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January 26, 2025

How is a Cryptocurrency Transaction Verified on a Blockchain Network and How Can Economic Experts Help with Investor Disputes?

Table of Contents

Transaction Verification Blockchain

The transfer of digital assets, specifically cryptocurrency coins and tokens, among buyers and within a blockchain network in which the execution of transfers between those sending and receiving cryptocurrency are authenticated by the network itself.Ā  These transfers are what are referred to as ā€œon-chainā€ transactions because the transfer takes place on a blockchain, as opposed to ā€œoff-chainā€ transactions which can occur, for example, on a cryptocurrency exchange where the trade execution is managed internally by the exchange.

This blog reviews concepts related to on-chain transactions that require blockchain verification procedures and how economics experts can help cryptocurrency investors better understand how these issues affect the market values of their cryptocurrency holdings and investment gains and losses.

A blockchain network is organized in such a way that no single individual is required to oversee transactions. Ā Instead, an important feature of a blockchain network is that the authenticity ā€“ execution and confirmation ā€“ of transactions is based on mutual concurrence among network participants.Ā  This consensus-based approach to transaction validation is an important feature of blockchain transactions.Ā  It has helped advance numerous new commercial activities built on blockchain technology such as Decentralized Finance, cryptocurrency exchanges, and the organization of the cryptocurrency market itself.

Key Takeaways

  • Cryptocurrency transactions rely on decentralized verification through nodes, ensuring security with public keys and digital signatures before being added to the blockchain.
  • Miners and validators play a crucial role in confirming transactions via consensus mechanisms like Proof-of-Work (PoW) and Proof-of-Stake (PoS), preventing fraud such as double-spending.
  • Disputes can arise from fraudulent transactions, network forks, and transaction censorship, highlighting the importance of understanding verification processes for legal assessments and damage evaluations.
  • These issues affect the economic value of a blockchain network, including the digital assets ā€“ coins and tokens ā€“ whose market values depend on the integrity and performance of the network.Ā  Deficiencies on these issues can give rise to disputes that translated to economic losses, and possibly damages, for cryptocurrency traders and investors.

Overview of the Verification Process

Miners or validators play a crucial role in confirming transactions through consensus mechanisms like Proof-of-Work (PoW) or Proof-of-Stake (PoS). These mechanisms not only validate transactions but also prevent fraudulent activities, such as double-spending.

Once validated, transactions are grouped into blocks, which are then added to the blockchain, creating a permanent and tamper-resistant record.Ā  A summary of the key steps in this process is presented here.

Transaction Broadcast

The transaction broadcast is the first step in cryptocurrency verification. Upon initiation, the transaction is sent to multiple nodes that participate in maintaining the blockchain. These nodes check the transactionā€™s validity, ensuring the sender has sufficient funds and authenticating the digital signature.

Broadcasting is an important step in the transaction validation and integrity of the public ledger as it allows verification by multiple independent miners or validators. The completion of this step establishes transparency and distributes the transaction across the decentralized network for processing, making it a crucial part of the permissionless feature of blockchain verification.

Mining or Validation

Mining or validation confirms cryptocurrency transactions and adds them to the blockchain. In Proof-of-Work (PoW) systems, miners solve complex cryptographic problems to validate transactions and create new blocks, requiring significant computational power..Ā  The computational resources act as a barrier to any actor attempting to undo or alter transactions that have already been added to the blockchain ledger.Ā  Fraudulent activities to change the blockchain ledger are thus deterred by both a costly tampering barrier and the consensus mechanism that allows miners to easily detect and reject erroneous blocks.

In Proof-of-Stake (PoS) systems, validators are chosen based on the amount of cryptocurrency they hold and are willing to ā€œstakeā€ as collateral when proposing a new block of transactions to the blockchain. Ā In contrast to expending computational resources to deter tampering as in PoW, potential bad actors are deterred by PoW by the significant financial staking resources they would have to expend to undo or alter a block.

Both PoW and PoS mechanisms also prevent double-spending and ensure transaction legitimacy. Miners or validators are incentivized with rewards, such as newly created cryptocurrency or transaction fees, which, as an in-kind reward or reward tied to the performance of the network, helps to create a self-interested motive .

Adding Transactions to the Blockchain

Once validated, transactions where, as discussed above, each block includes the cryptographic solution or hash that prevents it from being altered. This block is thus added to the blockchain via the Pow or PoS consensus mechanisms, ensuring network-wide agreement. Each block links to the previous one (via the hash value), creating a chronological and immutable chain of transactions.

This process reinforces tamper resistance, since altering any existing block in the chain would require altering all subsequent blocks on the ledge given they are cryptographically linked via unique hashes.Ā  In other words, altering the ledger at any block entails not only expending resources in terms of PoW or PoS to recreate the targeted block, but a cumulative sum of such resources since downstream blocks would also need to be modified to deceive the market.

Potential Disputes in the Verification Process

Verification processes are not infallible and have strengths and weaknesses.. Fraudulent transactions, such as attempts at double-spending, can challenge the integrity of the verification process. Network forks, whether hard or soft, may lead to disagreements about which blockchain version holds valid transactions.Ā  While blockchain verification processes are designed to prevent these outcomes, disputes can still arise.

As discussed below, transaction censorship or delays by miners or validators can also impact usersā€™ ability to complete time-sensitive operations, leading to legal conflicts. These potential issues highlight the importance of understanding the transaction fee verification process when evaluating liability and damages in cryptocurrency-related cases.

Fraudulent Transactions and Double-Spending

Fraudulent transactions occur when someone manipulates the blockchain network to authorize illegitimate transfers. Double-spending, a specific type of fraud, involves spending the same cryptocurrency more than once, undermining system trust. Consensus mechanisms like Proof-of-Work (PoW) and Proof-of-Stake (PoS) are designed to prevent double-spending by requiring network-wide agreement.

Legal disputes may arise when fraud or double-spending leads to financial losses for individuals or businesses. .Ā  Undetected double-spending effectively deflates the value of the cryptocurrency since the number of coins and tokens are artificially overcounted.Ā  The duration of such episodes can depend on how quickly the activity endures, which relates back to the verification process.Ā  For example, PoS may verify blocks more quickly than PoW because of the latterā€™s dependence on computing speed to solve a random puzzle.

Forks and Network Splits

Forks occur when a cryptocurrency network splits into two separate chains, often due to disagreements over protocol changes. Hard forks create permanent divergence with each chain following its own set of rules, while soft forks maintain compatibility with the original chain. Network splits can lead to disputes over which chain contains the ā€œvalidā€ transaction history or ownership of funds.

Legal challenges may arise when forks impact asset value, disrupt transactions, or create ambiguity in contracts. Understanding the economic and technical implications of forks is crucial for evaluating damages and liability in cryptocurrency disputes.Ā  Economists understand the economics of networks, which in the case of a fork, could give rise to price and volume discrepancies that cause uncertainty and undermine the economies-of-scale benefits of the network since it is effectively being split into smaller networks.

Transaction Censorship or Delays

Transaction censorship occurs when miners or validators intentionally exclude specific transactions from being processed on the blockchain. Delays may arise due to network congestion, high transaction fees, or suspicious behavior by network participants. These issues can disrupt business operations, breach contractual obligations, or lead to financial losses, prompting legal disputes.Ā 

Censorship or delays may also raise questions about the neutrality and fairness of the networkā€™s operation. Understanding the causes and consequences of these issues is crucial for assessing liability and damages in crypto-related cases. Ā Economists utilize sophisticated data analysis tools to detect and quantify what is referred to in econometrics as ā€œcensoringā€ and ā€œselectionā€ bias that can help prove liability and measure impact and damages when transaction censorship is suspected.

Economic Insights for Cryptocurrency Transactions

Certainty that transactions will be executed efficiently and successfully is critical to financial markets generally.Ā  A cryptocurrency blockchainā€™s performance and value hinges on the integrity of the trade execution and confirmation process, which requires robust blockchain verification.Ā  Greater transaction integrity can have a reinforcing positive effect on a blockchainā€™s value (or a negative effect if integrity weakens), since superior network performance fuels wider user acceptance and more ubiquitous access within the cryptocurrency marketplace.

Economic analysis can uncover patterns in cryptocurrency transactions, helping identify fraudulent activity or quantify financial losses. Economists assess the impact of transaction fees, delays, or network disruptions on individuals and businesses. Evaluating the economic incentives of miners or validators provides insight into network behavior and potential vulnerabilities.Ā  These factors affect the quality and value of a blockchain network, and in turn the value of digital assets that depend on the networkā€™s performance. Economic analysis provides a tool to assist investors understand how these factors affect the gains and losses on their own digital asset trades and investments.

Investor losses on coins and tokens that may require damages calculations in cryptocurrency disputes often require expertise in valuing lost assets, unrealized gains, or operational disruptions. Economic insights bridge the gap between technical blockchain processes and their real-world financial implications.

Summary

Understanding the transaction verification process in blockchain networks is vital for navigating the increasingly complex world of digital finance. This knowledge is especially crucial for resolving disputes, as it helps in assessing liability, determining damages, and evaluating the validity of evidence. The verification process is designed in principle to ensure the integrity and security of the network.Ā  As discussed above, verification affects not only the technical performance of a blockchain, but the economic tradeoffs to investors and the overall economic value of the blockchain as a financial platform.

The economic implications of transaction verification, such as costs, delays, and network disruptions, can significantly impact the outcomes of legal disputes. By bridging the gap between technical blockchain processes and their real-world financial implications, an economics expert can better navigate blockchain-based evidence.

Frequently Asked Questions

What is the first step in verifying a cryptocurrency transaction?

The first step in verifying a cryptocurrency transaction is to broadcast it to the network, allowing nodes to participate in the validation process. This consensus process ensures that the transaction meets all necessary criteria to establish the authenticity of the transactor and the validity of transaction before being confirmed and added to the blockchain.

How do Proof-of-Work and Proof-of-Stake mechanisms prevent double-spending?

Proof-of-Work and Proof-of-Stake mechanisms prevent double-spending by requiring network-wide consensus for transaction validation, ensuring that each cryptocurrency can only be spent once. Both of Proof-of-Work and Proof-of-Stake require resource commitments by validators that serve as barriers that prevent tampering or altering the blockchain.Ā  This collective agreement among participants strengthens the integrity of the blockchain.Ā  In situations where double-spending may have occurred, economists can help value losses to those who suffered damages from being a victim of double-spend transactions.

What are forks in a blockchain network?

Forks in a blockchain network are the result of a split into two separate chains, typically arising from disagreements regarding protocol changes. This process can affect the functionality and governance of the network.

Why might a transaction be delayed or censored on a blockchain network?

A transaction may be delayed or censored on a blockchain network due to factors like network congestion, high transaction fees, or intentional actions by certain participants. Understanding these issues can help evaluate the economic tradeoffs and costs of transacting on the blockchain, investing in cryptocurrencies and identifying potential liability and/or damages claims..

How can economic analysis help in cryptocurrency disputes?

Economic analysis can effectively uncover fraudulent activities, quantify financial losses, and evaluate the effects of transaction fees or network disruptions in cryptocurrency disputes. Economic experts possess the right skills and tools to analyze the incentives of blockchain participants, the performance of blockchain networks, and assist investors understand how these factors affect the gains and losses on their own digital asset trades and investments Economics provides a clear framework to address and resolve disputes effectively and efficiently.

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