As a leading provider of business accounts and payment solutions for digital assets, we constantly find ourselves in discussions with institutions on the characteristics of blockchain, cryptocurrencies, and digital assets. One of the features often highlighted in blockchains is their trustless nature. However, what is understood as ‘trustless’ and what distributed systems offer aren’t always the same.
In this article, we will consider a variety of questions and essential concepts that contribute to distributing trust in blockchains.
Trustless in Crypto
Before looking at how trustlessness is established, we first need to answer, “what does trustless even mean?”.
‘Trustless’ refers to a quality of a decentralised blockchain, whereby in using the network there is no need to rely on trust in a third party. A trustless system has a mechanism in place where all participants can reach a consensus on a single truth without any one overarching authority and without needing to know or trust each other, hence the name.
Unlike traditional networks operated by centralised financial institutions such as SWIFT, Bitcoin was created as a system where anyone with a computer and an internet connection can participate in validating transactions. Since all transactions are stored on a public ledger, anyone can view their full history. Instead of trusting one central institution, trust is placed into code and carefully designed economic incentives. While ‘trustless’ might suggest blockchains don’t require any trust, this isn’t the case. Trust is distributed, and the need for it is minimised but not eliminated. How this plays out is best illustrated with a few examples.
How is Trust Distributed Across the Blockchain for Different Currencies?
As mentioned above, trust is distributed among network participants in blockchains, the underlying technology of crypto. Depending on the network, that can be tens or even thousands of different parties.
A critical distinction for how a network distributes trust is its consensus algorithm, which defines how network participants determine the single source of truth. The most prominent algorithms are Proof-of-Work (PoW) andProof-of-Stake(PoS). The debate around them has recently reached mainstream media again as the crypto industry witnessed one of the biggest blockchain upgrades, Ethereum’s Merge, which marked its transition from Proof-of-Work to Proof-of-Stake.
The major difference between these two algorithms are the inputs they require to validate transactions.
Proof-of-Work
PoW chains require computing power, therefore electricity, to secure the network, and validate new transactions. Fittingly, the entities in PoW chains that validate transactions and add blocks to the chain are called miners. They “mine” for new coins by trying to find a certain number faster than other miners, a number which can only be found through trial and error. The one who first finds the correct number receives the network’s native token as a reward, but only if a majority of other miners corroborate that the number found is correct. This mechanism ensures that rewards can only be earned through honest behaviour.
The only way to attack and compromise a PoW chain is by gaining over 50% of the overall computing power, an endeavour that is prohibitively expensive for sufficiently powerful PoW chains like bitcoin.
Proof-of-Stake
Unlike PoW systems, PoS relies on network participants locking up assets in the network to start validating. This assumes that once people have something at “stake”, they will be interested in keeping the system running. In PoS networks, block producers are called validators and are typically chosen randomly from a pool of validators, their probability of being selected being weighted by the amount of assets they have at stake. Depending on the chain, there might be a fixed number of validators for the entire blockchain. Anyone can start becoming a validator as long as they lock up enough of the protocol-native token. For validating transactions, validators are rewarded with the protocol-native currency. If they behave maliciously, their stake is slashed, disincentivising bad behaviour.
PoS is significantly more energy-efficient as it doesn’t incentivise the accumulation of computing power. The threshold to attack the integrity of a PoS blockchain varies however is usually in the region of 33% of the stake. Once a single actor controls that amount of stake, they can damage the system. Recently released blockchains and alternative Layer-1s nearly all rely on PoS for its energy-efficient properties, allowing chains to scale faster without the cost of bootstrapping security through expensive hardware.
All of this becomes more feasible when looking at how trust is actually distributed in existing leading currencies.
Bitcoin
Bitcoin(BTC) was the first successful cryptocurrency and pioneer for PoW. Miners worldwide ensure that transactions are validated and follow the protocol’s rules. The current reward for mining a block is 6.25 BTC. Trust is placed in the miners operating sufficiently independently from each other so that no one entity has control over a majority of mining power.
Ethereum
Ethereum(ETH) recently transitioned from PoW to PoS in a bid to further scale the network and make it more energy-efficient. Consensus is determined by stakers that have deposited at least 32 ETH into the staking contract. They earn annualised returns of 4-6% for providing security to the network.
Tether/USDT
Tether USDT is an (in)famous stablecoin with the leading marketcap among its kind. It was launched in 2014 initially on a Bitcoin sidechain called Omni. It seeks to maintain a 1:1 peg with the US dollar at all times, which Tether supports by offering 1:1 redeemability between the USDT token and real US Dollars. Since its inception, USDT has added support for a wide variety of blockchains, natively running on all major chains from Ethereum to Tron. It’s worth noting that even though the stablecoin is available on many chains, it doesn’t mean it is truly trustless. Tether is the company behind its issuance and while they claim to honour 1:1 redemptions for US Dollars, at times serious doubt has been put on their ability to do so. As issuer of the token, they control the smart contract, which means that they could, if they wanted to (or were legally obliged to), block anyone from transacting with their coins.
USDC
USDC is the 2nd largest stablecoin by marketcap and was born out of a joint venture between the cryptocurrency exchange Coinbase and the fintech payments company Circle. It launched on a limited basis in September 2018 and has since climbed up to be one of the most used stablecoins in the space. A major accounting firm audits its reserves, and regular reports provide market-leading transparency. USDC is available on a variety of blockchains, including Ethereum and Polygon. Yet, just as with any other centralised stablecoin issuer, it’s not genuinely trustless as they have the power to block addresses – and have exercised it to comply with regulation.
While all these currencies handle trustlessness differently, it’s worth covering what concepts enable blockchains to be trustless in the first place.
How Can a Blockchain be Trustless?
There are broadly three components that give blockchains their trustless nature.
Public-Key Cryptography
Public-key cryptography is a fundamental principle of all crypto and ensures the authenticity of the sender of a transaction. It’s also referred to as asymmetric cryptography and relies on a public and private key keypair.
The public key is visible to anyone, whereas the private key is visible only to the owner. Whenever sending a transaction, the sender uses their private key to generate a digital signature. The recipient can then verify that the transaction really came from the right user. When sending and receiving crypto, users will share their wallet addresses (public keys) with others, but only the owner with the private key is able to use the coins inside that wallet.
The biggest benefit of public-key cryptography is that it provides digital signatures that cannot be repudiated. One potential downside is that the responsibility for keeping ones private keys lies heavily with the user. If the private key is lost, there is no way to restore access.
While cryptography ensures the authenticity of senders, it doesn’t yet preventdouble-spending.
Machine Consensus and Crypto-Economic Protocols
Blockchains rely on mathematics, economics and game theory to incentivise participants to reach consensus and behave honestly.
Sometimes, machines reaching consensus alone isn’t sufficient to maintain a blockchain. A vast majority of blockchains undergo updates to adapt to changes in the broader environment or to follow a roadmap to enhance decentralisation and scalability. Whenever such changes need to happen, they rely on social consensus and governance.
Social Consensus and Governance
Ultimately, blockchain networks still rely on humans to run them. Not everything can and should be decided upon purely through machine consensus. A vast majority of blockchains are open-source. Therefore, anyone can propose changes and updates, often just by posting on GitHub.
Major improvement proposals are voted upon by the underlying community managing a blockchain, and if a majority favours it, the blockchain will be amended. Depending on the upgrade, the blockchain might undergo a Hard Fork or a backward-compatible Soft Fork. While the recent Ethereum Merge was mostly supported, previous forks haven’t been as agreeable. One example was the creation of Bitcoin Cash from the dominant Bitcoin chain, which split the community.
Nevertheless, that’s part of the beauty of open-source code and blockchain, enabling individuals to participate in consensus and decide upon the fate of a network they use.
Trusted Custody
We believe that robust, regulated, and sophisticated custody providers that have a deep understanding of crypto will be the backbone of our industry.
Pleaseget in touch with our teamto learn how BCB Group can support your business.
BCB Group comprises BCB Prime Services Ltd (UK), BCB Payments Ltd (UK), BCB Digital Ltd (UK) and BCB Prime Services (Switzerland) LLC. BCB Payments Ltd is regulated by the Financial Conduct Authority, no. 807377, under the Payment Services Regulations 2017 as an Authorised Payment Institution. BCB Prime Services (Switzerland) LLC, a company incorporated under the laws of the Swiss Confederation in the canton of Neuchâtel with business identification number CHE-415.135.958, is an SRO member of VQF, an officially recognized self-regulatory organization (SRO) according to the Swiss Anti-Money Laundering Act. This update: 14 Oct 2020.
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