- Blockchain is a decentralized, digital database that stores transactions and other forms of data.
- Key blockchain features include immutable records, distributed ledger security, and smart contracts.
- Blockchain has many other uses outside of cryptocurrencies.
It's almost impossible to say "cryptocurrency" without mentioning blockchain. Decentralized digital assets like cryptocurrencies and stablecoins are created and traded using blockchain technology.
All the best cryptocurrency exchanges provide investors access to blockchains like Bitcoin and Ethereum. The blockchain is distributed across a network of computers called nodes to ensure transparency and secure trading.
Here's how blockchains work, with a closer look at their pros, cons, and potential applications.
Introduction to blockchain
A blockchain securely stores data segments through a self-managing, peer-to-peer (P2P) network of computers. Blockchain technology relies on a distributed ledger that records all past, present, and future data. Without blockchains, there wouldn't be cryptocurrencies.
"A blockchain is commonly used to build a distributed ledger," says Lorien Gabel, cofounder and CEO of Figment.io. Ledgers, he added, track accounting transactions and accounts — we can think of it as a database that stores information. "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."
How blockchains works
Unlike traditional databases that use a third party or intermediary, a blockchain is completely decentralized.
Blocks and chains
A blockchain is a digital database that chronologically stores "blocks" of data. These blocks are linked together on what's known as the "chain."
"Blockchains are made of, well, blocks," explains Gabel. "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."
As for the blockchain process, here's how it works: Whenever a new transaction takes place (e.g., a bitcoin or ether buy order), that data is sent to a network of computers (nodes) that solve math equations to validate the transaction.
If the transaction is rejected, it won't appear on the blockchain. But if it's confirmed, the nodes will add the data as a new block on the ledger, chaining it to the prior blocks (and the ones that follow) to maintain the chain's security. Once this step is done, the transaction is complete.
Consensus mechanism of nodes
Nodes are strong computers connected to a blockchain network to process, maintain, and verify crypto transactions. Nodes rely on consensus algorithms and must be connected to an open-source operating system.
Types of blockchain nodes include mining nodes, full blockchain nodes, master nodes, and light nodes. For example, the Bitcoin blockchain uses light nodes to save storage space that only downloads key data.
Decentralized network
A decentralized network means no third parties can monitor or interfere with transactions. The blockchain system is self-regulating, thanks to a P2P computer network of nodes that verify all new data and distribute cross-network copies of the blockchain to keep it secure.
Key features of blockchain
Blockchain-secured transactions offer many perks, including efficiency, security, and lack of intermediaries. This makes blockchains ideal for those looking to safely store a range of data.
However, since blockchains have no centralized party to govern the database, you can't recover any assets if you lose your private key. This is important to remember if you want to take advantage of blockchain-powered transactions.
Transparency through smart-contracts
Smart contracts make the blockchain publicly accessible and promote investor accountability. Crypto traders typically trade on the blockchain using pseudonyms. While you may not know the real-life person behind the screen, all their trading information is readily available to ensure full transparency and security.
"[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. This allows them to execute once the terms are met.
Immutability
Each transaction that the nodes add to the blockchain is permanent. Once the computer network verifies the data and adds it as a new block, that record is permanent. And this serves much more important purposes beyond simply keeping the system running.
"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," explains Gabel.
In order to change the data on the ledger and have the modified chain become the majority chain, someone would have to alter both the duplicate of the ledger while adjusting at least 51% of other users' copies of the database. Therefore, the immutable records component makes it extremely difficult to hack the system.
Security
Blockchain technology utilizes a P2P network of computers to process and store transactions in a digital database securely. Unlike traditional databases that rely on central authorities, blockchain completely removes the need for intermediaries.
Features like immutable records and smart contracts work to keep all data secure.
Applications of blockchain
Overall, blockchain technology has many uses in the crypto world and beyond, but it's important to understand how it works before using it.
"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
This is perhaps one of the most well-known uses of blockchain technology. The blockchain stores data for all cryptocurrency exchanges. All crypto transactions are recorded and publically available to anyone through the blockchain.
By building your blockchain, you can design your own cryptocurrency for others to trade. You can choose its purpose, tokenomics, functionality, and legality.
Direct transactions
Transactions are completed directly between merchants and consumers, eliminating the need for bank loans or money borrowing. Some prominent examples of P2P networks include file-sharing sites (sites that allow users to share and download content), media streaming sites (such as YouTube, which allows users to upload content for viewers to access), and crypto trading platforms.
Healthcare
Blockchain has several possible applications within the medical industry. It can secure medical records, healthcare data, and other related electronic records. However, security and privacy concerns need to be addressed before blockchain technology can be used in the healthcare system.
Voting systems
Though not currently in effect, the idea of using blockchain to improve the voting process has become a topic of discussion. Arguments in favor urge that it could prevent voter fraud and offer a simpler way of counting votes. Those against it insist that such a system could pose national security concerns.
Other applications
Other uses for blockchains are:
- Banking and finance: Blockchain has many uses for money transfers, especially for fiat currencies (e.g., USD, EUR, or JPY) that individuals typically exchange through financial institutions like banks or payment services.
- Records of property: This technology can validate property transactions between two parties, whether it be property deeds or other assets.
Types of blockchain
Here are the different types of blockchains:
Public blockchains
Public blockchains are open and accessible to anyone, encouraging widespread participation in creating, verifying, and auditing crypto, NFTs, and similar transactions. This decentralized approach enhances security by making it more difficult for malicious participants to exploit the network. With a large number of participants, fraudulent or suspicious activity is less likely to go unnoticed.
However, blockchains' public nature makes them vulnerable to attacks from hackers and scammers. Additionally, privacy can be a concern, as all transactions are publicly visible. Although blockchain participants operate under pseudostems, individuals' real identities could be potentially uncovered.
Private blockchains
Private blockchains are invitation-only. Unlike public blockchains, which allow participants to operate under pseudonyms, private blockchains generally require some degree of identity verification. They aren't decentralized but instead a distributed ledger that focuses on efficiency and stability.
Only certain users can participate in blockchain activities like running a full node or validating a transaction. Private ones are more limited than public blockchains and are generally used to run tasks for businesses and other organizations.
FAQs about blockchain
Is blockchain the same as bitcoin?
No, blockchain is not the same as bitcoin. Bitcoin is the first and most popular cryptocurrency with its own blockchain network. Blockchain is the underlying technology that makes secure transactions possible for bitcoin and other altcoins trades.
Is blockchain secure?
The blockchain is secure because it uses cryptography, smart contracts, and public records. Essentially, a blockchain uses the concept of safety in numbers to ensure transparency and authenticity. Public blockchains may still be vulnerable to hackers and scammers who take advantage of the free-to-use network.
What are the limitations of blockchain?
The limitations of Blockchain include scalability, energy consumption, and regulatory concerns. Due to the large number of users and transactions, blockchain networks are typically slow, with transaction verifications being fairly time-consuming. Moreover, a lot of energy is needed to run blockchain networks, leading to concerns about the environmental impact of blockchain technology.
