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Preface to the Series
The advent of blockchain technology in the year 2009 has
completely revolutionised the digital space. The idea of creating a
universal, entirely decentralised network for carrying out
transactions of a myriad nature has forced us to re-think the
capabilities and limitations of the internet. While blockchain
technology holds the future and the key to ensuring ease of
carrying out transactions over the digital space, the same has also
led us to contemplate some very pertinent questions as to the
legality of such transactions devoid of any laws or regulations
overlooking the same. A blockchain network that is transnational in
nature also leads us to examine how our existing territorially
limited laws can ensure supervision over transactions happening
over such a vast network.
The present series seeks to examine some of these raging
questions that need to be discussed, deliberated and answered. The
series has been divided and presented into multiple, separate,
comprehensive parts, with each part dealing with a specific
subject. The first paper in the series is presented in three parts,
wherein the first part will capture the intricacies of the
blockchain network, its essential characteristics and types, while
the second part will discuss blockchain from a legal perspective
and will set out the measures adopted by various sectoral
regulators in India, the third and final part shall discuss the
initiatives of various States in India in advancing the
implementation of the technology. The forthcoming parts in the
series aim to analyse the interaction of the technology with
distinct legal practices such as Data Privacy, Arbitration, Dispute
Resolution, Corporate Transactions, Intellectual Property Rights
etc.
PART A | BLOCKCHAIN TECHNOLOGY – THE SCIENCE BEHIND THE
REVOLUTION
A) Introduction
As the world advances towards a digital revolution, it has led
to the birth of a decentralised world that seeks to self-govern and
not rely upon a central authority of power to sustain and survive.
It is a world that is increasingly controlled by codes, hash,
programming to name a few. This system of decentralised power over
the internet arises from a general mistrust of central structures,
established rules of conduct (overregulation) and governance that
seeks to promote an era of digital anarchy.
The name ‘blockchain’ stems from its technical structure
— a chain of blocks. Each block is chronologically linked to
the previous block via a cryptographic hash. A block is a
data structure that allows each system to store a list of
transactions/information. Transactions are created and exchanged by
peers of the blockchain network which modify the state of the
blockchain. As such, transactions can exchange monetary amounts,
but are not restricted to financial transactions only and even
allow the execution of arbitrary code within so called smart
contracts.1
Blockchain was created to support a uniform, secure,
decentralised system for sustaining the transfer of value-based
crypto assets. The technology that first made its appearance in
2008 in a paper written by Satoshi Nakamoto2 (a
pseudonym), was directed towards creating a decentralised online
economy which did not require a central authority to sustain or
govern the system, one that was beyond borders, and their
concomitant rules and regulations. In essence, blockchain
technology was as big of a revolution as the creation of the
internet, combining a rebellion against all sources of power with
the genius of cryptography so much so that it seems almost ironical
that during the current times governments across the globe have
started channelling the usage of the technology having realised the
potential it possesses. While Nakamoto’s paper only sought to
utilise blockchain technology for enabling the transfer of
cryptocurrencies, more specifically bitcoins, this is merely a
singular application of the revolutionary technology. The genius
behind the technology lies in the distributed ledger system that it
works on.
Interestingly, cryptocurrencies unlike tangible currencies are
easier to copy and may be re-utilised since these constitute
completely digital transactions leaving no trace in the tangible
world especially in absence of a central authority. This issue was
witnessed by DigiCash which was created by cryptographer David
Chaum in 1994.3 Digicash relied upon Chaum’s company
to validate all transactions and unfortunately, when his company
went bankrupt in 1998, DigiCash went down with it.4
Blockchain showcased an elegant solution to this problem of
double spending and continued reliance on a central regulatory
figure. Blockchain permitted mutually mistrusting entities to
perform financial payments without relying on a central trusted
third party while offering a transparent and integrity protected
data storage.5 Due to these properties, blockchain as a
technology has gained much attention beyond the purpose of
financial transactions – with the technology being utilised
across various fields and services, such as financial market, IOT,
supply chain, medical treatment, voting, storage and decentralized
autonomous organizations to name a few.6
B) Blockchain Technology- How does it work
What is a Blockchain?
Blockchain, has been defined as a digital, decentralised
(distributed) ledger that keeps a record of all transactions that
take place across a peer-to-peer network.7 A
peer-to-peer network allows all participants within the network to
share files, resources and data that does not separately require a
main server computer.8 Blockchain may also be conceived
as a transparent distributed database that records details of all
transactions performed by the system’s
participants.9
Put simply, a blockchain stores a record of information (as
a ledger) that does not require a central authority to govern
the network (decentralised). The technology is powered by
an interconnected network of participants (nodes or
miners), that lend to the network the unique characteristics
of being decentralised and distributed.
Nodes
A blockchain network is a multi-layered dimension in itself with
several systems or nodes connected to the network, with no
third-party interference or control. A node could be a laptop, a
computer, or even a small server. Each node over a blockchain
network stores the entire record of transactions over the network.
These nodes are linked together by a software protocol which
governs the blockchain network.
If we are to draw a parallel between a banking system and a
blockchain, the similarity lies in the fact that both systems need
to store information with respect to transactions. While banks
store the information on a private and centralised system, the
storage system in a blockchain is completely different and unique
with the entire blockchain functioning as a giant, decentralised
ledger that stores information.10 Each node over a
blockchain network stores a copy of the information/transactions
over the network, such that there is no central single system
serving as a ledger for the information. The records so saved gets
automatically updated whenever a new transaction is added to a
block.
Interestingly, while a technical glitch in the central server of
a bank that stores the records of all transactions might cause a
massive uproar, the same would just never happen on a blockchain
network because even if one ‘node’ (i.e. a system)
fails to function or experiences a glitch of some sort, the
remaining network of nodes would still hold a copy of the records
in the ledger. Another major difference between a bank ledger and
the decentralised ledger is that while all nodes have access to the
records stored over a blockchain network the same is not the case
in a bank ledger which is subject to restricted access and any
steps to access the records without authorisation might land one in
prison. This system also allows all nodes over the network to
validate and authenticate each and every transaction before it can
be stored on a block.
11
The above figure is a classic representation of a decentralised
ledger. Alice who wants to send cryptocurrency over the network to
Bob will have to do the same through a network of nodes spread
across the globe. Once the transaction has been validated through a
consensus mechanism, the records maintained by every node over the
system will get automatically updated.
Miners
Certain set of nodes who perform a more specialised function are
referred to as ‘miners’. A ‘miner’ is a node in the
network who works towards authenticating a transaction. Simply put
miners are nodes who have invested in higher levels of programming,
specialised mining software and computer power that enables them to
carry out extremely complex computational tasks in order to
validate a transaction. While all miners are nodes, all nodes may
or may not be miners.
Any person who wishes to join a blockchain network as a miner
only needs to create an account over a platform that gives access
to the network, and additionally invest in specialised computer
software and programming powers. Upon doing the same, the person
(or in essence his system) may become a miner and thereafter may
participate in validating transactions. In reality, it is not the
individual miner who authenticates the transaction, rather it is
the system that performs extremely complex tasks using hashing
functions (SHA-256) towards authenticating the transaction. The
process of performing SHA-256 hash twice to arrive at a winning
lottery number which is less than a target threshold, which in turn
can then be used to authenticate and add new blocks of information
to the blockchain, is known as mining. In exchange for the task of
authenticating, miners are incentivised with a block reward by the
network.
Public and Private Keys
Blockchains possess the capacity to function on a transparent,
public network, where the identities of nodes and miners are hidden
away with private keys and encryptions. Every node over the network
has a public key and a private key that are paired together. While
a public key is visible to all and could be considered akin to an
email address, the private key is more like a password and is
possessed by the node only. The private key attaches authenticity
to any information sent out by the node or any transaction made by
attaching a digital signature to the transaction and the private
key is only known to the miner/node it belongs to.12
Validating a Record and Proof of Work
For a transaction to be validated over a blockchain network,
each miner over the network performs the SHA- 256 hash twice in the
hope that the said hash will provide a number lesser than a target
threshold. Essentially, it is like performing a long mathematical
division and hoping that the number arrived at is a single digit.
The miners/computers are expending huge amounts of energy hoping
that it would randomly pick a winning lottery number (and not a
mathematical puzzle as is commonly misunderstood) which will allow
the miner to claim that they have the next block and thus entitled
to the next block reward.13
Hashing is an integral part of the process because it assists
other nodes in authenticating or tracing the transaction. While
mining and hashing techniques are complicated and a detailed
explainer on these is outside the purview of this paper, it is safe
to say that mining involves a game of trial and error by each miner
until one hits the jackpot by creating a valid hash and
authenticating the transaction. A miner’s system has to keep
generating hash numbers till one wins the gamble. The Bitcoin
network typically uses the Secure Hashing Algorithm 256 (SHA-256)
that performs the task of reducing every input transaction to a
fixed output length of 256 bytes. This means no matter the input
length of the data, the output length is always fixed.
Before the block with the validated information can be added to
the blockchain, the same has to be verified by a majority of nodes
over the system. These nodes run a simple calculation in order to
ensure that the hash output so generated is valid and abides by the
network protocol. This system of verification ensures that only
authentic data has been stored on a block. Once the block has been
verified, it is added to the network.
What does a Block comprise of?
Every validated transaction is stored on a block which is then
added to the chain. Each block over a network comprises of four
components: (a) Timestamp; (b) Nonce & Difficulty; (c) Hash of
the present block; and (d) Hash of the previous block.
When a miner attains the winning lottery number, it generates a
unique hash number that attaches validity to the transaction. A
hash is a unique 64 digit hexadecimal number that operates as a
unique fingerprint for each block. Instead of searching for a
certain transaction in a network of thousands of blocks, every
transaction can simply be traced through its unique
hash.14 The hash so generated is authenticated by a
majority of nodes over the network, once authenticated the
transaction gets recorded in a block.
A block does not simply record the hash of its own data, it also
stores the hash of the previous block. However, the first block in
a blockchain (called the ‘Genesis Block’) cannot point
towards the hash of a previous block. The Genesis Block depicts the
previous hash value as 0.15 This feature lends to
blockchain network a certain amount of authenticity, since
modifying the hash of a particular block would necessarily require
modification of the hashes contained in all other preceding blocks
over the network. Accomplishing this would require a node or a
miner to possess extremely fast computational power that changes
the hash numbers of the blocks faster than they are created.
In addition to the hash, each block over the blockchain network
also consists of a nonce number. This number is appended to the
block header, and miners must guess this nonce number through trial
and error in order to get through to the hash
value.16
17
Consensus Algorithm and Forks
A blockchain network has no centralised authority to govern and
regulate the system. All the decisions over the network have to be
made by the network of nodes by reaching a consensus. The consensus
mechanism may manifest itself in several ways over a blockchain
network. For instance, consensus may be said to be achieved when a
majority of the nodes validate the hash generated by the miner and
create a consensus that the block should be added to the blockchain
(the proof-of-work consensus).18 This consensus is of
utmost significance on the network due to the lack of a central
authority.
This consensus forms the grundnorm upon which the blockchain
subsists. However, in some cases, the nodes may be unable to come
to a consensus as to a certain transaction. This is where a
‘fork’ or a split is created. A fork results in creation of
a new chain of blocks stemming from the previous chain. The fork
created may be a soft fork, one that does not alter the validity of
the old chain, however, it may also be a hard fork, one wherein the
new chain cannot be validated with the old rules, and a consensus
is needed as to which chain of blocks should
prevail.19
Bitcoin transaction cycle
The diagram below elaborates how a transaction is undertaken on
a bitcoin network:
20
C) Characteristics of blockchain technology
Blockchain networks carry a unique set of characteristics, few
being:
Decentralised Network
Like the internet, blockchain network transcends borders and
functions seamlessly. Nodes over a blockchain network may be spread
across the globe each possessing a copy of all transactions taking
place over the network. This decentralised network of nodes spread
across the globe constitute the real authority over a blockchain
network responsible for keeping the network up and running. There
is no central authority governing the activities over the network,
no central server holding all records together. The nodes over the
network operate together in-tandem with each other to verify
transactions, adding a block to the chain, and serving as
individual ledgers with updated record of all transactions taking
place over the network.
Consensus-based mechanism
The blockchain network functions on a pre-defined consensus
mechanism. The consensus that has to be reached among the nodes
over the network accords to the network its unique characteristics,
constituting the ability to remain decentralised, and rendering
data stored over the network non-repudiable. For validating and
recording a new transaction over the network, a consensus of nodes
would have to be achieved. The consensus mechanism allows users to
trust the network without the need of knowing the identity of other
nodes.
Tamper proof network and non-repudiable data
The soul of a blockchain network lies in the fact that there is
no central power figure in the system. If we imagine a blockchain
network to be a nation in itself, it would be a nation run by the
individual citizens all of whom have equal power to run the same,
build aspects that they want, and most importantly simultaneous and
uniform access to information. Relying upon the same analogy, on a
blockchain network, citizens are replaced by the individual nodes
in the system. All of these nodes have equivalent and universal
powers. All of them have the capacity to authenticate or validate
transactions broadcasted over the network, although they must
compete to achieve the valid hash.
While the records of transactions stored on a block are
accessible to all nodes over the network, the data stored on a
block cannot be modified or deleted. If data over a block is indeed
to be modified or deleted, it would require a consensus of more
than half the number of miners or nodes over a system, that is,
about 51% of the system would have to collude in order to attain
the objective.21 This would mean convincing a majority
of anonymous nodes over the system to tamper the data, which on the
face of it may be challenging.
Also, since all records are stored with a unique hash and every
block is timestamped, tampering with one block will trigger the
requirement to modify all the previous blocks which will require
massive computational power especially in order to attain 51%
consensus.22 This unique characteristic essentially
makes a blockchain network tamper-proof and resilient to change.
This may be of great benefit in several sectors (especially
financial sector) that must necessarily rely upon the tamper proof
nature of records, for instance, banking and financial sectors.
D) Types of Blockchains
While all blockchains operate in a similar manner, blockchains
may be of three types depending upon the extent of accessibility to
the system:
- Public Blockchains–
This is an open, free network where anyone can create an ID and
join the network. Each user joining the network forms a node and is
automatically granted the power to authenticate transactions, or
access the data stored in blocks. In a public blockchain network,
there is no central authority who owns or grants access to the
network thus keeping it free for access by all. The bitcoin network
is the best example of a public network in which anyone can
participate and get full access to the entire network. - Private Blockchains–
Private blockchains are generally used by entities who do not wish
their data to be accessible to the general public. A private
blockchain is equivalent to an intranet system installed by
entities to make local data sharing fast and efficient. In a
private blockchain only identified users have the permission to
access the network and the underlying transactions. The
permissioned users are given access by the respective authority
in-charge of the blockchain network. - Consortium
Blockchains– Consortium blockchains
are a hybrid of public and private blockchains. While private
blockchain networks might have a single organisation controlling
access to the system, in a consortium network the system is
controlled by several organisations pooling in together. The same
may be beneficial for organisations with a common desired
objective. For instance, about 94 companies signed up to be a part
of the IBM/Maersk Blockchain based supply chain
initiative.23 Similar consortium blockchains may be
formed in specific sectors such as healthcare and banking.
E) Conclusion
Blockchain technology constitutes one of the most potent digital
revolutions of our times and it is here to stay. With consistent
research and efforts on in the field in order to make it more
compatible with distinct sectors, the technology is bound to be
closely tied up with digital advancements in the near future.
While the technology may prove to be quite beneficial when
applied across sectors, certain concerns may arise. While the
inherent decentralised, tamper-free nature of the technology lends
certain benefits and advantages to the network, the same
characteristics also bring forth a plethora of challenges. These
concerns arising from the interplay of the technology with the law
and various sectoral regulators shall be discussed in the second
part of this paper.
Footnotes
1. Karl Wüst & Arthur Gervais,
Do you need a Blockchain?, (April 27, 2020, 10:33 am), https://eprint.iacr.org/2017/375.pdf.
2. Satoshi Nakamoto, Bitcoin: A
Peer-to-Peer Electronic Cash System, (April 28, 2020, 11:01
am), BITCOIN.ORG, https://bitcoin.org/bitcoin.pdf.
3. Aaron Wright & Primavera De
Filippi, BLOCKCHAIN AND THE LAW 19 (2018).
4. Id.
5. Supra note 2.
6. Iuon-Chang Lin & Tzu-Chun Liao,
A Survey of Blockchain Security Issues and Challenges,
INTERNATIONAL JOURNAL OF NETWORK SECURITY, Vol.19, No.5, 653-659
(2017).
7. Blockchain: the next innovation to
make our cities smarter, (May 18, 2020, 11:10 am), FICCI-PWC,
http://ficci.in/spdocument/22934/Blockchain.pdf.
8. James Cope, What’s a
Peer-to-Peer Network?, (April 27, 2020, 13:30 PM), https://www.computerworld.com/article/2588287/networking-peer-to-peer-network.html.
9. Balamurali K., 2020: an Era of
b-Governance Blockchain, 21ST NATIONAL CONFERENCE ON
E-GOVERNANCE – COMPENDIUM OF SELECTED PAPERS, 2020, DEP. OF
ADMINISTRATIVE REFORMS & PUBLIC GRIEVANCES, GOVT. OF INDIA, 69,
73.
10. The Economist, Blockchain The
Next Big Thing, Or Is It?, (April 27, 2020, 13:30 PM), https://www.economist.com/special-report/2015/05/07/the-next-big-thing.
11. CB Insights, What is Blockchain
Technology?, [image], (April 27, 2020, 13:30 PM), https://www.cbinsights.com/research/what-is-blockchain-technology/.
12. Leon Di, Why do I Need a Public
and Private Key over a Blockchain? (June 08, 2020, 19:13 PM),
https://blog.wetrust.io/why-do-i-need-a-public-and-private-key-on-the-blockchain-c2ea74a69e76.
13. Keir Finlow Bates, https://www.linkedin.com/feed/update/urn:li:activity:6678487266249314304/
.
14. Online Hashcrack, Hashing in
Blockchain Explained, (April 27, 2020, 15:00 PM), https://www.onlinehashcrack.com/how-to-hashing-in-blockchain-explained.php.
15. Medium, What is Genesis Block and
Why Genesis Block is needed?, (May 16, 2020, 10:00 PM), https://medium.com/@tecracoin/what-is-genesis-block-and-why-genesis-block-is-needed-1b37d4b75e43.
16. Jake Frankenfield, Nonce
(May 16, 2020, 10:00 AM) https://www.investopedia.com/terms/n/nonce.asp.
17. Hash of the previous block,
[image], (May 9, 2020, 8:45 pm), https://www.mdpi.com/J/J-02-00021/article_deploy/html/images/J-02-00021-g002-550.jpg.
18. Investopedia, Consensus Mechanism
(Cryptocurrency), (May 16, 2020, 14:30 PM), https://www.investopedia.com/terms/c/consensus-mechanism-cryptocurrency.asp.
19. Geeks for Geeks, Blockchain
Forks, (May 15, 2020, 11:57 PM), https://www.geeksforgeeks.org/blockchain-forks/.
20. How Bitcoin Transactions
Work?, [image], (June 10, 2020, 13:28 PM), https://janzac.com/how-bitcoin-transaction-works/.
21. The Economist, supra note
10.
22. Aaron Wright, supra note 3,
at 36.
23 Darya Yafimava, What are
Consortium Blockchains and What Purpose Do they Serve?, (April
29, 2020, 9:00 AM), https://openledger.info/insights/consortium-blockchains/.
Originally published 6 August
2020
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.