What are Blockchain Protocols & How Do They Work?

Blockchain protocols allow for the recording of transactions in a trustless, distributed, peer-to-peer manner using a public ledger without the need for any central authorities. 

Blockchains have changed how the world organizes capital, data, and assets and will continue to have implications across several industries, including financial services, real estate, supply chains, etc. 

The blockchain concept had existed before Bitcoin came to public light in 2008, but Bitcoin is the first significant example of a blockchain that everyone now knows. 

Bitcoin arose to solve the fundamental problem of lack of trust in value transfer methods and peer-to-peer payments over the Internet without double-spending, meaning without spending the same set of values twice, since digital information can typically be copied. 

The public ledger that is blockchain maintains a continuously growing list of transactions and data chained and stored within blocks that are cryptographically secured from tampering or change by any parties using the network, making it immutable. 

Additionally, because it is a distributed, public ledger, all parties using the network can see the past history of transactions, and the transactions can never be removed. The ledger becomes a shared and synchronized database across all parties, allowing all transactions to be publicly witnessed and transparent via a block explorer

How Do Blockchain Protocols Work?

The blockchain is run by a network of nodes, or distributed networks of computers. These independent nodes verify the accuracy of transactions, maintain updated versions of the ledger, and record new transaction data on the public ledger. 

The ledger is built as a linked chain of blocks. Each block contains a number of transactions validated as legitimate by the network during a specific time span and then recorded in the ledger. 

Each block also includes the cryptographic hash of the prior block in the blockchain linking one block into a chain of blocks, which provides integrity of the previous block all the way back to the genesis block of the blockchain. 

The benefit of blockchain is that it allows for distributed control instead of only functioning as a distributed database where data is still controlled by one entity. This allows different parties, people, and institutions that may not necessarily trust what the other is saying is legitimate to share information without requiring a central administrator (like a governing body or central bank) to verify the information alone. 

Instead, the blockchain depends on its unique consensus mechanism, whereby nodes validate and record transaction data to reach a consensus that determines the final output of data into the ledger. 

This prevents a single, non-trustworthy player or small majority from maliciously deciding to change the record of the ledger. For Bitcoin, this would require a majority to obtain 51% control of the hash rate for the Bitcoin network, which is almost impossible to do.

As new transactions are added to the blockchain, the prior transactions become more difficult to manipulate. With 13,000+ live Bitcoin nodes today on the network, it becomes almost impossible for a bad actor or hacker to remove past blocks from the chain or publish fraudulent data to the ledger. 

Different Types of Blockchains

While the above details the Bitcoin blockchain, there are several types of blockchains with their own style of reaching consensus, governance, and other factors. 

Ethereum is a platform for decentralized blockchain projects such as dApps, decentralized Finance (DeFi), Non-Fungible Tokens (NFTs), and smart contracts. 

NFTs are blockchain-based tokens that each represent a unique asset such as a piece of digital content, media, art, or other tokenized asset and verify its ownership and authenticity. NFTs are designed to be cryptographically verifiable, unique or scarce, and easily transferable.  

Any developer and project in the world can use the Ethereum public blockchain in a permissionless manner to launch their own tokens, including NFTs, as long as it adheres to the specifications of the Ethereum network. 

Today, the Ethereum network regularly facilitates the flow of tens of billions of dollars of value, with over $150B USD of value currently locked in smart contracts on its network as of Q4 2021 to facilitate decentralized asset exchange such as involving lending, insurance, and payments. 

Ethereum network Total Value Locked in DeFi, Source: https://defillama.com/chain/Ethereum 

Due to the adoption of DeFi and NFTs, Ethereum has recently become so widely used that using the Ethereum network has become cost-prohibitive for many users today due to high transaction fees and congestion on the network. 

NFT Trade Volume 2021, Source: The Block

Thus, many participants have explored other Layer-1 blockchain platforms that offer similar decentralized applications like Ethereum, with lower transaction fees and varying decentralization and security profiles.

Other Layer-1 blockchain protocols involve blockchains with varying performance and utility to target niche or enterprise sectors, such as Avalanche, Flow, Solana, and Terra, and have also innovated with new consensus algorithms, blockchain architectures, and execution environments. 

As alternatives for specialized tasks, certain purpose-built niche blockchains have arisen, such as high-performance blockchains for creating NFTs such as Flow, blockchains for making supply chains more efficient, or others to help move and store different types of information at a higher throughput than on major public blockchains such as Bitcoin.

Unlike the general-purpose blockchain of Ethereum, Flow is built to efficiently scale for billions of people interacting with NFTs such as in-game items. Flow was created by Dapper Labs, the team behind NBA Top Shots and CryptoKitties. 

Flow improves upon Ethereum specifically for the use case of NFTs to create fast, proof of stake-powered consensus without the sharding in ETH 2.0, near instant finality without reducing decentralization, in contrast to Ethereum’s 12-60 second time-to-finality, and is scalable for the large demands of a growing blockchain gaming industry while being inexpensive to use. 

Solana is another high-performance public blockchain created to track transactions in a specific sequence, optimizing scalability over decentralization, and enabling scalable apps and NFTs for developers and users, with extremely low transaction fees and high throughput.

Final Thoughts: Blockchain Use Cases

Blockchain as a technology can be used for any use case, enterprise or otherwise, that deals with the transfer of data or value in some form. 

It has the potential to revolutionize the financial services industry due to removing the need for intermediaries such as payment processors. Any industry that involves agreements, which is almost every business in the modern economy, can benefit from the use case of smart contracts, which are agreements denoted in code. 

Elections, voting, and governance, in general, are another use case of blockchain that can become more transparent and easier to participate in for all parties. 

Rights to intellectual, physical, or creative digital property is another use case that blockchain makes easy to authenticate and transfer as tokenized assets, in the example of NFTs. 

Due to the decentralized, trustless, and immutable nature of blockchain technology can create several innovations and impact many industries that will continue to change the organization and transfer of data and assets.  

While Bitcoin was the original blockchain that came to public light, Ethereum and other more niche and specific blockchains are where the majority of modern-day development is happening. 

A Guide to Purpose-Built Blockchains

As blockchains exploded in adoption and use cases over the last decade, the number of challenges blockchains face has increased to meet the divergent and growing applications of the technology across various industries.

As cryptocurrencies and token offerings expand to more use cases and specific functions, their underlying infrastructure must specialize in creating a better developer and user experience. Programmatically different blockchains are being deployed for specific use cases, such as shipping, supply chains, financial infrastructure, and NFTs. 

Bitcoin and Ethereum are the original “catch-all” general-purpose blockchains; their purpose is to be the public blockchain network for all types of activity for all network participants. However, as adoption and usage have soared, catering to the network activity for the masses hasn’t been without problems.

While blockchain thus far has been most famous for its role in the rise of digital currencies, there is plenty of non-cryptocurrency uses for the technology. Purpose-built blockchains may make trade-offs with the core blockchain trilemma factors of centralization, security, and scalability to meet different industries’ needs with greater efficiency.

Challenges with Catch-All Blockchains

Most of the major public blockchains, like Ethereum, tend to face immense challenges with filling niche needs.

The first significant challenge in question is that of speed and throughput. Compared to Visa’s 65,000 transaction per second (tps) throughput, Bitcoin can only process 7 transactions per second, while Ethereum can do about 15-25 tps. Both are more decentralized than Visa, and permissionless, but specific use-cases might not need these advantages. 

Both the BTC and ETH networks have become busier than ever, especially with the NFT activity in 2021, and more adoption is on the horizon. As a result, the cost of sending a transaction has skyrocketed, regardless of what’s being sent. 

In Aug. 2021, Eth gas fees reached as high as $30 on average for a simple transaction, with smart contract transaction fees like for using dApps and NFTs being much higher, often in the range of $100-200 or more, which is a trend that had been increasing throughout 2021. 

“Catch-all” blockchains are like highways that don’t always differentiate the types of traffic to the extent that niche purpose blockchains can. Blockchain networks like Bitcoin and Ethereum are too slow and too expensive for the vast majority of smaller-scale, everyday transactions. 

Ethereum’s architecture isn’t customizable, but it does allow for a large array of different use cases including data recording data, supply chain management, insurance, tokenization of assets, and more. Moreover, Bitcoin and Ethereum were built with the principles of pseudonymity, censorship resistance, and transparency in mind.

This poses issues for some industries. For example, legacy regulated capital markets and financial services often have regulatory needs for identity, compliance, confidentiality, governance, and settlement, which aren’t fulfilled by Bitcoin’s and Ethereum’s functionality. 

What are Purpose-Built Blockchains?

These issues have led to blockchain projects building distributed ledgers that target specific use cases. 

Blockchains are diversifying to become more specialized to specific tasks and. For example, they can enable higher throughput activities, faster settlement time, and less fees. These three features can make supply chains more efficient, help move and store different types of information, or capture a higher volume of transactions than major public blockchains today. 

Specific purpose blockchains can be built solely around the efficient and cost-effective exchange of tokens, execution of smart contracts, or other enterprise functions.

With purpose-built blockchains, large-scale complex applications can solve their unique problems without compromising or bending to problems inherited by catch-all blockchain architecture.

Examples of Purpose-Built Blockchains

Acala is a DeFi-focused blockchain that builds a set of financial primitives including the ACA stablecoin, a DEX with unified liquidity provisioning, and staking derivatives. Acala aims to become a parachain on the Polkadot network and is fully EVM-compatible, meaning Ethereum developers can migrate their smart contracts without significant changes to the code. 

Acala is essentially a niche blockchain optimized for use case of DeFi, created with the goal of reducing public network congestion and creating a more efficient and robust ecosystem.

Solana is a high-performance public base-layer blockchain created to track historical events (using proof-of-history) and transactions in a specific sequence, optimizing scalability over decentralization, and enabling scalable apps for developers and users, with low transaction fees and high throughput.

Algorand created a highly scalable, low fee network, decentralized digital currency, and smart contract platform specifically for the financial services industry to use. 

Flow is dedicated to serving NFTs at a much more efficient scale than Ethereum.

Enterprise blockchains can be used to streamline business processes at scale and serve the needs of corporations in a permissioned and centralized manner. For the corporate use case, ledger data visibility can be restricted to a select group of people. 

A nation-state creating and using its own blockchain for central bank digital currencies is another example of a purpose-built blockchain with different parameters of centralization, security, and visibility of transactions.

Ant Group launched AntChain, its own in-house productivity blockchain platform, that it claims offers an “all-in-one workstation that reduces the deployment time of the company’s blockchain-based solutions by as much as 90 percent.” Today, AntChain handles over 100M digital assets on its blockchains daily, and affiliate AliPay handles 1B transactions per day.

Final Thoughts: 

Blockchain technology is expected to expand global GDP by nearly $1.8 trillion in the next decade. The technology of purpose-built blockchains can be used for specific and optimized use cases to serve large-scale and complex applications while meeting both the growing needs of enterprise and consumers. 

Without any updates to the core networks, catch-all blockchains would continue to experience immense challenges if they were used for every niche need: think more cars and trucks funneling into a bustling highway. 

Purpose-built blockchains solve for speed, throughput, and other architectural limitations to meet the global needs of varied industries, spanning public, private, and enterprise needs.