.

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit podcast.blockshots.net

Episode 27 - Liquidity Pools, Swaps, and Yield Farming May 23, 2022

Show notes

Financial services are generally based on transfer of funds between parties. For example, when we borrow money from banks that money is deposited by someone. They earn interest for depositing their money, and we pay interest on the loan. The money moves between the depositor and borrower through the bank. On a larger scale, many people deposit money at the bank and the bank then lends that money to potentially many borrowers.

This involves the bank to manage large amount of currency, which, in turn, allows the bank to provide several financial services (forex, etc.). The bank basically pools money from many depositors to create a liquidity pool. The bank is also a centralized service provider.

Now let’s try to apply the same concept to decentralized systems. To provide financial services using decentralized applications — also known as DeFi or Decentralized Finance — users deposit (lock) their tokens in smart contracts to help create liquidity pools. Borrowers then borrow these tokens as loans and pay interest. Depositors earn interest for locking their tokens.

Liquidity pools are the basic building blocks and enablers for financial services in the DeFi space. In addition to simple lending, liquidity pools are also used in decentralized exchanges for token swaps. In such setting, the pools are maintained in token pairs so that users can easily swap or exchange their tokens with other tokens. The fee charged for the swap is (partly) distributed among the pool contributors/depositors.

The term for earning from contributing to liquidity pools is called Yield Farming. Users lock their tokens or token pairs in DeFi smart contracts and, in return, earn tokens. These could be some percentage of the same tokens and/or DeFi app specific tokens. Several DeFi apps provide features and strategies for users to maximize their yield by locking their tokens in multiple pools.

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit podcast.blockshots.net

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