The emergence of the blockchain space is mainly driven by the promise of a global decentralized trusted smart contract platform, which could solve a few serious issues in the way we transact, organize and govern in a digitized world. However, as with any innovation, the development is largely dependent on technical enabling factors which themselves have not yet matured. Here, we take a closer look at each of these factors, and their preliminary solutions.
- The discussion regarding the scalability of smart contract blockchains reached a high point during the launch of the blockchain application named “Cryptokitties“, a marketplace and breeding ground for virtual kittens. Because of its popularity, the underlying Ethereum blockchain experienced an enormous congestion, which caused significant delays in the confirmation of blocks. Consequently, the Ethereum development community is looking for ways to solve the scaling issue. Similarly, Bitcoin also faces scaling issues, which caused the Bitcoin Cash fork in 2017.
- In a paper, Alex de Vries found that Bitcoin mining operations use at least 2.55 gigawatts annually, an amount similar to the energy consumption of Ireland. In the future, the energy consumption could even grow to 7.67 gigawatts.
- The cryptocurrency space has faced considerable volatility, which in part could refer to the uncertainty regarding underlying fundamentals. In February this year, the volatility among the 6 cryptocurrencies with the largest market cap reached almost 150%/yr.
Connecting the dots
The first issue that has plagued the blockchain space is scaling the technology to a level that allows it to facilitate real world transaction density. In general, the transaction density in blockchain systems is determined by the size of the blocks in which new data is added to the existing chain. However, simply increasing the block size could lead to a centralization of the mining power, since only powerful nodes will be able to process the larger workload. Hence, in general, two alternative approaches have emerged: on-chain (first layer) and off-chain (second layer) solutions. The first approach, known as “sharding”, divides the validating network in “shards”, where each shard is assigned a different batch of transactions. By dividing the work instead of letting each node validate every transaction, the throughput increases. The second approach is to build second layer off-chain solutions, which allow for the settlement of transaction batches in the blockchain (first layer), thereby taking up less space within each block. Good examples are Plasma (for Ethereum) or Lightning Network (for Bitcoin).
Second, permissionless blockchains face criticism due to their considerable energy consumption. This energy consumption is caused by the underlying “proof of work” consensus protocol. By means of a computationally intensive (cryptographic) puzzle, this protocol forces each validator of the blockchain (so called miners) to make an upfront investment (the cost of energy and hardware), which results in honest actors, thereby keeping the blockchain secure and immutable. While there is still ambiguity about the extent to which crypto-mining is actually wasteful, the general perception of it being wasteful could already stall adoption. In order to solve this issue, some blockchain solutions have opted for different consensus protocols, such as ‘Proof of Stake’ (PoS) that do not rely on stakes extrinsic to the chain (e.g. energy), but that instead are intrinsic (e.g. an amount of staked cryptocurrency). However, some believe that using PoS comes at the cost of security.
Third, even though blockchains are useful for maintaining data integrity, due to their immutable nature, it cannot be guaranteed that external data sources, also known as oracles, and the interaction of these oracles with the blockchains are trustworthy (i.e. “garbage in, garbage out”). This, in turn, has resulted in the emergence of technologies and businesses to address the issue. For instance, Oraclize, TLSnotary, and Intel’s Software Guard Extensions enable the secure interaction between oracles and blockchains; elsewhere, Chainlink Oracle Service attempts to guarantee the data integrity by using multiple oracles and incentive mechanisms.
A final important issue of blockchains is related to their transparent nature, which enables nodes to validate the content of the blockchains independently. This characteristic is at odds with security and privacy concerns which demand that sometimes data needs to be hidden. Consequently, a few different technologies are being developed to keep data secret while, at the same time, keeping it machine readable and computable (e.g. Oasis labs, Enigma, TEE, zk-STARKS).
In sum, we can see that scalability, energy consumption, data integrity and data security/privacy are important technical obstacles that need to be addressed before blockchain-driven applications will take center stage. Interestingly, in solving these issues, we see that trade-offs between scalability, decentralization and security/privacy must be made. In the end, as was the case in the development of the Internet and the Web in the last decades, during which we experienced security issues (e.g. solved by HTTPS), scalability issues (e.g. solved by TCP/IP), and workload problems (e.g. network bandwidth), the hurdles in the blockchain space are not necessarily insurmountable. They should, however, be perceived as underlying technologies that each have their own paths of development. In fact, the maturation of blockchain tech is the continuation of the development of the Internet, in which consensus protocols are added to the stack.
- The development of blockchains will stimulate research and development in adjacent domains like encryption, chip manufacturing, distributed computing systems and virtual governance. Hence, it is expected that in the slipstream of the maturation of the blockchain space, other new technologies and applications will emerge.
- Since the trade-offs between scalability, decentralization and security/privacy will be different for different applications, it is expected that in the foreseeable future, the blockchain space will be heterogeneous instead of a one-size fits all blockchain. For instance, store of value blockchains (e.g. Bitcoin) will need higher security (e.g. by using PoS), whereas means of exchange blockchains will rely on PoS or second layer solutions.