Blockchain Technology: Principles, Proof of Work and Proof of Stake, and Application in Banking Industry

This project evaluates the key principles of blockchain technology, demonstrates how proof-of-work and proof-of-stake concepts work, and identifies the application of blockchain technology in the banking industry. It discusses the pros and cons of blockchain technology and its potential impact on the economy.

Blockchain Technology
Name, Student ID
Emai Address
Abstract
Blockchain technology is a concern, mainly due to its
subversive nature of bitcoin. Bitcoin is revolutionary to a certain
extent because it proves that the digital cryptocurrency system can
operate independently of the "traditional" banking system. By
bringing together a set of technologies, it can bring trust to an open,
completely decentralized network—an untrusted environment. The
project evaluates the key principles of blockchain technology. It
will demonstrate how proof-of-work and proof-of-stake concepts
works. The project also identifies the application of the blockchain
technology in banking industry.
I. INTRODUCTION
Blockchain is a database that consists of certain chains of
transactional operations that obeys established rules and provides
access to stored information. This principle of operation
completely eliminates the possibility of fraud, theft of personal
information, and also protects private rights. For many, blockchain
is Bitcoin, however, this direct association is not entirely true. It is
only the basis on which such a cryptocurrency works (1).
Blockchain is an interesting topic to study because the world is
heading towards blockchain. More transparent and auditable, and
more difficult to attack. Blockchain can make organizations more
transparent, democratic, decentralized, more effective, and more
secure (2). In the next 5-10 years, the blockchain may subvert
many industries. It is therefore crucial to understand the principles
underlying this noble technology.
II. UNDERLING BLOCKCHAIN
Blockchain combined with cryptography technology can ensure
transaction traceability, irreparable modification, nonrepudiation
and unforgeability, support data security sharing and large-scale
collaborative computing, and privacy protection for user identity
and confidential data (3). It is more suitable for distributed
application scenarios that require high privacy and security.
Traceability means that every change of the transaction will be
recorded in the blockchain in chronological order, before and after
the association, and the transaction can be queried from the release
source to the latest (4). There are two mechanism in which
blockchain ensure security and nonrepudiation. These include the
principle of Proof of Work and Proof of Stake.
Proof of Work- POW
The proof of work (POW) is used to prove that a person has done
the job, and after getting everyone's approval, a new block is
created, and then the person who does the job has a certain bitcoin
as a reward. It was created to address denial of service and other
security abuse. Hash cash is a proof of work mechanism that was
invented by Adam Back in 1997 to resist denial of service attacks
and spam gateway abuse (5). Prior to Bitcoin, hash cash was used
for spam filtering and was also used by Microsoft for products such
as hotmail/exchange/outlook (Microsoft uses a format that is
incompatible with hash cash and names it as an electronic
postmark).
A hash function, gives an input x, which computes the
corresponding output H(x). For the hash function used by the
Bitcoin encryption system, the following requirements are
required: Collision-free, that is, avoid entering two different
numbers and get the same output (no input x≠y, but H(x)=H(y)). In
fact, this feature is not true in theory. For example, the SHA256
algorithm used by Bitcoin will have 2^256 kinds of output. By
performing 2^256+1 input, it will inevitably generate a collision;
even from the perspective of probability, 2^130 inputs will have
99% chance of a collision (6). However, it can be concluded,
assuming that a computer performs hash operations at 10,000 times
per second, it takes 10^27 years to complete 2^128 hashes! It can
even be said that even if all the computers made by humans have
been calculated from the birth of the universe to today, the
probability of collision is extremely small. Occult, that is, for a
given output H(x), it is computationally impossible to reverse the
input x.
The main feature of the workload proof system is that the client
needs to do a certain difficulty to get a result, but the verifier can
easily check whether the client has done the corresponding work
through the result. A core feature of this approach is asymmetry:
work is moderate for the requester and easy to verify for the
verifier. Unlike the verification code, the verification code is
designed to be easily solved by humans and not easily solved by
computers.
The figure below shows the process of proof of workload:
Fig. 1. Process of proof of workload
Given string such as Hello World, the first thing is to hash it. The
string is SHA256 hashed. If the resulting hash result (in
hexadecimal form) starts with "0000", the verification passes. In
order to achieve the goal of this workload proof. We need to
constantly increment the nonce value and perform a SHA256 hash
on the resulting new string. According to this rule, we need to
calculate 4251 times to find a hash hash with the first 4 digits being
0.
"Hello, world!0" =>
1312af178c253f84028d480a6adc1e25e81caa44c749ec81976192e2
ec934c64
"Hello, world!1" =>
e9afc424b79e4f6ab42d99c81156d3a17228d6e1eef4139be78e948a
9332a7d8
"Hello, world!2" =>
ae37343a357a8297591625e7134cbea22f5928be8ca2a32aa475cf05
fd4266b7
...
XXX-X-XXXX-XXXX-X/XX/$XX.00 ©20XX IEEE

"Hello, world!4248" =>
6e110d98b388e77e9c6f042ac6b497cec46660deef75a55ebc7cfdf65
cc0b965
"Hello, world!4249" =>
c004190b822f1669cac8dc37e761cb73652e7832fb814565702245cf
26ebb9e6
"Hello, world!4250" =>
0000c3af42fc31103f1fdc0151fa747ff87349a4714df7cc52ea464e12
dcd4e9
Next, it is possible to change the input to "Hello, world+ integer
value". The integer value is 1 to 1000, that is, the input becomes an
array of 1000 values: "Hello, world!1, Hello, World!2...Hello,
world!1000". Then, for each input in the array, perform the proof
of the workload required in the above example—find a hash hash
with a leading zero of four zeros.
It is easy to calculate, and it is expected that 2^16 attempts (the
pseudo-random property of the hash value allows us to make a
probability estimate) can get a hash of 4 leading zeros. And to
calculate the actual calculation results of the 1000 calculations just
performed, we will find that the average number of calculations is
66,558 times, which is very close to 2^16 (65536). In this example,
the number of calculations expected by mathematics is the
“workload” required. The repeated proof of the workload will be a
statistically probabilistic event (6).
PoS
PoS, Proof of Stake, the PoS mechanism is actually a system that
determines the distribution of interest based on the amount of
money held by the user and the time. In the PoS mechanism, there
is a concept called “coin age”. Each coin generates 1 currency per
day. If the number of coins held by the user reaches 100 and the
time is 30 days, then the owner has a currency age of 3000. At this
time, if the user finds a PoS block, his currency will be emptied.
Every time the user is emptied by 365, the user will get interest of
0.05 coins in the block (this can be understood as an annual interest
rate of 5%). As the currency age is zero, no new block is found,
and the miner's computing power is also zero (7).
Compared with PoW, PoS mechanism is an upgrade consensus
mechanism. It reduces the difficulty of mining according to the
ratio of the number of tokens and time of each node, and speeds up
the search of random numbers. In practice, the PoS mechanism has
the advantage of shortening the consensus reaching time to a
certain extent, and also has greater security in terms of security,
which has a great effect on the application of big data in the
financial field. In addition, the PoS mechanism builds the
foundation for the frontier application of blockchain technology.
The disadvantage is that mining is still needed, and in fact it does
not fundamentally solve the pain points of commercial applications
(8).
III. BLOCKCHAIN APPLICATION IN BANKING INDUSTRY
Blockchain is a true peer-to-peer technology that allows
users to verify and execute transactions without the need for an
intermediary organization. This is a disruptive impact on banking.
In the financial industry, many early advocates of blockchain
technology believe that middlemen will become history (9).
Accenture believes that blockchain technology will make the
current financial ecosystem more efficient and eliminate
transactional frictions caused by lengthy coordination processes
between counterparties.
Some of the roles in the current banking ecosystem will be
redefined because the blockchain can flatten existing business
models, so the role of “middle man” is no longer needed. However,
there are also some roles that will not disappear in the future
ecosystem, but will only change. For example, the central bank will
not disappear, but will play a key role in the “consensus”
mechanism. Any transaction group verified under the decentralized
ledger method needs to use a consensus mechanism (10).
Similarly, regulators will not disappear because they must
check and ensure that the rules are followed in real time, rather
than going through the cumbersome review process after the
transaction. In addition, it is very likely that a new profession will
be born, such as trusted service management, a profession that
manages and manages the use of blockchain support services. The
name is borrowed from other industries to refer to similar new
services.
Blockchain Pros
Incorruptible
As this technology has various mechanisms for data verification,
the alteration of the information contained in the blockchains
becomes practically impossible. And as there is a network of users
who verify the veracity of the information, whenever someone
wants to falsify blockchains, in addition to the entire network being
notified of changes to occur, it needs to control more than 50% of
the P2P network (11).
Error free
As there is a network of people who constantly check the data, and
as the information has to be agreed by everyone, the results are
always checked and correct. And as there is a network of
administrators, each with a copy of the blockchain, the information
contained in it is not lost (12).
Reduced transaction costs
As there are no intermediaries in the transaction process, there are
no additional costs originating from third parties.
Faster process
P2P system operates 24 hours a day throughout the week. Thus, the
information is transmitted and saved automatically, much faster.
Cons of the blockchain
Difficulty to Implement
As Blockchain is revolutionary, one of its disadvantages is its
difficulty in implementing. Like any disruptive technologies,
identifying all protocols needed is not easy.
Unemployment
Blockchain can lead to massive loss of jobs because it takes the
place of intermediaries. This can significantly the rate of
unemployment (13).
Anonymity
As far as blockchain technology is concerned, once the person has
right access, he or she can see all records related to
cryptocurrencies because it is an open network.
Inefficiency
Blockchain has users such as miners. And each of them has to
confirm the information within a block. The process can result in
inefficiency (14).
TABLE 1. Pros and Cons of Blockchain
Pros Cons
Incorruptible Difficult to implement
Error free Unemployment
Reduced transaction cost Anonymity
Faster process Inefficiency
SUMMARY
Conclusion
As a decentralized digital currency, bitcoin is derived from the well-
known blockchain technology, and entrepreneurs are beginning to
believe that more and more industries will be transformed by this
technology, and there are many business cases. The blockchain will
permeate every sector of economy. The blockchain application
scenarios and business models are still being explored. The
blockchain may develop into an infrastructure similar to the Internet
in the future, or it may be a trust agreement on the Internet. In the
future, if it is widely used like the Internet, it will greatly reduce the
credit cost of the whole society, and then promote the
transformation of the information Internet to the value Internet.

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