An Introduction to the Web3 World - Blockchain, Smart Contracts

Exploring the Fundamentals of Blockchain and Smart Contracts: Your Introduction to the Web3 World and Its Transformative Technologies

What is Web3, Blockchain and Smart Contracts?

In the rapidly evolving digital landscape, terms like Web3, blockchain, and smart contracts are becoming increasingly common. But what exactly do they mean, and why are they so important?

This article is designed to demystify these key concepts, offering a clear and comprehensive introduction.

Whether you’re new to these concepts or seeking a deeper understanding, this guide will provide you with the foundational knowledge you need to navigate the world of Web3 confidently. Let’s dive in and explore how these technologies are poised to revolutionize the way we interact with the digital world.

First Thoughts - Bitcoin and Blockchain

So Bitcoin was introduced by the pseudonymous Satoshi Nakamoto as one of the first applications of blockchain technology. The Bitcoin Whitepaper outlines how Bitcoin facilitates peer-to-peer transactions through a decentralized network, leveraging cryptography to ensure security and integrity. This innovation gave rise to what is often referred to as “digital gold”, offering a new way to store value with a fixed supply, akin to the scarcity of gold. For a deeper dive into Bitcoin's foundational principles, refer to the Bitcoin Whitepaper. In a future article, I’ll simplify the Bitcoin Whitepaper into a shorter and snappier summary.

Before we delve in any further, what is a blockchain?

• Blockchain: In web3, a blockchain is a digital ledger that records transactions across many computers in a secure and decentralized manner. Each block contains a number of transactions, and every new block is linked to the previous one, forming a chain. This makes the data tamper-resistant. Example: Bitcoin's blockchain records all BTC transactions.

Ethereum and Smart Contracts

Building on the blockchain concept introduced by Bitcoin, Ethereum was created by Vitalik Buterin along with many others to expand its capabilities. Ethereum introduced the concept of smart contracts, revolutionizing how digital agreements are executed. Vitalik Buterin released the Ethereum Whitepaper in 2014, prior to the project’s launch in 2015. Again, an article will be available in the future summarizing the Ethereum Whitepaper.

Ethereum levelled up the playing field by introducing decentralized agreements, i.e. Smart Contracts, decentralized organizations and many other interactions. While Bitcoin's primitive blockchain primarily supports decentralized transactions, Ethereum extended these capabilities with Smart Contracts. Smart Contracts were first proposed by Nick Szabo in 1994. Ethereum brought this concept to life, enabling a broader range of applications compared to Bitcoin’s more limited scripting capabilities.

So what are Smart Contracts?

• Smart Contracts: Smart contracts are a set of instructions executed in a decentralized way without the need of a centralized/third party to run them. In summary, they are a set of instructions written in code on the blockchain.

Here’s an example of what an Ethereum smart contract looks like:

// SPDX-License-Identifier: MIT

pragma solidity 0.8.19;

contract SimpleStorage {
    uint256 myFavoriteNumber;
    struct Person {
        uint256 favoriteNumber;
        string name;
    }

    Person[] public listOfPeople;

    mapping(string => uint256) public nameToFavoriteNumber;

    function store(uint256 _favoriteNumber) public {
        myFavoriteNumber = _favoriteNumber;
    }

    function retrieve() public view returns (uint256) {
        return myFavoriteNumber;
    }

    function addPerson(string memory _name, uint256 _favoriteNumber) public {
        listOfPeople.push(Person(_favoriteNumber, _name));
        nameToFavoriteNumber[_name] = _favoriteNumber;
    }
}

It is also important to note the difference between Decentralized and Centralized:

• Decentralized: A system where control and decision-making are distributed across multiple nodes or participants.

• Centralized: A system where a single authority manages and controls operations and data.

In summary,

• Decentralized: Good :)

• Centralized: Can be Bad as it is Easy to Manipulate :(

To dive deeper, Bitcoin also has smart contracts but are intentionally set to ‘Turing incomplete’ because the point of Bitcoin was to act as a store of value, a ‘digital gold’. Bitcoin’s scripting language is `Turing incomplete`, meaning it cannot handle complex computations or general-purpose programming tasks. It is designed this way to ensure security and simplicity, focusing on basic operations needed for financial transactions rather than supporting complex programming.

Ethereum uses store of value in addition to utility through the use of smart contracts. Since Ethereum’s release, there have been a number of different blockchains that have come out with smart contract functionality, such as Avalanche (AVAX), Polygon (MATIC), Solana (SOL), Polkadot (DOT), etc. The good news is that many blockchains are compatible with Ethereum-style smart contracts, making it easier for developers to transition and build across different platforms.

On the topic of smart contracts, you may have encountered the term ‘Ethereum Virtual Machine (EVM)’.

• Ethereum Virtual Machine (EVM): The EVM is the computation engine that executes smart contracts on Ethereum.

Ethereum provides a platform for developers to build decentralized applications (DApps) and is the foundation for many Web3 projects.

• DApp (Decentralized Application): A DApp is an application that operates on a decentralized network or blockchain, powered by smart contracts, and functions without a central authority. DApps can be used for various purposes, including finance and gaming. Example: Uniswap, a decentralized finance application.

In summary you can think of DApps as follows:

• DApp ≈ Decentralized Application ≈ Decentralized Protocol ≈ Smart Contract

The Oracle Problem

Despite their potential, smart contracts face a significant challenge known as the ‘Oracle Problem’. Smart contracts operate within the blockchain's environment and cannot directly access external data. To bridge this gap, oracles are employed.

• Blockchain Oracle: These are any device that interacts with the off-chain world to provide external data or computation to blockchains, enabling smart contracts to interact with real-world events.

To keep things decentralized, you can’t work with a Single Blockchain Oracle. You need multiple Blockchain Oracles, i.e. a Decentralized Oracle Network to avoid reliance on a single source. This removes Centralization!

This gives rise to the term ‘Hybrid Smart Contracts’.

• Hybrid Smart Contracts: This combines on-chain code (running on a blockchain) with off-chain data and computations provided by oracles. This allows the contracts to interact with data and systems outside their native blockchain. Example: A smart contract for a rental agreement that uses oracles to verify the current weather. If it’s raining, the contract automatically provides a discount to the renter for that day.

Chainlink is an example of a modular Decentralized Oracle Network that can bring external data and computation into a smart contract to ensure end-to-end Decentralization, thus creating a ‘Hybrid Smart Contract’. Chainlink is the most popular and powerful Decentralized Oracle Network. It works on multiple blockchains like Ethereum (ETH), Solana (SOL), Avalanche (AVAX) and many more.

Blockchain Benefits

Here’s a quick look at the benefits of using blockchain technology showcasing its potential to streamline, secure, and decentralize the financial sector.

• Decentralization: Blockchains are maintained by many node operators, reducing the risk of a single point of control or failure.

• Transparency: Public ledgers allow anyone to verify transactions, promoting openness and accountability.

• Flexibility: Blockchains support various applications, from finance to supply chain management.

• Speed & Efficiency: Transactions settle quickly without intermediaries, reducing delays and costs.

• Security & Immutability: Cryptography ensures data integrity, making it nearly impossible to alter past transactions.

• Counterparty Risk Removal: Peer-to-peer transactions eliminate the need for a central authority or third-party trust.

• Smart Contracts: Self-executing contracts automate processes, ensuring terms are met without manual intervention.

Blockchain Limitations

Conversely, there are a number of limitations to blockchain technology, specifically the challenges it faces in scaling, efficiency, and regulatory compliance.

• Scalability: Blockchains can only process a limited number of transactions per second, which can lead to delays and higher costs as demand increases.

• Energy Consumption: Some blockchains, particularly those using Proof of Work (PoW), require significant computational power and energy, raising environmental concerns.

• Complexity: Implementing and understanding blockchain systems can be complex, often requiring specialized knowledge and technical expertise.

• Regulatory & Legal Issues: The legal status and regulatory framework for blockchain transactions and smart contracts can vary and be uncertain across different jurisdictions.

• Data Privacy: While transactions are transparent and immutable, this can sometimes conflict with the need for data privacy and compliance with regulations.

Layer 2 Scaling Solutions

Scalability remains a challenge for growing blockchains. Layer 2 (L2) solutions address this by building on top of the main blockchain to enhance its scalability and efficiency.

• Layer 1 (L1): The base blockchain network that handles the core operations, including transaction processing and network security. Example: Ethereum.

• Layer 2 (L2): Technologies built on top of a Layer 1 (L1) to improve scalability and efficiency by processing transactions off the main blockchain. Example: Arbitrum built on Ethereum’s Blockchain.

There are two main types of L2 solutions:

• Optimistic Rollups: A Layer 2 scaling solution that processes transactions off-chain and assumes they are valid by default. Only in the case of disputes does it check the transactions on-chain. Examples: Optimism and Arbitrum.

• Zero-Knowledge Rollups: A Layer 2 scaling solution that uses cryptographic proofs to verify transactions off-chain and post aggregated proofs to the main blockchain. This method enhances scalability while ensuring security. Examples: ZK Sync and Polygon ZK EVM.

These definitions might not fully resonate right now, but don’t worry, we’ll dive deeper into Layer 2 solutions once we have a solid grasp of blockchain mechanics later on.

Web1, Web2 and Web3

Web3 can be thought of as the next evolution in the generations of the internet. Unlike earlier versions of the web, Web3 is permissionless and operates on decentralized networks rather than centralized servers. This shift promotes censorship-resistant and transparent agreements and transactions, fostering an ownership economy.

• Web1: The early web with static content, accessible without permissions.

• Web2: The modern web with dynamic content, where companies manage and control data on their servers.

• Web3: The decentralized web with dynamic content, enabling user control and ownership.

The Purpose of Smart Contracts

In the real world, nearly every action involves some form of agreement or contract. Whether it's purchasing furniture or paying for your broadband bill, these transactions are governed by agreements. Traditional contracts, however, rely on trust between parties, which doesn’t always guarantee honesty or fairness.

For example, people used to believe that depositing their money in a traditional bank would guarantee its safety. However, traditional banks have sometimes failed to protect people's funds, as seen during the Great Depression. This highlights a flaw in trust-based agreements / traditional contracts.

Blockchain and smart contracts can ensure transparency and automate checks to prevent financial instability, enhancing trust in financial systems.

Smart contracts create a trustless environment where agreements are immutable, decentralized and transparent. This approach has the potential to transform various sectors by promoting fairness and reliability.

• Immutability: Once recorded, data cannot be changed, manipulated or deleted, ensuring a permanent and unalterable record.

To summarize:

• Traditional Contracts: Depend on trust in centralized entities.

• Smart Contracts: Offer transparency, decentralization, and immutability.

Smart contracts are revolutionizing various markets by encoding agreements executed by a blockchain, ensuring that no single party can alter the contract. The agreement and its terms are publicly accessible and executed automatically.

As more industries adopt smart contracts and blockchain, the advantages of these technologies become increasingly evident. They represent trust-minimized agreements or "unbreakable promises."

Features of Smart Contracts

Smart contracts offer several distinct features that set them apart from traditional agreements.

• Decentralization: One key feature of smart contracts is their decentralization. smart contracts operate on a blockchain network managed by numerous node operators. This collective management ensures that no single entity controls the contract, contributing to a decentralized and resilient system.

• Transparency & Flexibility: All transactions and contract executions are visible to participants on a blockchain network. This transparency ensures that all parties have equal access to information and adhere to the same rules.

• Speed & Efficiency: Smart contracts and blockchain transactions are notably faster and more efficient compared to traditional banking systems. Traditional bank transfers processing time can vary from days to weeks. In contrast, blockchain transactions are completed almost instantaneously, streamlining interactions and reducing delays.

• Security & Immutability: Once deployed, smart contracts are immutable, meaning their terms cannot be altered. This immutability contrasts sharply with centralized systems where data can be manipulated or hacked. Blockchain's decentralized nature significantly reduces the risk of breaches, as compromising the system would require controlling a majority of the network nodes. Additionally, data on the blockchain is distributed across many nodes, ensuring that even if some nodes fail, the data remains secure and intact.

• Elimination of Counterparty Risk: Smart contracts remove the need for trust between parties. Once a contract is deployed, its terms are fixed and cannot be altered by either party. This reduces the risk associated with traditional agreements where there is always a chance that one party might fail to fulfill their obligations. Smart contracts enforce agreements automatically, ensuring that all parties adhere to the agreed terms.

Applications of Smart Contracts

Smart contracts have not only introduced new opportunities but have also transformed existing industries. Here are some key applications currently shaping the Web3 landscape.

• Decentralized Finance (DeFi): DeFi leverages smart contracts to provide financial services without intermediaries. This allows users to interact with financial markets in a transparent and efficient manner, accessing complex financial products securely.

• Decentralized Autonomous Organizations (DAOs): DAOs are managed entirely through smart contracts, offering benefits like transparent governance and streamlined operations. DAOs represent a potential evolution to politics and governance.

• Non-Fungible Tokens (NFTs): NFTs are unique digital assets that can represent ownership of digital art or other exclusive items. NFTs open new avenues for creators and artists to monetize their work.

• Supply Chain Management: Smart contracts can automate and track the movement of goods across the supply chain, ensuring transparency and reducing fraud. They can verify each step of the process, from manufacturing to delivery.

• Healthcare: In healthcare, smart contracts can manage patient consent, track medical records, and streamline insurance claims, ensuring data privacy and reducing administrative overhead.

• Real Estate: Smart contracts can facilitate property transactions by automating contract execution, handling payments, and recording property ownership, thus reducing the need for intermediaries.

How Do Blockchains Work?

To understand how a Blockchain works, it is important to understand the concepts of a Hash and a Block.

Hash Concept:

• Hash: This is a unique fixed length string that identifies a piece of data. A Hash is created by inputting a piece of data into a hash algorithm that generates an output.

• Hash Algorithm: This is a function / algorithm that computes data into a unique hash.

Bitcoin uses SHA256 as the hash algorithm to generate hashes for its transactions.

• SHA256: This Cryptographic Hash Algorithm belongs to the SHA-2 (Secure Hash Algorithm 2) family, where it generates a fixed-size 256-bit hash value from input data.

We'll cover Bits, Bytes, and Binary Numbers in a future article, but for now, you don’t need to worry about understanding those concepts.

You can try hashing your own inputted data using SHA256 here, but an example is shown below:

Inputted Data: Subscribe to GuireWire
Hash: 0733ff843fba9641bac225c7f41103d2ef4de113edde9490805b7521980c4c92

Ethereum uses Keccak256 as the hash algorithm to generate hashes for its transactions.

• Keccak256: This Cryptographic Hash Algorithm belongs to the SHA-3 (Secure Hash Algorithm 3) family, where it generates a fixed-size 256-bit hash value from input data.

Again, you can try hashing your own inputted data using Keccak256 here.

Blockchain Concept

Now that we’ve covered the basics of hashing, let’s take a closer look at how these hashes fit into the overall structure of a blockchain. A blockchain is essentially made up of a series of "blocks," each containing specific data.

• Blockchain: A digital ledger consisting of a chain of blocks, each containing data. The chain is decentralized and secured using cryptographic hashes (e.g., SHA256), ensuring that once data is added, it cannot be altered without affecting all subsequent blocks.

• Block: A discrete unit within the blockchain that contains a set of transactions or data. Each block is linked to the previous one, forming a continuous and immutable chain.

Each block is made up of five key components:

• Block #: A unique number assigned to each block in the blockchain, indicating its position in the sequence. It helps maintain the order of blocks and track the chain’s progression.

• Nonce: A special number used in the mining process to create a valid hash. Miners adjust the nonce to find a hash that meets specific criteria, like starting with a certain number of zeros.

• Block Data: The information contained within the block, which can include transaction details, timestamps, and other relevant records. The data varies depending on the blockchain's use case.

• Block’s Previous Hash: The unique digital fingerprint of the previous block in the chain. It links the current block to the one before it, ensuring the continuity and security of the blockchain.

• Block’s Hash: A unique digital fingerprint generated by feeding the block's data and nonce into a hash algorithm (e.g., SHA256). Even a small change in the data alters the hash entirely, ensuring the block's integrity and security.

Mining involves the computational trial and error process of finding an acceptable value to produce a hash which typically follows a certain pattern, such as starting with four zeros. The value found, which satisfies this, is known as the 'nonce'. The problem or criteria a miner has to solve will vary from blockchain to blockchain, but the concept is the same.

You may have encountered the term ‘Genesis Block’:

• Genesis Block: This is the first block on the blockchain where the previous hash does not exist.

As stated previously, A blockchain is a sequence of blocks, and each new block contains a reference to the previous block’s hash. This creates a chain where any change to a block’s data affects not only its hash but also all subsequent blocks. This feature makes blockchain immutable, meaning changes to historical data are nearly impossible without re-mining the entire chain.

If a single entity controlled the blockchain, they could theoretically alter data and re-validate the blocks. To prevent this, a blockchain is decentralized, meaning it’s managed by multiple participants, or “peers,” across a network. If one participant tries to alter the chain, the majority of the network, holding the correct version, ensures that any tampered blocks are rejected.

These “peers” across a network are known as Nodes:

• Nodes: Individual “peers” (e.g., Computer running a Blockchain - Peer A) that participate in and maintain the decentralized blockchain network by validating and relaying transactions and data.

Blocks aren’t limited to random strings of data. They can also contain transactions. The example below showcases blocks storing transaction details. Any change to a transaction within a block disrupts the entire chain, maintaining the integrity of the system.

Smart contracts are essentially the data or transaction component within a block on a blockchain. Platforms like Ethereum have a significant advantage because they offer extensive functionality, enabling the creation of decentralized applications (DApps) and more complex programmable contracts, unlocking a wider range of use cases beyond simple transactions.

Traditional Networks vs Blockchain

In traditional networks, applications rely on centralized servers controlled by a single entity, which means they can be shut down or altered by the organization running them. Blockchains operate differently, relying on a network of independent nodes that together create and maintain the blockchain. Anyone can join this network, making it decentralized. If one node fails or behaves maliciously, the blockchain remains intact as long as other nodes continue running, which enhances security and reliability.

Consensus Mechanisms

Blockchains use consensus mechanisms to validate transactions and maintain network integrity.

• Consensus: This is defined as the mechanism used to reach an agreement on the state or a single value on the blockchain especially in a decentralized system.

A consensus protocol in a blockchain ensures that all participants in a decentralized network agree on a single version of the truth, such as the correct transaction history or block sequence. It can be divided into two essential components:

• Chain Selection Algorithm: This determines which version of the blockchain is considered valid when there are competing chains.

For example, Bitcoin uses the ‘Nakamoto Consensus’ or longest chain rule, where the chain with the most cumulative computational work is considered the official blockchain. This ensures that everyone in the network aligns with the same version of events.

• Sybil Resistance Mechanism: This mechanism prevents individuals from creating multiple identities or "nodes" to manipulate the network.

The two most common Sybil Resistance Mechanisms are Proof of Work (PoW) and Proof of Stake (PoS):

• Proof of Work (PoW): Miners solve complex computational puzzles to add new blocks, making it difficult for any one entity to dominate the system. PoW requires significant energy but ensures fairness as miners must put in equal effort to earn rewards.

• Proof of Stake (PoS): In PoS, Validators stake cryptocurrency as collateral. They are chosen to validate blocks randomly, and if they misbehave, they lose their stake. This system is energy-efficient but can be viewed as less decentralized due to the financial barrier of staking. In a Proof of Stake system, “miners” are known as “validators" because they aren't actually mining blocks, they're validating other nodes.

Blockchains are vulnerable to attacks like Sybil attacks, where users create multiple accounts to manipulate a network. In a 51% attack, if an entity controls the majority of a network, it could theoretically alter transaction history. However, larger and more decentralized blockchains, like Bitcoin and Ethereum, make these attacks extremely difficult due to their consensus protocols.

PoS is becoming more popular due to its energy efficiency and environmental benefits. However, it raises concerns since it is seen as less decentralized due to upfront staking costs.

By using decentralized networks and robust consensus mechanisms, blockchain technology ensures security, transparency, and resilience.

Conclusion

So, we’ve taken a dive into Web3, blockchain, and smart contracts together, unraveling these intriguing concepts and seeing how they’re reshaping our digital world. From Bitcoin's foundational blockchain to Ethereum’s game-changing smart contracts, we’ve covered a lot of ground.

While there are still hurdles to overcome, the potential for Web3 to shake up various industries is truly exciting. Think decentralized finance and transparent supply chains, these innovations are setting the stage for a more open and efficient digital future.

Now that you’ve got a good grasp of these fundamentals, you’re ready to dive deeper into the Web3 ecosystem. Keep an eye out for future articles where we’ll work together to Secure the Chain and make Web3 a better space. My goal is to make this technology accessible and understandable, whether you’re interested in Web3 Development, Web3 Security, investing, or just getting a better sense of how it all works. And on that note, I hope this article gives you a strong starting point as you explore the possibilities of this fascinating field. Thank you for supporting my work.

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