Blockchain technology is a fundamental concept in the digital world, acting as a decentralized digital database that secures and stores various types of data, including transactions. Its core attributes—immutable records, distributed ledger security, and smart contracts—make it a versatile tool extending far beyond its most recognized application: cryptocurrencies.
Cryptocurrencies, stablecoins, and other decentralized digital assets rely on blockchain technology for their creation and trading. Exchanges such as Bitcoin and Ethereum provide investors with access to blockchains. The transparency and secure trading facilitated by blockchain are enabled by its distributed nature across a network of computers, known as nodes.
This article will explore the inner workings of blockchains, examining their advantages, disadvantages, and potential real-world applications.
Introduction to Blockchain
At its core, a blockchain securely stores data through a peer-to-peer (P2P) network of computers. It adopts a distributed ledger to record all historical, current, and future data. Without blockchain technology, cryptocurrencies, as we know them, wouldn’t exist.
“A blockchain is commonly used to build a distributed ledger,” explains Lorien Gabel, cofounder and CEO of Figment.io. “Distributed ledgers don’t have to be on a blockchain to be considered ‘distributed’; they just have to be shared with other computers on the network.” These ledgers track accounting transactions and accounts, essentially functioning as a database for information.
How Blockchains Work
Unlike traditional databases that employ a third party, blockchains are fully decentralized.
Blocks and Chains
A blockchain is a digital database that stores “blocks” of data chronologically, these blocks are subsequently linked together on a “chain.” Gabel elaborates, “Blockchains are made of, well, blocks. Each block contains a timestamp, transaction data, and a mathematical function from the previous block. Computers that mine blocks or run validating nodes that sign blocks will include that mathematical function — called a cryptographic hash — from the previous block into the current block to form a chain.”
Here’s a breakdown of the blockchain process:
- Transaction Initiation: When a transaction occurs (like purchasing Bitcoin or Ether), data is sent to a network of nodes.
- Transaction Validation: Nodes solve complex mathematical equations to validate the transaction. Rejected transactions won’t be added.
- Block Creation: Confirmed transactions have their data added as a new block to the ledger.
- Chaining and Completion: The new block is chained to prior blocks, securing the integrity of the data. This completes the transaction.
Consensus Mechanism of Nodes
Nodes, essentially powerful computers connected to a blockchain, are critical for processing, maintaining, and verifying cryptocurrency transactions. They operate using consensus algorithms and must be connected to open-source operating systems. Various types of blockchain nodes exist, including mining nodes, full blockchain nodes, master nodes, and light nodes. Bitcoin’s blockchain, for instance, utilizes light nodes to save storage space.
Decentralized Network
A decentralized network operates without the control of third parties; no entity can monitor or disrupt transactions. The system is self-regulating due to a peer-to-peer network of nodes that verify data and secure the network by distributing blockchain copies.
Key Features of Blockchain
Blockchain-secured transactions provide numerous advantages, including efficiency, high security, and the elimination of intermediaries. This structure proves ideal for anyone looking to safely store different types of data. However, a key thing to consider: because blockchains don’t possess a central governing party, assets are unrecoverable should you lose your private key. This is a critical point to remember when engaging in blockchain-based transactions.
Transparency through Smart Contracts
Smart contracts, which are publicly available, promote investor accountability. Traders will use pseudonyms when using the blockchain, but all trading data is readily available to those that are interested in seeing the results.
“[A smart contract] is a self-executing contract with the terms of the agreement directly written into lines of code on the blockchain,” Gabel explains. They execute automatically once their conditions are satisfied.
Immutability
Once the computer network verifies and adds a transaction to the blockchain, that record becomes permanent. Gabel explains, “Transactions are irreversible, permanently recorded, and available for everyone. It’s challenging and complicated for any one actor to change or falsify data recorded on a ledger.” Altering data on the ledger necessitates changing a copy of the ledger and modifying at least 51% of other users’ databases. This immutability makes it exceptionally challenging to hack the system. In essence, it ensures the system cannot be changed after it’s written.
Security
Blockchain technology uses a P2P network of computers to process and store transactions securely within a digital database. This eliminates the need for intermediaries, setting it apart from traditional databases that depend on central authorities. Features like smart contracts and immutable records further enhance data security.
Applications of Blockchain
Blockchain technology’s applications extend beyond the world of cryptocurrencies. “Blockchain technology provides a solution to the challenges of storing, managing, and protecting data,” says Gabel. “It provides a useful and secure way of authenticating information, identities, transactions, and more, creating a secure ledger that can be updated in real time.”
Cryptocurrency
Perhaps the most recognized application. The blockchain serves to store data for all cryptocurrency exchanges to do every transaction on the network. By creating one’s own blockchain, you’re capable of designing your own cryptocurrency for others to trade.
Direct Transactions
Transactions can occur directly between consumers and merchants, eliminating the need for intermediaries. Peer-to-peer (P2P) networks support this, as seen in file-sharing, media streaming (YouTube), and crypto trading platforms.
Healthcare
Blockchain offers potential to manage and protect healthcare data and related electronic records. However, this technology still needs to address pressing security and privacy concerns before adoption can happen.
Voting Systems
Blockchain could potentially improve voting processes by preventing voter fraud and simplifying vote counting, but this is only theoretical at this point. There are concerns about security, including those of national security.
Other Applications
Additional use cases for blockchain technology include:
- Banking and Finance: Blockchain can be adapted for money transfers, especially for transactions of fiat currencies (e.g., USD) through financial institutions.
- Records of Property: It can validate property transactions, whether related to property deeds or other assets.
Types of Blockchain
Public Blockchains
Public blockchains are open and accessible to everyone. Decentralization bolsters security by hindering malicious behavior thanks to broad participation. Despite this, hackers and scammers can still attack these kinds of blockchains, and privacy can be a concern.
Private Blockchains
Private blockchains are invitation-only, generally requiring identity verification. They are distributed ledgers that focus on efficiency and stability, not decentralization. Access to performing blockchain functions is limited to certain verified users.
FAQs about Blockchain
Is blockchain the same as bitcoin?
No. Bitcoin is the first cryptocurrency with its own blockchain network. Blockchain is the underlying technology that enables bitcoin and other altcoins trades.
Is blockchain secure?
Yes, because of cryptography, smart contracts, and public records. Public blockchains may still be vulnerable to hackers and scammers.
What are the limitations of blockchain?
The limitations include scalability, energy consumption, and regulatory concerns. Blockchain networks can be slow, and they require a great deal of energy.
