What Is Blockchain & How Does It Work?
What Is a Blockchain?
A blockchain is a distributed database that stores information, like transactions, electronically through ‘blocks’. These blocks are strung together through the use of cryptography. Anyone is able to view the information in these blocks. As an example, on the Bitcoin blockchain, anyone is able to see every Bitcoin transaction that has taken place.
A blockchain is unique, because it doesn’t require an intermediary, or ‘middle man’, to allow transactions to take place. It is a decentralized system that lets people transfer value between each other, without any other party being involved.
Blockchains are best known for their role in cryptocurrency. You may have noticed that we say “a blockchain” or “blockchains”, instead of just “blockchain”. That’s because there is no one, singular blockchain. There are instead different blockchain networks, such as the Bitcoin blockchain.
Blockchains unofficially get their name because of the way that data is structured within their databases. Instead of structuring their data into a table, like a typical database, they are structured into blocks. Each block is then linked to other blocks.
What happens is this; A single block is created, and data is fed into it. Once that block becomes full, and no more data can be added to it, a new block is created, and it becomes linked to the previous block. This process is then repeated again and again, creating a blockchain.
On decentralized blockchains, data is immutable. This means that once data is added to a block, it cannot be reversed. This allows all data on a blockchain to be viewed by anyone, permanently.
How Does a Blockchain Work?
Like we said before, a blockchain is a string of blocks which are linked to each other. For the sake of illustration, think of it like one of those paper chains that you used to make as a kid, to decorate your house or schoolroom. However, in this example, every paper link in that chain contains information, like transactions.
The most recent paper link that you added to your chain, is today’s blockchain data, the one before that contained yesterday’s data. This keeps going until you go back to the first paper link you created, which contains the first ever blockchain transactions.
You’ll then have seen every transaction to ever take place on your paper chain blockchain. Now, if anyone tries to manipulate one of your paper links, then it will break, and the whole chain will be aware that something bad just happened (the chain broke!).
This explains how a blockchain works, however, we haven’t covered how it gets built or maintained. Let’s dig into this!
You may have heard of the term “ledger” before. Ledgers are used to record information of sorts. In real estate, they are used to keep track of alterations made to a house, or previous sales of the property.
In bookkeeping, they are used to store transactions that a company handles. These traditional, offline ledgers can easily be manipulated and edited, without anyone being present to see it happen. This presents a security/transparency issue. This means that you can’t guarantee the validity of the information.
However, in a blockchain (a public one), transactions are sealed cryptographically. This prevents anyone from editing/tampering with the information in any block on the blockchain. The transactions are verified by a distributed consensus mechanism.
These consensus mechanisms are also how additional blocks get added to the blockchain. The process of adding new blocks to a blockchain is called mining.
Not all blockchains use mining, however, Bitcoin does. Here is what happens. When you want to sell your Bitcoin, you pay a fee so that nodes can check if your transaction is legitimate.
These nodes then solve mathematical problems in order to validate your transaction. When they’re successful, they create a 64-digit hash. Your transaction is then added to the blockchain and the miner receives your fee as compensation for their work.
The new transaction goes into a block, this new block receives a unique key and the more blocks which get added to a blockchain, the harder the blockchain becomes to manipulate.
Also read: What is an IDO?
How are Blockchains Used?
By far the most common use of a blockchain is cryptocurrency. People buy, trade, sell, exchange their crypto coins all the time, and those transactions are stored on a blockchain.
Users can transfer crypto assets via a blockchain quickly and without the need for an intermediary party.
However, blockchain and cryptocurrency are not the same, and blockchain has many uses outside of crypto.
Finance
Banks, and financial institutions, can use a blockchain to facilitate transactions in fiat currencies, like GBP, US Dollar or the Euro. Most banks only operate during normal working hours. This means that transactions cannot be processed on weekends, early mornings, late evenings, or bank holidays.
By utilizing blockchain technology, customer transactions can be processed within minutes, regardless of what time of day it is. Blockchain technology is 24/7.
Healthcare
Blockchain technology could be used as a substitute to store patient records. When a record is signed, it can be easily written into a blockchain. In the interest of patient confidentiality, a private key could be used, which will only allow certain individuals access to see those records.
Real Estate
A lot of manual, slow work is involved in signing a property deed. A deed has to be manually delivered to a government employee, which is then manually entered into the central country database.
Not only is this process tedious, but because of its manual nature, it is also open to human-error. These errors make it very difficult to track property ownership.
On top of this, countries that are war-torn have little infrastructure, meaning that it is almost impossible to store records of property ownership.
With blockchain technology, this information can be stored on the blockchain and property owners can have peace of mind that their deed is securely and permanently stored.
Smart Contracts
Smart contracts are digital contracts which are built into a blockchain. People involved in a smart contract will agree to certain conditions being met. Once these conditions are met, the contract processes itself automatically.
For example, a smart contract might be created in order to sell a car. The buyer will agree to pay for the car, and this payment will be held on to by the smart contract. The payment will be automatically released, once the buyer has received what they need from the seller (like the keys).
This has a benefit over traditional contracts, because no notary is needed, and therefore no fees are needed to pay the notary.
Food Supply Chains
The food industry has to deal with outbreaks of bacteria being introduced to their food supply. If all transactions involved in processing/transportation of these food goods were on the blockchain, then it would take food companies much less time to identify the source of these outbreaks.
When food is found to be contaminated, it can be easily traced back to its origin. Uses of blockchain in food supply are already being proposed and acted upon.
Also read: What is DeFi?
Types of Blockchain?
Public
Public blockchains are open networks which are accessible to everyone. They use the proof-of-work and proof-of-stake consensus mechanisms. Two examples of public blockchains are Bitcoin and Ethereum.
Private
Private blockchains sound like an oxymoron. These are centralized blockchains which are ruled by a single authority. In order to join these blockchains you need permission from the system admin.
Hybrid Blockchains
Hybrid blockchains, or consortiums, are a mix between private and public blockchains.
Sidechains
Sidechain blockchains are when 2 blockchains are run side by side. It allows users to transfer digital assets between 2 different blockchains. This is supposed to help with scalability and processing efficiency.
Benefits of Blockchain
Decentralized
There is no centralized database on which a blockchain is stored. Instead, blockchain data is copied and spread out over a number of computers (nodes).
Each time that a new block is created, the information is sent out to every computer in the network. By spreading this information out to various locations, there is no central database which can be hacked or manipulated.
Private
Blockchain networks offer transparency of transactions, however, this information is not tied to anyone’s personal details. Although anyone can view any transaction on the network, it is not possible to identify the person making the transaction.
When a user makes a transaction, their public key is recorded, not their name or address.
Transparent
Like we just mentioned, blockchain networks are transparent. Anyone who wishes to is able to view the code of a blockchain. Auditors are thus able to review cryptocurrencies like Bitcoin for security and they can even suggest upgrades to it. Quite often, if enough people agree that a recommended upgrade would be better for them / the cryptocurrency, it will be enacted.
Banking the Unbanked
Arguably one of the best features of blockchain technology is that absolutely anyone has access to it. Regardless of your ethnicity, race, age, gender or anything else, blockchain tech is open to you.
Plenty of people in developing countries lack access to a bank account, or they are paid in small quantities of cash. Blockchain can help the unbanked. It is much safer for these people to store their wallet key in their home, than bundles of cash.
Lower Cost
In traditional finance, third parties are paid fees to process transaction. However, with blockchain technology, you have no intermediaries to pay, and you are charged lower fees.
Drawbacks of Blockchain
Illegal Activity
Confidentiality on blockchains is both a benefit and a drawback. It can be classed as a disadvantage when you consider that it facilitates illegal activity. Personal information is not passed through blockchain networks, therefore, it’s very difficult to track who is making which transactions.
The Silk Road is one example of blockchain technology being used for illegal activity. The Silk Road was an online dark web marketplace for drugs and money laundering.
Users could buy and sell drugs without being tracked.
Environmental Impact
Blockchain networks use a huge amount of electricity in the process of mining. It’s estimated that Bitcoin miners use the same amount of power as Norway and Ukraine.
Then again, Bitcoin is supposed to be an alternative to the traditional finance system and traditional banking systems are expected to use double the electricity that Bitcoin does.
Also read: what is Bitcoin?
Speed Inefficiencies
Blockchains are trying to keep up with growing global demand. However, these growing pains lead to inefficiencies in processing transactions. Bitcoin and Ethereum are therefore unable to process anywhere near as many transactions as a company like VISA.
Who Invented the Blockchain?
Blockchain technology was first conceptualized by Stuart Haber and W. Scott Stornetta in 1991. They were mathematicians who wanted to create a system where document timestamps couldn’t be manipulated.
However, it was Satoshi Nakamoto who implemented the world’s 1st blockchain network after launching Bitcoin.
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