New technologies which include cloud technologies, artificial intelligence and blockchain technologies have stimulated to make tangible changes in the worldwide economy including the ways  goods, services, capital and assets are exchanged or sold. Blockchain technologies and cryptocurrencies are a part of this stimulation.

During some recent years  cryptocurrencies which are very popular have changed our notions about money, yet cryptocurrencies are “products” of blockchain technologies and can be used to  solve economic problems and different problems of everyday life.

Blockchain Technologies

Blockchain technologies are block chains which follow each other by the means of special hash code. Each block contains sequential information that isn’t possible to change as it’s a part of block nets, which is available to all the members of the net. Hash code is associated with the fingerprints because it’s almost impossible to change. In order to understand the underlying idea of blockchain technologies the equation of blockchain technologies is represented below:

Blockchain technologies = Database + Consensus mechanisms

The validity of blockchain based transactions is provided by the means of consensus mechanisms. For example nowadays there are several thousands of cryptocurrencies and their consensus mechanisms are of a great number too. In order to understand consensus mechanisms we’ll refer to Proof of Work (Pow) and Proof of Stake (POS) mechanisms which are used for Bitcoin and Ethereum.

The Byzantine Generals’ Problem

Working mechanism of Bitcoin is the consensus mechanism, i. e an agreement mechanism. This mechanism was first used  as a working mechanism of cryptocurrencies in 2009 by Satoshi Nakamoto, but it had still been processed in the 20th century (in 1982 by Leslie Lamport, Robert Shostak and Marshal Pease) [1].

Computer systems must be able to find out one or several misinformation of their components and not let the misinformation affect on the whole system. The authors have tried to reveal how and by what means that is possible by the option of finding the solutions for the Byzantine generals problem. In the case of the POW mechanism the transactions implemented by bitcoin confirm nodes located in different parts of the world. And in order not to fail the cryptocurrency system because of the wrong verification of the transactions, the principles of the solution of the Byzantine generals problem were used. The Byzantine generals problem can be introduced as a question: how to make sure that numerous subjects that are located in different places, reach an absolute agreement before taking the action? This situation is introduced by the actions of Byzantine generals who are in different parts of the city and get attacking or withdrawing orders and after getting it, inform each other about the orders to reach an agreement. But some generals are betrayers and share misinformation with other generals. As a result an information net is created in which misinformation also exists . In the same way in order to confirm the cryptocurrency transaction, computers must coordinate their actions so that the transaction is implemented. But how to act in that case and how to understand which is the valid order? For solving this problem these conditions must be followed : [2]

  •  All the loyal generals make the same decision.
  •  The small number of betrayers cannot make the generals change their decision.

So, all the computers must reach an agreement about each information which is transferred by the net. No matter if there are computers which share misinformation, the other computers of the net confirm the valid transaction. As a result the whole net must reach an agreement concerning each information. This agreement is called consensus and that’s how the idea of consensus mechanisms originated. In the system of nowadays’ cryptocurrency there are thousands of computers which  provide the safety and reliability of the transactions through this mechanism.

In the case of bitcoin the mechanism of mining works. Mining means that while making a transaction, computers (the term miner is referred to both a person who deals with mining and a computer by means of which the transaction is confirmed) use their calculating power to confirm the transaction and get bitcoins. Miners confirm the cryptocurrency transactions, but as there are a lot of miners, a choice must be made whether which of them is to confirm the transaction and get a bitcoin reward. The POW mechanism works for that purpose, it decides who the transaction confirming miner is, relying on the calculated power used by it. Thus the more electrical energy the miner uses to confirm the transaction, the higher is the possibility that it will make it of all the others, and yet this mechanism demands and consumes much electrical energy which is too costly. [3] Specialized miners use extra servers and equipment to increase the calculating power of their computers. There are also mining pools, where separate miners unite the power of their computers thus getting more calculating power and they make more confirmations of transactions and the rewarding bitcoins are distributed by the proportionality of the invested power of each miner. According to estimations the electrical energy used for the confirmation of the transactions of the net is equal to the consumed electrical energy of Ireland in a year.  [4]

On the other hand the POS mechanism that is the consensus mechanism of ethereum, chooses miners according to their invested ‘’stake count’’. That is, if the miner wants to confirm any transaction,  it must own some amounts of cryptocurrencies (the more cryptocurrency it has on its account, the higher is the possibility that it will be the one to confirm the transaction). In case of the false confirmation of the transaction, it will lose its stake count, and in case of valid confirmation it will get some payment. In comparison with the mechanism of the POW, The POS doesn’t consume much electrical energy and its advantage lies exactly in it. [5]

Cryptocurrencies

It’s already obvious that the description of blockchain is hard to imagine without the notion about cryptocurrencies and the discussion of cryptocurrencies is hard to imagine without blockchain. Thus let’s refer briefly to cryptocurrencies.

Cryptocurrency is a digital asset which is provided as a means of exchange to be applied using cryptographic functions for providing the safety of financial transactions, creating extra points and confirming the exchange of the asset [6]. According to Coinbase.com cryptocurrency is digital money provided for the digital age [7] i.e. cryptocurrencies are physically non-existing assets. They aren’t circulated in the form of coins and paper money. Blockchain technologies lie in the base of cryptocurrencies which let the transactions made by the means of cryptocurrencies be decentralized, transparent and immutable. These are the features of cryptocurrencies and are distinguished from traditional money.

Decentralization: As we know the economy in traditional economic systems is managed by the government. The immutability of traditional currencies is controlled by central banks, yet the cryptocurrencies aren’t managed by any government, bank or any other organization. That’s why the demand and their circulated quantity affect the market price of the cryptocurrencies. No other organization can affect the price, neither the conducted policy nor by the means of applied tools. Cryptocurrency transactions are implemented and confirmed by  means of open nets which don’t have any controlling or managing organization. Cryptocurrencies are decentralized in computer nets which are located in different parts of the world. After the confirmation each transaction is recorded in the so-called distributed ledger that is available to everyone and contains coded information about the conducted transaction. [8]

Transparency: All the transactions which are conducted with cryptocurrencies, are visible to all the members of society, but it doesn’t mean that the personal data of all those conducting transactions are visible. The transactions are conducted in a cryptographic way in order to provide privacy. While conducting the transaction on the platform, each user gets its public key which represents a range of random numbers and letters. Thus the society can follow the cryptocurrency transactions by relying only on the data of the public keys. That is to say, cryptocurrencies are transparent but they keep the privacy of the personal data at the same time. This peculiarity of cryptocurrencies is mainly exploited by criminals and companies.

Immutability: This concept mostly refers to blockchain technologies as it’s they that let the safe implementation of the cryptocurrency transactions. While conducting each transaction, blocks full of the data of the transaction are created and confirmed which succeed each other by means of a unique code. That code can hardly be changed (blockchain technologies are considered to be immune enough, yet it’s never mentioned that they are 100% safe). The confirmation of the transactions are made by miners, which are motivated by the reward expected after the valid confirmation of each transaction in the form of cryptocurrency. The mechanism of motivation makes the miners confirm all the transactions which are valid and the confirmed transactions are checked and reconfirmed by the other participants of the network after which the transaction is considered to be implemented.

  1. L. Lamport, R. Shostak, M. Pease, “ACM Transactions on Programming Languages and Systems”,1982 
  2. L. Lamport, R. Shostak, M. Pease, “ACM Transactions on Programming Languages and Systems”, 1982, p. 11
  3.  Kang K., LeeS., “Money, Cryptocurrency, and Monetary Policy”, 2019, p. 9
  4. https://www.economist.com/the‐economist‐explains/2018/07/09/why‐bitcoin‐uses‐so‐much‐energy 
  5. https://medium.com/novamining/main-differences-between-pow-and-pos-cryptocurrency-mining-c4cc279d9739
  6. https://en.wikipedia.org/wiki/Cryptocurrency 
  7. https://www.coinbase.com/learn 
  8. Jericho J., “Understanding cryptocurrencies”, 2019, p. 12 


Authors: Inga Sedrakyan & Hayk Kalantaryan © All rights reserved.

Translator: Sona Naghdalyan.