Three generations of cryptocurrencies.
In January of 2018, market capitalization of cryptocurrency Cardano (trading symbol: ADA) has surpassed USD$15 billion. The cryptocurrency has consistently been in the top 10 cryptocurrencies in the world by market capitalization. Cardano is a project by a Hong Kong company Input Output Hong Kong (IOHK). Charles Hoskinson, the former chief executive officer of Ethereum, has co-founded the IOHK project together with Jeremy Wood.
IOHK Co-founders. Three generations of cryptocurrencies
Hoskinson graduated from the Metropolitan State University of Denver, where he studied Analytic Number Theory. Prior to co-founding IOHK, he co-founded two start-ups in the cryptocurrency space. The first one was Invictus Innovations and the second one was Ethereum. Hoskinson was the founding chairman of the education committee of the Bitcoin Foundation. In 2013, he created Cryptocurrency Research Group.
Jeremy Wood is a graduate of Indiana University. After the graduation, he moved to Japan. He has been living in Asia since 2008. Before co-founding IOHK, he was a member of Ethereum together with Hoskinson. Wood and Hoskinson call Cardano a “third generation cryptocurrency.”
First generation of cryptocurrencies: Bitcoin
Bitcoin is a first-generation cryptocurrency. Satoshi Nakamoto has launched Bitcoin in 2009. It is a pioneer digital currency that has proven that digital currencies can be a way for people and organizations to engage in financial transactions without using a third party. Bitcoin has also shown that blockchain is a viable technology that offers a number of benefits compared to existing automation and transaction functionality.
The main principles behind Bitcoin are decentralization, transparency, and limited coin supply.
Decentralization of Bitcoin
Bitcoin network is decentralized, which means that anybody can become a user or miner of Bitcoin. The network doesn’t have a chief executive officer, a main office or brick-and-mortar locations. It exists because people and organizations choose to be a part of it. This approach has both pros and cons. The biggest advantage of bitcoin is the there is no third party that can decide to print more money or re-distribute the money by introducing new taxes or schemes, which is what many world governments have been doing in the past. For example, during the world financial crisis of 2008, the government of the United States decided to bail out certain banks and businesses, including Citigroup, Bank of America, Goldman Sachs, US Bankcorp, Suntrust, Capital One, American Express and many others. You can see the full list of companies, including the data about the bailouts and the companies repaying the money to the government at https://projects.propublica.org/bailout/list Iceland, Great Britain and many other countries have also either nationalized certain companies or bailed them out.
A bailout means that a government gives money to a company that has made a lot of mistakes. The government obtains money from tax collections. While the government can borrow money by issuing bonds and using other ways to borrow, it will eventually need to pay the borrowers and the only way to do so is by collecting taxes. Therefore, a bailout means transferring the responsibility for the mistakes of a few onto the shoulders of all taxpayers. A scenario like this is not possible with Bitcoin because the Bitcoin network does not have a central authority that could decide to “print more money” or “redistribute the money.”
Complete transparency of the Bitcoin network
Some people think that the Bitcoin network offers a lot of privacy. This is simply not true. All the transactions that occur on the Bitcoin network become a part of the Bitcoin blockchain. Anyone at any time could visit the Bitcoin blockchain explorer and search for transactions.
It is true that the Bitcoin network does not attach a name of a person or an organization to the transactions. The network only uses addresses and not names. Bitcoin addresses work similarly to emails because you can use an address to both send and receive funds. Every bitcoin wallet can have an unlimited number of addresses, but in many instances people and organizations use the same address over and over again. For example, if a non-profit sends an email asking for donations and indicates one bitcoin address in all the emails, you can then track all the donations to the address using the Bitcoin blockchain explorer. This also means that if you know that someone is about to participate in a transaction and you know the size of the transaction, you can look for this transaction on the Bitcoin blockchain. While it is possible to break a transaction into many parts (this is something that some privacy-focused cryptocurrencies, such as Monero, do), Bitcoin users mostly don’t do it and the network is very transparent.
Limited coin supply on the Bitcoin network
On the Bitcoin network, miners compile transactions into the blocks of the network. To give miners an incentive to do the work, the network gives a reward for creating a block of the Bitcoin blockchain. This is how the network adds Bitcoins to the circulation.
On average, the network creates a block every 10 minutes. This number may vary depending on the number of miners on the network and the number of transactions that users are sending to each other. You can see how quickly the network is creating blocks as you are reading this article by vising Bitcoin blockchain explorer at https://blockchain.info/ and check out the “Age.” For example, if you see that the latest block was created 4 minutes ago and the block before that was created 15 minutes ago, it means that it the Bitcoin network 11 minutes to create the latest block.
In total, there can only be 21 million bitcoins. This is how Satoshi Nakamoto programmed the code of the Bitcoin network. As of January of 2018, there have been more than 16 million bitcoins in circulation, which is over 80% of the total supply. The network was giving 50 bitcoins for mining a block on the network for the first 210,000 blocks. Then, the reward divided in half and was 25 bitcoins for the next 210,000 blocks. After that, it split in half again and became 12.5 bitcoins. It is estimated to drop to 6.25 bitcoins in 2020. You can see the latest up-to-date information about the number of bitcoins in circulation, total number of bitcoins left to mine, current bitcoin price as you are reading this article by visiting http://www.bitcoinblockhalf.com/. The reward for block creation will keep going down until the network has 21 million bitcoins in circulation. This is supposed to happen around the year 2140. Nakamoto’s vision for the network was that after 2140 the miners will keep doing the work because they will be receiving transaction fees from the Bitcoin network users.
The fees on the network are completely voluntary. Users do not have to include a fee when they initiate a transaction, yet miners also do not have to include any of the transactions into the blocks that they mine.
Bitcoin is possible because the Bitcoin network operates using blockchain technology. Blockchain is an open, transparent ledger created by the Bitcoin miners. The bitcoin ledger includes all the transactions that have occurred on the Bitcoin network since its inception in 2009. The ledger will also include all future transactions that will happen on the network.
Blocks of the blockchain are similar to paper pages in a paper ledger. Every new block contains a hash for the previous block. A hash is a function of a cryptography algorithm. For example, if you have a set of numbers (1, 1, 1, 2, 2, 3) and you run it through a cryptography algorithm, you would get a much shorter hash, say, 4e2. On the bitcoin blockchain, the set of numbers is information about bitcoin transactions and previous blocks of the blockchain. The sets are much bigger than in the example above. For instance, block #506659 of the bitcoin blockchain contained 1820 transactions. However, the principle stays the same: a large set of data returns a much smaller hash. A cryptography algorithm (Bitcoin uses SHA-256) will always return the same hash for the same set of data. For example, the hash for block #506659 was 00000000000000000004c6c40974e1b01c5dfdb4f7141ce01927e4b9abeead70. You can see all the information for block #506659, including information about hashes and transactions,here: https://blockchain.info/block/00000000000000000004c6c40974e1b01c5dfdb4f7141ce01927e4b9abeead70.
Fundamentally, blockchain technology allows miners to seal the blocks with hashes. A real-world analogy would be a paper ledger each page of which contains a summary of transactions on the previous pages. This summary (hash) is created in such a way that if someone were to change any information about previous transactions, the hashes would stop to match. As a result, the Bitcoin network contains a series of blocks with all the transactions that have occurred on the network since 2009 and because all the blocks are sealed with hashes, they are tamper-proof. Because the network is decentralized, anyone can download a full copy of the ledger (a computer with a full copy of the ledger connected to the network is called a node) and if someone were to try and temper with the network, that someone would have to change the information in over 51% of the copies of the ledger to be successful.
First generation cryptocurrencies such as Bitcoin offer a lot of advantages, including transparency and decentralization. However, they also come with a lot of limitations.
One of the biggest problems with Bitcoin is that the Bitcoin network can only process between three and seven transactions per second.
Here is why the capacity of the Bitcoin network is what it is: a block of the Bitcoin blockchain is 1 megabyte. An average transaction is 250 bytes in size (it can be bigger or smaller depending on the number of inputs and outputs). The blockchain creates a block every 10 minutes. These numbers result in the transactional capacity of the network being equal to 3 to 7 transactions per second, which is much less than 20,000+ transactions per second that the Visa Financial Network can handle.
The Bitcoin network operates based on the laws on supply and demand. The users do not have to pay fees for sending a transaction, but miners who are responsible for including the transaction into the Bitcoin blockchain also do not have to include the transaction if they choose not to do so.
As the popularity of the Bitcoin network exploded in 2017, so did the average transaction fee. Suddenly, the network had more transactions that it could handle and the miners were free to choose any transactions they wanted when creating the blocks of the Bitcoin blockchain. On the Bitcoin network, all transaction fees go to miners, which is why miners started choosing the transactions with the highest transaction fees. This led to the fees increasing exponentially. For example, on December 21, 2015, an average transaction fee on the Bitcoin network was USD$0.0784. Two years later to date, on December 21, 2017, an average fee was USD$54.901 (this is not a typo: the fee went from seven cents to over fifty dollars).
Because the network has fee and capacity issues, it simply can’t become a mainstream worldwide currency. Nobody will be paying an equivalent of USD$3 for a cup of coffee when they together with the $3 payment they have to include $50 as a transaction fee.
The blockchain technology offers a lot of benefits and possibilities. In essence, it allows the creation of transparent tamper-proof ledgers that could solve a lot of problems and inefficiencies in a lot of industries. For example, if a description of actions of doctors were to be included in a public ledger, then it would be easier for patients to choose a doctor. There could also be a ledger with a repair history of cars. While blockchain only allows to send money without any conditions, ledgers could also implement conditions such as “send $X only if Y happens,” where $X is a sum of money an Y is some event. Blockchain could be beneficial in data storage. There could be a blockchain network that stores several copies of files on different servers and connects storage users to storage providers based purely on supply and demand, without any third party. There could also be all kinds of blockchain-based marketplaces for everything and anything from unused cellphone minutes to apartment rentals. None of this functionality is available on the Bitcoin network.
Finally, it is impossible to change the way the Bitcoin network operates, be it block size, the speed of block creation or introduction of conditional transactions, without getting the majority of the users to update their software. At the same time, the network doesn’t provide incentives to users to reach a consensus on anything, be it software updates, new features or the future of the Bitcoin blockchain in general. The Bitcoin network uses an algorithm called “proof-of-work” to verify the blocks that miners add to the Bitcoin blockchain. Consensus and voting are not a part of the algorithm, which is one of the reasons why so many new cryptocurrencies have appeared simply because someone wanted to make a change to bitcoin. Such cryptocurrencies include Litecoin and Bitcoin Cash, both of which are first-generation cryptocurrencies.
Litecoin is different from Bitcoin in that it uses a different cryptography algorithm called Scrypt versus Bitcoin’s SHA-256. Litecoin also creates blocks of its blockchain faster, every 2.5 minutes instead of Bitcoin’s every 10 minutes. Other than the technical differences, the functionality of the network is very similar to Bitcoin. Bitcoin Cash is a cryptocurrency that split from Bitcoin on August 1, 2017. Bitcoin Cash and Bitcoin have the same blockchain for the blocks one through 478558. Block 478559 was the first block that was different on the Bitcoin Cash and Bitcoin blockchains.
Bitcoin Cash came into existence as an attempt of a group of developers to solve the Bitcoin scalability issue by increasing the size of a block on the Bitcoin Cash blockchain from 1 megabyte to 8 megabytes.
Because of a much larger size, blocks on the Bitcoin Cash blockchain can include eight times more transactions compared to Bitcoin. This means that the supply of space for transactions is much higher. Higher supply usually means lower prices and that’s exactly what happened on the Bitcoin Cash network. For example, on January 6, 2018 average transaction fee on the Bitcoin Cash network was USD$0.192. On the same day, average transaction fee on the Bitcoin network was USD$32.498.
However, the events that have occurred since August of 2017, when Bitcoin Cash became a separate currency, have shown that such an increase can only work as a temporary solution. The switch of SatoshiDice to Bitcoin Cash is a perfect example of that.
Satoshi Dice is a betting game that operates on a blockchain network. The difference between Satoshi Dice and regular betting websites is that to play the game, a player doesn’t need to visit any websites or install any software. To play, a user sends money to one of the static addresses. Different addresses are associated with different betting outcomes. Once the service determines the winners, it distributes the money it has received. Satoshi Dice migrated to Bitcoin Cash after the Bitcoin Cash network came into existence because of the lower fees on the network. Satoshi Dice transactions quickly started accounting for more than 5% of all block space on the Bitcoin Cash blockchain. If the popularity of cryptocurrencies continues to grow, another twenty or so games will take all the space on the network and the size of the blocks will become an issue again, which means that the real issue is not the size of the blocks but a way to achieve consensus on the blockchain network such as Bitcoin.
Ethereum is an example of a second-generation cryptocurrency. Ethereum took Bitcoin’s innovations several steps further and introduced ways to use blockchain that fix many of the problematic issues with the Internet.
Decentralized applications on the Ethereum network
The Ethereum network is similar to a decentralized app hosting platform and marketplace, on which anyone could create, publish and sell their own decentralized applications (or dapps). There is no strict definition of the term “decentralized application.” A dapp is an application that doesn’t depend on a central authority, connects users and creators and of app directly, and in some way uses blockchain principles and technology. For example, a distributed version of Twitter could be saving all the public tweets on its own public blockchain and thus solve the issue of censorship once and for all.
In the whitepaper for the Ethereum network, its founders described three types of decentralized applications. The first type is the dapps that manage money, possibly under certain conditions. An example of such a dapp in action would be user A agreeing to send user B a certain amount of money if the weather on a certain date in Miami is colder than 60 degrees Fahrenheit.
The implementation of such apps is possible on the Ethereum network because the developers of the network equipped it with smart contract functionality.
Smart contracts on the Ethereum network
A smart contract is a virtual agreement between parties that involves some kind of transaction or exchange. The main benefit of smart contracts on the Ethereum network is that once a contract becomes active, it becomes decentralized. The network enforces and executes the contract serving as an independent enforcing party, without the parties in the contract having to find and pay a middleman. Smart contracts make it possible to transfer power from the people and organizations who currently manage contracts to the networks.
This doesn’t mean that removing attorneys from the process of contract creation and execution is a good idea. While it is true that the Ethereum network will enforce and execute a contract, it will do so “as is.” If there are discrepancies or issues with conditions of the contract, the network will still execute the contract. In technology, this is also known as “garbage in, garbage out.” The network will not convert a poorly constructed contract into a well-constructed one. It will also not notify the parties about potential issues that the contract may be coming with. If you plan to run smart contracts on the Ethereum network (or any other network), you best bet is still to hire an experienced attorney who will go over the potential issues with you. The network will simply execute what the parties agree to, without going into the details of the agreement.
However, even with these limitations, the potential of smart contracts is tremendous. Most contracts in existence today rely on a third-party for reviews, authentication, monitoring, execution, and enforcement. Typically, such a third-party is someone from the legal profession, for example, an attorney, a court or a judge. Legal professionals in most jurisdictions need to get education and obtain government certifications before they can practice law, which is why the costs of dealing with a third-party currently are often huge. Because most of the work is done by humans and not machines, there are high risks of loss, theft and destruction. Smart contract can eliminate all of these risks altogether. When a smart contract network utilizes blockchain technology, a decentralized blockchain can store several copies of the contracts on various machines. If someone tries to change the conditions of a contract, the blockchain would simply reject the changes. Trying to destroy a contract would also be not possible if the network has multiple nodes on it (a node on a blockchain network is a computer with a full copy of the network’s blockchain).
Decentralized applications managing external sources, governments and voting
The second type of decentralized apps on the Ethereum network is the dapps that manage money and need another piece. For example, an app may be paying money to hardware owners for using their computers to perform some computations. The third type is the dapps that do not deal with money and deal with governance and voting instead, essentially making it possible for people to create organizations that are state-free, tamper-proof, fully transparent and democratic. Such an organization would have a computer run it instead of humans. The participants could create a smart contract with rules and vote on the rules that they agree on. The term for such an organization is DAO, which is short for decentralized autonomous organization (not to be confused with “The DAO,” which was a project on the Ethereum network).
Cryptocurrency Dash is an example of a decentralized autonomous organization. On the Dash network, a percentage of new currency that the network creates goes into the development fund. This is one of the big differences between Dash and the Bitcoin network because on the Bitcoin network the miners get 100% of the coins that the network creates as a reward for creating blocks of the Bitcoin blockchain.
All members of the DASH network can see how much money is in the fund and where it came from. All members of the network also get to make proposals about improvements and changes to the network. All proposals are also visible to anyone. If the development fund has enough money in it to fund a proposal, members can vote which proposals get funded. You can see the proposals that the members are voting on as you are reading this article by visiting https://dashvotetracker.com/
Once a proposal gets enough votes, it gets implemented. People are hired specifically to do work on the project and everyone can see how much contractors get paid and what they are getting paid for.
Applications of second-generation cryptocurrencies
Features such as smart contracts make it possible for second-generation cryptocurrencies to enter financial and insurance markets on a scale that was not possible with first-generation cryptocurrencies.
For example, banks can use blockchain in capital markets and trade finance. They can create smart contracts to guarantee that sellers will be paid and the money will stay in escrow until buyers receive the goods. This approach could be extremely useful in industries with high prices of assets, such as real estate or car sales. In the United States, the average homeowner sells and buys real estate every five to seven years. Blockchain could improve all parts of the process, including the verification of funds, transfer of property rights and elimination of fraud.
Smart contracts can also play a role in trading, enabling users to buy and sell goods and services when price reaches a certain threshold, providing safety and confidence that no insider trading, error or manipulation will occur because a blockchain network is managing the contract.
Execution of documents such as letters of credit by big banks is usually a slow, lengthy process. This process can take hours on a blockchain network instead of days via a traditional letter confirmation and funds disbursement path.
Insurance via smart contracts is yet another tremendous opportunity. A smart contract can allow both buyers and sellers of insurance manage claims in a fully automated and transparent manner. For example, a farmer could buy crop insurance that makes a payment to the farmer if there is no rain for X number of days and the weather stays hotter than Y or colder than Z for N days. A blockchain network could manage the data and execute such a contract automatically. A blockchain network could also make it impossible to submit invalid claims. This way, the technology will save lot of money for insurers and optimize the process, which would mean more effective business, more competition and better rates and conditions for insurance customers.
Another obvious use for blockchain technology is the supply chain management. Because blockchains are temper-proof, they are great for tracking goods from the point of origin all the way to the final seller as the goods are moving through the chain and changing hands multiple times. Second-generation blockchain networks allow users not only to organize and track data, but also to use smart contracts to create sequences of events within a supply chain, for example, to assign shipping containers to different ships, trucks or trains automatically as the containers are entering a port, without having to employ any people to do the work.
Blockchain in healthcare
Healthcare is yet another great opportunity for blockchain technology. According to researchers from John Hopkins University (source: https://hub.jhu.edu/2016/05/03/medical-errors-third-leading-cause-of-death/), each year in the United States more than 250,000 death occur because of medical errors. This number means that deaths from medical errors are the third leading cause of deaths in the United States, right after heart disease and cancer. One of the issues that the scientists from John Hopkins University brought up was that current medical system is optimized for billing and not for collection of any other information, including vital health statistics. The researchers argued that only the issues on top of the list of causes of death get a lot of attention and funding. In the begging of the twenty-first century, these issues were cancer and heart diseases. Scientists from John Hopkins university suggest that the more accurate the data, the more attention the issues will get.
The study showed that the majority of error occur not because doctors do bad work, but because of the complexities in the coordination of care, record-keeping, fragmented insurance system, and other issues.
Healthcare blockchains could help the medical industry, reduce the number of errors, improve the coordination of care via smart contracts and collect vital information. Public healthcare blockchains could contain such information as age, gender and certain medical history facts without revealing the identities of particular patients. Then, any interested individual or organization could access the blockchain and get always get the same accurate information.
Private blockchains could store full medical records of patients and connect to specialized medical devices, providing them with necessary information and recording information they would get from a device.
One of the biggest issues in the medical industry today is disconnected data. Different doctors and different devices collect and store data that is extremely fragmented and can be lost or damaged. Blockchain networks could solve all of these issues.
The second-generation cryptocurrencies introduced a lot of improvements to the world of blockchain and decentralized decision-making. However, they have also inherited some of the main issues that prevent first-generation cryptocurrencies from becoming household money. The biggest of these issues is scalability.
Scalability of Bitcoin and Ethereum
As of January of 2018, both the Bitcoin network and the Ethereum network record all the transactions that happen on the networks into just one blockchain, meaning that the Bitcoin network has a blockchain and the Ethereum network has a blockchain. The problem with that is that all the members of a network get information about all the transactions that occur on the network. This is the main reason why neither Bitcoin nor Ethereum could serve as a mechanism for all the transactions in the world in the near future.
Both on Ethereum and on Bitcoin, each node on the network contains a full copy of the blockchain. If each node were to contain information about all the transactions that happen in the world, it would take a lot of time for the nodes to update their blockchains. This would result in a significant drag on the ability of a network to process transactions quickly, which, in turn, would result in people using a different way to transact with each other.
Traditional payment systems vs first- and second-generation cryptocurrencies
One of the benefits of using cash is that a transaction takes seconds. Even when using conventional electronic payments, people today are used to swiping a credit card or a debit card through a machine and getting an approval message for a transaction almost instantly. In the Western world, people are used to picking up coffee in Starbucks after ordering it through the Starbucks app a few minutes in advance and having a car showing up shortly after using an app such as Lyft or Uber.
In all of these instances, apps automatically withdraw money from an account of an app user in a way that the user doesn’t even notice it. Payments occur instantly in the background. Because of this convenience, nobody would make a switch to Bitcoin or Ether and wait for hours for transactions to go through, which has been the case in the past when the cryptocurrency networks were getting overloaded with transactions. Even if it were possible for a blockchain network to process all transactions that are occurring globally in a timely manner, storing all the transactions on one blockchain would mean that the size of the blockchain would be huge. This, in turn, would mean that users would need to have a lot of hard drive space. Also, only users with extremely fast Internet connections would be able to download the full blockchain. As a result, only a short percentage of all Internet users will be able to become nodes on the network, essentially turning a peer-to-peer network into a highly centralized network.
The payment network of financial giant Visa has processed over 40,000 transactions per second during the holiday season of 2013, setting a record for the network. Bitcoin has processing capacity of between three and seven transactions per second. The Ethereum network can process twice as many transactions as Bitcoin, up to fifteen transactions per second, but even this number is not even one-tenth of a percent of the processing capacity of Visa network.
Solidity as a permissive language and The DAO hack
Another issue of second-generation networks is lack of qualified developers and flaws in the structure of programming languages. For example, to create smart contracts on the Ethereum network, developers need to use programming language called Solidity. Solidity was created by a team of core Ethereum contributors, including Gavin Wood and Yoichi Hirai. It is a language on top of Ethereum Virtual Machine (EVM). EVM is a protocol that is responsible for execution of code on the Ethereum network.
One of the biggest issues with Solidity is that it is a very permissive language. It does not offer a lot of features and capabilities when it comes to restrictions, which was one of the reasons why “The DAO” hack occurred in the first place (It is important to note that during the hack the Ethereum network functioned exactly how it was supposed to function. The hack occurred because the developers of “The DAO” did not protect the project from all potential vulnerabilities).
“The DAO” was a combination of stateless decentralized autonomous organization and a participant-backed venture fund. Its goal was to create a new way for both nonprofits and businesses to structure and run organizations. The crowd sale for “The DAO” token started in April of 2016 and quickly broke all the records, becoming the largest crowdfunding project at the time and having raised an equivalent of over USD$120 million. The software code that ran “The DAO” made the project a subject to a holding period of 28 days for security purposes.
About a month after the start of “The DAO” crowdsale, a paper was published that warned about the security vulnerabilities of the code. On June 17, 2016, a hacker or a group of hackers have exploited the vulnerabilities of “The DAO” and were able to gain control of about USD$50 million in Ether tokens. Then funneled the money into “a child of the DAO.” However, because of the restrictions in the code and “child DAO” being essentially a copy of “The DAO,” the attackers were not able to withdraw the funds right away and had to wait 28 days just like the creators of the original project.
Issues with governance on the first- and second-generation blockchain networks
The hack of “the DAO” had led to a lot of discussions in the Ethereum community and a hard fork that has split the Ethereum network into two, which is yet another issue with first-generation and second-generation cryptocurrencies. The issue is not with software. It is about governance and reaching consensus.
One out of the two new Ethereum networks made changes to the code of “The DAO” in a way that prevented the hackers from withdrawing the funds. It was Vitalik Buterin, the founder of Ethereum, who introduced the changes, which is why the new network kept the old name, and stayed known as the Ethereum network.
The network that didn’t accept the changes became known as Ethereum Classic. Users, miners and developers that chose Ethereum Classic argued that decentralization of Ethereum is more important than prevention of a single hack and that one update could become a precedent for new updates and a central authority deciding what happens to the network.
As a third-generation cryptocurrency, Cardano plans to tackle all the issues that prevent first- and second-generation cryptocurrencies from growing, including scalability, interoperability and sustainability.
Scalability on the Cardano network
The issue of scalability of blockchain networks is not just about how many transactions per second the networks can process. Most popular blockchain networks, including Bitcoin and Ethereum, have thousands of nodes and miners and it wouldn’t be hard for them to tweak the software in a way that allows them to process transactions faster. The issue is also about storing the data about the transactions and having enough bandwidth on the network to process the information about transactions. Another aspect of the scalability issue has to do with governance. If Bitcoin or Ethereum were to introduce updates to their software, they would need the majority of users to accept the changes and update their software. First- and second-generation blockchain networks do not have a mechanism that would allow them to run a voting process and reach consensus.
To solve all these issues, the Cardano Network chose to use Ouroboros algorithm, which is a proof-of-stake algorithm. Both Bitcoin and Ethereum use proof-of work, in which miners seal blocks with hashes.
Energy consumption and proof-of-work
One of the biggest reasons why Cardano founders decided to go with proof-of-stake and not proof-of-work are energy consumption figures. As the popularity of the Bitcoin network has exploded in 2016 and 2017, so did the electricity that the miner burn in order to mine new bitcoins. For example, according to estimates by Morgan Stanley published in the beginning of 2018 in the Fortune magazine (source: http://fortune.com/2018/01/11/bitcoin-mining-tesla-electricity/), the costs of mining 1 bitcoin in 2017 were between USD$3,000 and USD$7,000. In 2017, Bitcoin miners used over 35 terawatts of electricity. For comparison, according to the data from 2016, in the year of 2014, the entire country of Denmark used 32 terawatts, less than all bitcoin miners in 2017. Also in 2014, the entire country of Bulgaria used 31 terawatts. The list of the countries that per year use less electricity per country than Bitcoin miners used in 2017 include Qatar, Belarus, Serbia, Ireland, Hungary, Ecuador, Iceland, Dominican Republic, Costa Rica, Estonia, and many more.
An analysis by Fortune magazine found that all Tesla cars on the road used about 1.3 terawatts of electricity in 2017, which means that all Tesla cars on the road (about 300,000 of them) used about 3% of electricity that miners in 2017 used to mine Bitcoins.
In August of 2017, generating a block of the Bitcoin blockchain required running over 2^60 (two to the sixtieth degree), or 1,152,921,504,606,846,976 (over a Quintillion) mathematical operations.
Cardano’s Proof-of-Stake: Ouroboros
A natural alternative to proof-of-work is proof-of-stake. In a proof-of-stake algorithm, the network randomly selects one of its members to create a block of blockchain or perform some other action based on the stake in the blockchain ledger that a member holds at the time of selection. This is the algorithm that networks such as Dash and NEO use to create blocks on their blockchains.
The creators of Cardano believe that not only does using proof-of-stake solve the electricity consumption issues, but it also imposes discipline on the network participants because the assignment of work occurs proportionately to the stake of the members in the network.
In the whitepaper that introduces Ouroboros, founders of Cardano come up with two properties that describe robust blockchains. These properties are persistence and liveness. The property of “persistence” means that once a node on a blockchain network claims that a transaction is valid, other nodes will also deem the transaction as valid. Liveness means that once a valid transaction stays on the network for a certain period of time, it becomes stable. The combination of liveness and persistence guarantees that honest transactions on a blockchain network become a part of the network and it becomes impossible to alter them.
Ouroboros algorithm uses two more important concepts, balance and stake. Balance is the number of tokens in the account. When users get some ADA, they can send it to other users up to the total balance amount.
Stake is different from balance as it allows users on the network to control the way the network operates. These ways include block creation, participation in the system of updates and taking part in multi-party computations. Every token on the network is linked to a balance and a stake.
There are two ways for a stake on the Cardano network to be connected to an ADA token. These ways are stake distribution and stake delegation. Stake distribution is a value associated with each token address on the network. Stake delegation deals with an issue of users being offline when being chosen to as slot leaders. Stake delegation process allows certain stakeholders to transfer their voting participation rights to other members of the network.
A stakeholder on the Cardano network is a node that has a positive stake. The network considers the value of the parameter of stake to elect a slot leader, which is a node on the network that has a right to create a block during a slot.
A slot is a term that describes a short period of time, say, 15 seconds. After the Ouroboros protocol assigns a leader to the slot, the leader can create one and only one block of the blockchain. This means that the protocol can choose a trusted set of members to maintain one of the blockchains for a certain period. Because of its design, the protocol allows for creation of multiple blockchains at the same time. The blockchains can run in parallel, allowing the network to process a much larger number of transactions than Ethereum or Bitcoin can handle.
Cardano approaches sustainability from several viewpoints. The first viewpoint is the issue of consensus and the network being able to reach an agreement and implement changes while at the same time staying decentralized.
Sustainability as absence of forks and ability to reach consensus
In the business world, sustainability is often about organizations having enough funds to sustain their operations. In the blockchain world, it is more than just about finances. As the history of the Bitcoin network and the Ethereum network shows, the issue of reaching consensus and having users decide “Where should we go?” is not any less important that the issue of “How do we get the funding?”
From this viewpoint, Cardano plans to achieve sustainability by implementing its Ouroboros proof-of-stake algorithm. The team behind the algorithm comes from five academic institutions. Professor Aggelos Kiayias, the director of Blockchain Technology Laboratory at the University of Edinburgh, is leading the team. One of the core innovations of the protocol is its modularity, which would allow the network to create sidechains, checkpoints and delegation mechanisms for parallel blockchains without disrupting the operations and functionality of the entire network.
Also, the developers of the Cardano network plan to have several layers to the network. The first layer is going to be Cardano Settlement Layer or CSL. This layer of the network will be handling financial transactions. In a way, it will operate similarly to Bitcoin (with proof-of-stake instead proof of work).
The second layer of the Cardano platform will be Cardano Computation Layer (CCL). This layer will run smart contracts and allow for execution of decentralized applications. The CCL layer will be independent from the CSL layer, meaning that software changes and implementations will not affect financial transactions.
Financial sustainability of the Cardano network
In the blockchain world, financial sustainability can come through a number of means. The first way is having project supporters, enthusiasts and volunteers provide the funding and perform at least a part of maintenance and development work for free. The issue with this approach is that, as history shows, with many early developers either lose interest or have to start meeting certain financial obligations that are not compatible with doing a lot of work for free. When this happens, the community behind the developers often can’t agree on the direction of the project and the development slows down significantly. Another issue with this approach is that it often leads to centralization of power in blockchain projects.
The next approach to funding is via an initial coin offering (ICO). The problem with this approach is that an ICO can only bring a limited amount of funding and sooner or later the project will run out of the funds collected during the ICO.
Cardano has outlined its monetary policy on a special page of its website. The page is https://cardanodocs.com/cardano/monetary-policy/
The project has sold close to 26 billion ADA coins during the launch. Also during the launch, it has generated vouchers for close to 5 billion ADA. The vouchers went to three separate entities of the Cardano community. The total supply of ADA coins will be capped at 45 billion, which means that about 14 million coins will be generated through token minting.
Moving forward, Cardano will have a treasury that will get a portion of newly minted coins and fees, similarly to how it happens on the Dash network. Also similarly to the Dash network, the stakeholders on the Cardano network will be deciding what happens to the money in the Cardano treasury.
Interoperability of the Cardano network
The idea of interoperability is based on the fact that just like there is a number of regular currencies and assets that people trade, including US Dollar, Euro, Japanese Yen, gold, silver, and platinum, there will likely be several cryptocurrencies.
Even today different cryptocurrencies are carving out niches for themselves. For example, many people consider Bitcoin to be “digital gold” and “storage or value.” They believe that while using Bitcoin today is not practical due to high transaction fees (that in January of 2018 ranged between USD$7 and USD$26), there has been no other digital currency that was able to sustain similar levels of attempted attacks as Bitcoin did.
On the other hand, there is Dogecoin that is valued at less than USD$0.01 per coin. Even with this value of individual coins, Dogecoin still has market capitalization of over 500 million dollars and many people view it and use it as a “digital tipping currency” because of the low value per coin and relatively long and stable history of the Dogecoin network.
As of the end of 2017 Bitcoin has remained by far the largest digital currency, yet at the same time the ecosystem of cryptocurrencies and blockchain networks keeps growing very quickly and in terms of market percentage, the dominance of Bitcoin is getting lower and lower.
Most digital currencies are not compatible with each other and “do not talk to each other,” and exchanging one digital currency into another may be complicated. To solve this issue, Cardano has introduced non-interactive proof of proof-of-work algorithm that it plans to use to validate transactions on a variety of networks. Cardano creators envision a multi-blockchain client that serves as a connector between various digital currencies and is able to verify transactions on a variety of networks.
Practical consequences of the absence of interoperability of first- and second-generation cryptocurrencies
In practical terms absence of interoperability between digital currency networks means that if you, for example, have ETH and need to get some BTC, you will need to use a third-party exchange. You will need to first send your funds there in ETH, then use the exchange and then withdraw the funds in BTC. This results in traditional third-party exchange platforms still holding the keys when it comes to setting the exchange rates and processing the transactions, which contradicts to the principle of decentralization and digital currencies being “peer-to-peer,” (The word “peer-to-peer” being one of the words in the headline of the original whitepaper by Satoshi Nakamoto in which he introduced Bitcoin to the world).
Another issue that those who mostly operate in cryptocurrencies are likely to experience because of the fact that first- and second-generation cryptocurrencies “do not talk” to each other is difficulty explaining to regular banks where the funds are coming from. If you need to transfer your digital currency into a regular fiat currency, your bank, being a regulated financial institution, will likely ask: “where did this money come from?” The bank will, most likely, not be happy with the answer “from a bunch of anonymous people on the Internet.”
The issues with larger systems and cross-chain applications
Aside from day-to-day practical matters of convenience, Cardano creators believe that making various cryptocurrencies “talk” to each other is important because today more and more blockchain platforms and systems incorporate a number of elements into their structure or even become parts of even larger systems themselves. For example, a network called Catena uses blockchain technology for authentication purposes and a Bitcoin client for certificate validation.
At the end of 2017, the full size of the Bitcoin blockchain was close to 150 gigabytes, which means that the bandwidth and hardware costs of operating a dedicated Bitcoin wallet with a full copy of the Bitcoin blockchain will most likely not be acceptable for a browser add-on or an embedded version of the wallet. The Cardano network algorithms can solve the issue for many other cryptocurrency networks.
Finally, with so many altcoins and blockchain projects on the market, there is a lot of interest in “cross-chain” projects that would work similarly to how API integrations work today on the Internet.
API is short for application programming interface, which is a set of protocols and tools to make various pieces of software communicate with one another.
The simplest version of a cross-chain protocol is a blockchain implementation of Bitcoin-to-Ether exchange. The Cardano protocol would enable similar functionality on a more complex level.
Non-interactive proof of proof-of-work
Bitcoin was introduced by Satoshi Nakamoto in 2009 and, as of the beginning of 2018, it remains the biggest cryptocurrency in terms of market capitalization. Bitcoin and many other cryptocurrency networks use proof-of-work algorithms to create tamper-proof blockchains that contain all the transactions that have ever occurred on the network.
To be able to work with Bitcoin and other cryptocurrencies that use proof-of-work algorithms, the developers of Cardano have created non-interactive proof of proof-of-work approach. This approach is what can enable proof-of-stake networks such as Cardano “speak” to proof-of-work networks such as Ethereum and Bitcoin.
Traditional proof-of-work algorithms need to verify a chain of blocks of a blockchain. For example, for a transaction to be considered valid on the Bitcoin network, it needs at least six confirmations. A confirmation is a reference to a transaction by one block of the Bitcoin blockchain. Six confirmations means that six blocks need to reference either the transaction or the blocks that have a reference to the transaction. Because the Bitcoin network creates blocks at the average speed of one block per every ten minutes, six confirmations may take an hour or even longer.
Non-interactive proof of proof-of-work verifies transactions in a different way. It introduces the idea of trustless side blockchains that developers can create on top of a main blockchain. To send money to the sidechain from the main chain and back, users need to prove that they have the funds that they are sending. To do so, Non-interactive proof of proof-of-work checks only a certain property by verifying one string of data instead of working with the entire blockchain. In the whitepaper for non-interactive proof of proof-of-work, Cardano developers construct efficient payment verification tools, also known as simple payment verification, and sidechain verification proofs. They then show that their constructions can withstand attacks that similar constructions were not able to deal with in the past.
Cardano founders say on their website that they use scientific philosophy and research-driven approach when it comes to developing their own cryptocurrency and their blockchain projects. This is one of the reasons why Cardano has partnerships with universities all around the world and has an entire team of Ph. D. scientists working on developing the network.
On its website, Input Output Hong Kong has an entire library of scientific papers. The papers cover the Ouroboros algorithm, the treasury approach to cryptocurrency development, a study of smart contracts and more.
Cardano’s relations with academia resulted in the first use case of Cardano blockchain through a partnership with the Greek Research and Technology Network (GRNET). GRNET provides Internet service and electronic infrastructure for the scientific, educational, research and academic community of Greece. The goal of the network is to give its members full access and ability to participate in the latest scientific discoveries and research. In addition to this, GRNET creates software that helps optimize the workflow of the Greek government, including modernization of services, structures and procedures available to the public. GRNET provides support to all universities, technical education institutions, research centers and close to 10,000 schools, thus helping over a million people get better education.
Together with Cardano, GRNET is working on building a blockchain that will allow its users to verify diplomas of graduates of schools in Greece.
The Equifax hack of 2016, during which hackers were able to get access to over 140 million personal records of US, UK and Canadian residents, illustrates perfectly the issues with storage and access to highly sensitive personal information.
Today, when a person needs to provide proof of identity or credentials on the Internet or offline, he or she may be forced to share all kinds of sensitive information, and then have to trust a third party with storage and protection of this information.
History shows again and again that neither the governments nor the private organizations are doing their job well when it comes to taking care of sensitive information.
According to CNBC (source: https://www.cnbc.com/2017/04/05/congress-addresses-cyberwar-on-small-business-14-million-hacked.html), over 14 million small businesses in the United States had their computer systems hacked in 2015 and 2016, which is over 50% of all small businesses in the country. Big businesses also often become victims of attacks. In 2013, Target had a data breach during which hackers gained access to personal information of over 70 million people. In 2014, attackers stole from Yahoo data associated with over 500 million accounts. Many of other large corporations, including LinkedIn, Uber, and others, have also experienced breaches on a large scale.
The argument for keeping sensitive information on the blockchain is about giving users more control about what information about them is out there and about the ability to verify data while not exposing a lot of sensitive information.
The issue is similar to the issue of a cryptocurrency network being able to verify transactions from other networks. In one of their research papers, Cardano founders argue that such a verification can occur using only a short string of data, without having to access the entire blockchain.
Today, the process of verification of school credentials works in the same way all over the world: a student graduates from a school and gets a piece of paper with a seal and a signature. The data about the student becomes part of school’s database. Both the piece of paper and the database can suffer from errors and damage. There is no easy way for students to access their official records. They may be able to access a student portal and get an unofficial printout of their grades and degrees, but to get an official record they have to wait and pay.
To confirm that students have the degrees that they are claiming to have, students need to submit an official letter from a school, or an official transcript to the potential employers. This process, including storage of diplomas and collection of transcripts, is long, time-consuming and inefficient. After a student submits the documents to a potential employer, the employer also needs to contact the school to verify the credentials and information, which is also time-consuming and inefficient. This is one of the reasons why many of the employers don’t even bother with asking prospective employees to have their schools send transcripts to the prospective employer.
The rate of change in the world is constantly accelerating and to succeed in their fields, professionals need to be learning and updating their skills all the time, yet there is currently no meaningful way to have one official academic record that combines degrees, certificates, experiences and achievements.
If an emergency happens, such as a flood, fire, or an earthquake, and a person loses his or her diplomas, there’s often no way for the person to prove who they are easily.
Storing information about diplomas, grades and graduation information on a private blockchain could eliminate the opportunity for errors and fraud and make the process of verification of educational credentials and grades fast, easy and efficient. This is what Cardano and GRNET want to accomplish as a result of their cooperation.
Putting information about someone’s education online can raise privacy concerns. For example, a doctor may want to participate in an online forum or a community without disclosing the fact that he or she is a doctor to avoid other members of the community asking for medical advice. The same may apply to any other professionals, including lawyers, engineers, and teachers. For this reason, Cardano and GRNET are planning to make only the cryptographic hash of diplomas available on the blockchain. As of January 2018, they haven’t decided if they are going to include all the diploma-relation information into a blockchain, but if they do, it will all be encrypted.
GRNET’s blockchain is going to be private (as opposed to public). With public blockchains, such as Bitcoin, Ethereum and others, anybody can download network software, a full copy of the blockchain or participate in the creation of new blocks on the blockchain. A private blockchain can impose restrictions on any of these elements. With diplomas, there’s no need for public to be able to create blocks of the blockchain. As of the beginning of January of 2018, the project had Cardano was working with three Greek Universities.
The project is not the first attempt to store education-related information on a blockchain network. For example (source for the example: MIT News, http://news.mit.edu/2017/mit-debuts-secure-digital-diploma-using-bitcoin-blockchain-technology-1017 ), in the summer of 2017, 111 graduates of the Massachusetts Institute of Technology had an option of getting their diplomas not just in the traditional paper format, but also via an app on their smartphones in addition to paper. The app was a result of a partnership between MIT and a company called Learning Machine (both MIT and Learning Machine are based in Cambridge, Massachusetts). The name of the app was Blockcerts Wallet. Using the app, graduates would be able to quickly prove to their employers that they went to the MIT. The primary goal of the MIT for the project was to allow its graduates to be in control of their records and choose with whom and when they share the information.
When creating the Blockcerts, Learning Machine used the same blockchain as the Bitcoin uses, including the same cryptography algorithm (SHA-256), but applied it to the storage and verification of academic and employment credentials.
Just like Satoshi Nakamoto made Bitcoin Core open source, Learning Machine and the MIT have made Blockcerts open source.
Later, employers or anyone else could upload the file to a special portal and immediately receive a verification response. The portal would locate the identification record of the digital diploma on the blockchain, verify the key and confirm that the diploma is valid.
The MIT and Learning Machine see creation of a blockchain that would allow stacking of certificates from various schools and institutions as the logical continuation of Blockcerts.
To validate this idea, Learning Machine has used blockchain technology to issue a certificate of employment to all of its employees.
The difference between the MIT/Learning Machine project and the collaboration between the IOHK and the GRNET is that IOHK plans to use blockchain for all the verifications steps.