Learn about blockchain technology and how it works as a distributed ledger system for storing and recording data securely and transparently.
What Is Blockchain Technology and How Does It Work?
A blockchain is a distributed ledger that is shared among nodes in a computer network. As a database, it stores information electronically in digital format. Cryptocurrencies, such as Bitcoin, rely on blockchains for maintaining a secure and decentralized record of transactions. The key innovation of a blockchain is that it ensures the fidelity and security of a record of data and generates trust without requiring a trusted third party.
A typical database differs from a blockchain in the way the data is structured. A blockchain groups information together in blocks that hold sets of information. These blocks have limited storage capacities and, when filled, are closed and linked to the previously filled block, creating a chain of data known as the blockchain. Every new piece of information that follows the newly added block is compiled into a new block, which will then be added to the chain once filled.
Databases, on the other hand, typically structure their data into tables, while a blockchain structures its data into chunks (blocks) that are strung together. This data structure inherently creates an irreversible timeline of data when implemented in a decentralized fashion. When a block is filled, it is set in stone and becomes a part of this timeline. Each block in the chain is given an exact timestamp when it is added to the chain.
How Does a Blockchain Work?
Blockchain technology enables the secure recording and dissemination of digital information without the possibility of tampering or revision. This functionality makes blockchain a fundamental pillar of immutable ledgers or logs of transactions that are unchangeable, unerasable, and indelible. Consequently, blockchain is also identified as distributed ledger technology (DLT).
Despite being proposed as a research idea in 1991, blockchain's broad implementation and applicability in the form of Bitcoin did not occur until 2009. Nevertheless, since then, the utilization of blockchain has witnessed a meteoric rise through the emergence of cryptocurrencies, decentralized finance (DeFi) applications, non-fungible tokens (NFTs), and smart contracts.
Blockchain Decentralization
Imagine a corporate entity possessing a server farm comprising ten thousand computers utilized to uphold a database housing all the account information of its clients. The company's ownership of a warehouse building housing all the computers beneath one roof grants full control over each machine, as well as all information contained therein. Nevertheless, this setup gives rise to a single point of failure. If the electricity at that location were to cease, or if its internet connection were severed, or if the building were to be engulfed in flames, or if an adversary erases everything with one stroke of the keyboard, the data would be either lost or corrupted.
Blockchain technology comes in handy by allowing the data held in that database to be distributed across numerous network nodes at different locations. This system not only generates redundancy but also ensures that the fidelity of the data contained therein is maintained. If someone attempts to modify a record at one database instance, the other nodes remain unaltered, thus preventing any nefarious action by an adversary. If a user tampers with the transactional records of Bitcoin, all other nodes cross-reference each other and detect the node carrying erroneous data easily. This system helps in establishing a transparent and accurate chronology of events, ensuring that no individual node within the network can modify any data contained therein.
Due to blockchain technology, information and history (such as cryptocurrency transactions) are irreversible. This record may consist of a list of transactions (as with a cryptocurrency). A blockchain can hold an array of other information, including but not limited to legal contracts, state identifications, or a corporation's product inventory.
Transparency
The decentralized nature of Bitcoin’s blockchain allows for complete transparency of all transactions, which can be accessed by personal nodes or blockchain explorers. Each node maintains its own version of the blockchain, updating it with new blocks as they are confirmed and added. Thus, it is possible to track the movement of Bitcoin with precision.
Take, for example, the unfortunate instances where exchanges were hacked, resulting in loss of all Bitcoin stored on them. Although the hacker may remain anonymous, the Bitcoins they acquire can still be traced to their new location if moved or spent.
It is important to note that the records stored in the Bitcoin blockchain, and most other blockchains, are encrypted. Only the owner of a record has the ability to decrypt it with their public-private key pair to reveal their identity. This allows for the anonymity of users while still preserving transparency.
Is Blockchain Secure?
Blockchain technology attains decentralized security and trusts through various means. Exceptionally, fresh blocks are always linearly and chronologically stored, being appended to the end of the blockchain. Once a block has been added to the end of the blockchain, tampering with its contents becomes a daunting task unless a majority of the network reaches a consensus to do so. This is because each block has its own hash, accompanied by the hash of the previous block, and the previously mentioned timestamp. Hash codes are generated using a mathematical function that transforms digital data into a string of numbers and letters. Any form of data manipulation leads to a corresponding alteration in the hash code.
Assuming that a malicious actor, who is also a node on a blockchain network, aims to modify a blockchain and pilfer cryptocurrency from other participants. If they change their own copy, it will no longer coincide with the rest of the copies. The moment the other participants cross-check their copies against each other, this specific copy becomes conspicuous, and the hacker's version of the chain will be invalidated.
To execute such an attack, the hacker must control and modify 51% or more of the blockchain copies concurrently so that their new version gains the majority status and becomes the accepted chain. Such an act necessitates an enormous amount of funds and resources since all the blocks would have to be reworked to change the timestamps and hash codes.
Due to the size of several cryptocurrency networks and their rate of expansion, the cost of such a deed would probably be insurmountable. Such an act would be excessively expensive and possibly fruitless. The hacker would be detected since network members would notice drastic alterations to the blockchain. Consequently, they would hard fork to a new version of the chain that remains unaffected. This would result in the attacked token's value plummeting, rendering the assault ultimately pointless, as the malevolent actor would have control over a worthless asset. The same situation would arise if the malevolent actor targeted the new Bitcoin fork. This mechanism is deliberately designed to make participation in the network far more economically incentivized than attacking it.
Bitcoin vs. Blockchain
Blockchain technology was first articulated in 1991 by Stuart Haber and W. Scott Stornetta, a pair of scholars who aimed to establish a system that could securely validate document timestamps. However, blockchain's first practical application did not occur until nearly twenty years later, with the advent of Bitcoin in January 2009.
Bitcoin is structured on a blockchain protocol. In a whitepaper introducing virtual currency, the anonymous founder of Bitcoin, known only as Satoshi Nakamoto, described it as "an innovative electronic cash system that is completely decentralized and devoid of any trusted intermediaries."
The essential point to note here is that Bitcoin exclusively employs blockchain as a tool to publicly record a registry of transactions, but blockchain, in theory, could be utilized to immutably preserve any amount of data points. As mentioned earlier, this could include transactions, election votes, product inventories, state identifications, property deeds, and so much more.
Currently, tens of thousands of projects are seeking to incorporate blockchains in various ways to enhance society beyond simply recording transactions. For example, it could be utilized as a secure means of voting in democratic elections. The immutability of blockchain implies that fraudulent voting would become substantially more challenging to carry out. In a voting system, every citizen of a country could be given a single cryptocurrency or token. Each candidate would then be assigned a unique wallet address, and the voters would transfer their token or cryptocurrency to the address of the candidate for whom they desire to vote. The transparency and traceability of blockchain technology would negate the necessity for manual vote counting, as well as the ability of unscrupulous individuals to tamper with physical ballots.
How Blockchain Technology Differs from Traditional Banking Systems
When it comes to the world of finance, blockchain technology has been touted as a game-changer. With its ability to decentralize transactions and remove the need for intermediaries, it's no surprise that many see blockchain as a disruptive force in the industry. However, it's important to note that banks and blockchains are vastly different, and understanding these differences is crucial to fully comprehending the potential impact of blockchain technology.
Decentralization vs. Centralization
Perhaps the most significant difference between banks and blockchains is their approach to decentralization. Traditional banks operate on a centralized model, with all transactions being processed through a central authority, such as a government or regulatory body. In contrast, blockchain technology operates on a decentralized model, meaning that there is no central authority or intermediary involved in the transaction process.
Privacy and Security
Another key difference between banks and blockchains is their approach to privacy and security. Banks have stringent security measures in place, such as encryption and authentication, to protect customer data and prevent fraud. In contrast, blockchain technology offers unparalleled privacy and security by design, thanks to its decentralized and encrypted nature. All transactions are stored on a public ledger, making it virtually impossible to alter or manipulate data without being detected.
Speed and Efficiency
Speed and efficiency are also significant differences between banks and blockchains. Traditional banks can take several days to process transactions, especially when it comes to international transfers. On the other hand, blockchain transactions can be completed in a matter of seconds or minutes, regardless of location. Additionally, because blockchain technology operates on a decentralized model, there is no need for intermediaries to verify transactions, which can significantly reduce transaction costs.
Blockchain vs Banks: A Comprehensive Comparison
In the finance sector, blockchain technology has been viewed as a revolutionary force that has the potential to disrupt traditional banking. However, it's important to note that banks and decentralized blockchains have several differences that set them apart. In this article, we will compare the features of banks to Bitcoin's implementation of blockchain to help readers understand the key differences between the two.
Hours of Operation: Banks vs Bitcoin
Banks are typically open during standard business hours, from 9:00 am to 5:00 pm on weekdays, and some have limited hours on weekends. Additionally, banks are closed on banking holidays. On the other hand, Bitcoin operates 24/7, 365 days a year, with no set hours of operation.
Transaction Fees: Banks vs Bitcoin
Banks charge different fees depending on the type of transaction. Card payments can vary based on the card and are not paid directly by the user. Instead, fees are paid to payment processors by stores and are usually charged per transaction. This can sometimes increase the cost of goods and services. Checks can cost between $1 and $30 depending on the bank. ACH transfers can cost up to $3 when sent to external accounts. Outgoing domestic wire transfers can cost up to $25, while outgoing international wire transfers can cost up to $45.
On the other hand, Bitcoin has variable transaction fees determined by miners and users. The fee can range between $0 and $50, but users have the ability to determine how much they are willing to pay. This creates an open marketplace where if the user sets their fee too low, their transaction may not be processed.
Transaction Speed: Banks vs Bitcoin
Banks generally take longer to process transactions. Card payments can take 24-48 hours, while checks can take up to 72 hours to clear. ACH transfers and wire transfers typically take 24-48 hours and within 24 hours, respectively. However, bank transfers are not usually processed on weekends or bank holidays.
Bitcoin transactions can take as little as 15 minutes and as much as over an hour depending on network congestion.
Know Your Customer Rules: Banks vs Bitcoin
To open a bank account, government-issued identification is required, and banks must perform "Know Your Customer" (KYC) procedures. This means that it is legally required for banks to record a customer's identification prior to opening an account.
In contrast, anyone or anything can participate in Bitcoin's network with no identification. In theory, even an entity equipped with artificial intelligence could participate.
Ease of Transfers: Banks vs Bitcoin
To perform digital transfers via a bank, a government-issued identification, a bank account, and a mobile phone are typically required. In contrast, to transact Bitcoin, an internet connection and a mobile phone are the minimum requirements.
Privacy: Banks vs Bitcoin
Bank account information is stored on the bank's private servers and held by the client. However, the privacy of bank accounts is limited to how secure the bank's servers are and how well the individual user secures their own information. If the bank's servers were to be compromised, the individual's account would be compromised as well.
In contrast, Bitcoin can be as private as the user wishes. All Bitcoin is traceable, but it is impossible to establish who has ownership of Bitcoin if it was purchased anonymously. If Bitcoin is purchased on a KYC exchange, then the Bitcoin is directly tied to the holder of the KYC exchange account.
24/7 Availability: Banks vs Bitcoin
Traditional banking operates on a schedule, with set hours of operation and holidays. However, blockchain technology operates 24/7, 365 days a year. This means that users can access their finances at any time and from anywhere in the world, making it a more convenient option.
Lower Transaction Fees: Banks vs Bitcoin
Transaction fees can be a significant burden for traditional banking users, especially for international transactions. However, with blockchain technology, users have the ability to set their transaction fees, which can be as low as zero. This creates an open marketplace where users can select the fees they are willing to pay, making it a more cost-effective option.
Faster Transaction Speed: Banks vs Bitcoin
Traditional banking transactions can take anywhere from 24 hours to several days to process, depending on the type of transaction and location. However, blockchain transactions can be completed in as little as 15 minutes, making it a faster option.
No KYC Procedures: Banks vs Bitcoin
Traditional banks require "Know Your Customer" (KYC) procedures to verify a customer's identification before opening an account. This can be a time-consuming process and can limit access to banking services for some individuals. On the other hand, blockchain technology does not require KYC procedures, allowing anyone or anything to participate in the network.
Increased Privacy: Banks vs Bitcoin
Privacy is a major concern for many people when it comes to their finances. With traditional banking, personal information is stored on the bank's servers and held by the client, making it vulnerable to hacking and security breaches. On the other hand, blockchain technology can be as private as the user wishes. All transactions are traceable, but it's impossible to establish who owns the Bitcoin if it was purchased anonymously.
Enhanced Security: Banks vs Bitcoin
With traditional banking, the level of security a client has with their account is only as good as the bank's servers that contain client information. However, with blockchain technology, the larger the network grows, the more secure it becomes. Bitcoin holders have complete control over their own security measures, making it a more secure option.
No Government Interference: Banks vs Bitcoin
Governments can easily track people's bank accounts and seize assets within them for various reasons. However, with Bitcoin, it's much harder for governments to track and seize assets, especially if the Bitcoin is purchased anonymously. This provides more freedom and control for the user.
The Advantages and Disadvantages of Blockchain: Is It Worth Investing In?
Blockchain technology has been making waves in various industries, promising secure, transparent, and decentralized record-keeping. Despite its complexity, it offers potential advantages that could revolutionize the way we conduct transactions and handle sensitive information. However, as with any technology, there are also drawbacks to consider.
Pros of Blockchain Technology
- Improved Accuracy and Efficiency
Blockchain technology eliminates the need for human intervention in verifying transactions, reducing the risk of errors and increasing accuracy. Transactions are processed quickly and efficiently, without the need for third-party intermediaries, which can result in cost savings.
- Decentralization for Enhanced Security
Blockchain's decentralized nature makes it less vulnerable to tampering and hacking. By distributing transaction data across a network of nodes, it becomes difficult to corrupt or manipulate the information.
- Transparency and Privacy
Transactions recorded on a blockchain are transparent, meaning that anyone can view them. However, personal information is kept private and secure through the use of cryptographic algorithms. This creates a level of trust between parties, as they can verify each other's identities without revealing sensitive information.
- Alternative Banking System
Blockchain technology provides an alternative to traditional banking, especially in countries with unstable or underdeveloped governments. It can offer a secure way for citizens to store their personal information and transact without the need for intermediaries.
Cons of Blockchain Technology
- High Cost of Mining Bitcoin
Mining Bitcoin, the most popular cryptocurrency, requires significant technology resources, including expensive hardware and energy consumption. This can make it difficult for individuals and smaller organizations to participate in the mining process.
- Low Transactions per Second
Blockchain's decentralized nature can also limit its ability to process a large number of transactions simultaneously. This has been a challenge for some blockchain-based applications that require high-speed transactions.
- History of Illicit Use
The anonymity of blockchain transactions has made it attractive to criminals, resulting in its use in illegal activities, such as on the dark web. This has led to negative perceptions and regulatory scrutiny.
- Uncertain Regulatory Environment
Regulation of blockchain technology varies by jurisdiction, and its legal status is still uncertain in some areas. This has led to uncertainty for companies and investors looking to invest in the technology.
- Data Storage Limitations
Blockchain technology relies on a distributed network of nodes to store and process transactions. This can limit the amount of data that can be stored on the network, which can be a disadvantage for some applications.
Benefits of Blockchain Technology: Revolutionizing Industries
Blockchain technology is rapidly becoming a game changer in various industries. Its decentralization, transparency, and security make it the ideal solution for businesses seeking to improve their processes and reduce costs. In this article, we will discuss the benefits of blockchains and how they are transforming industries.
Accuracy of the Chain
The blockchain network operates with minimal human involvement, resulting in less human error and a more precise record of information. Transactions are approved by thousands of computers on the network, and any error made by one computer would only affect one copy of the blockchain. For that error to spread to the entire network, it would require at least 51% of the network's computers, a near impossibility for large networks like Bitcoin.
Cost Reductions
Blockchain eliminates the need for third-party verification, which results in reduced costs. For example, businesses incur small fees for accepting payments using credit cards because banks and payment-processing companies must process those transactions. In contrast, Bitcoin has no central authority and minimal transaction fees.
Decentralization
Blockchains do not store data in a central location. Instead, they are copied and distributed across a network of computers. Whenever a new block is added to the blockchain, every computer on the network updates its blockchain to reflect the change. By distributing data across a network, rather than storing it in a central database, blockchain becomes more difficult to tamper with. Even if a hacker were to obtain a copy of the blockchain, only a single copy of the information would be compromised, not the entire network.
Efficient Transactions
Blockchain is active 24/7, 365 days a year, allowing transactions to be completed in as little as ten minutes. Transactions on centralized platforms can take days to settle, especially cross-border trades that require parties to confirm payment processing. Blockchain's efficiency is especially useful in such scenarios, given the time zone differences.
Private Transactions
Although blockchain networks like Bitcoin are public, users cannot access identifying information about the users making those transactions. When a user makes a public transaction, their unique code, called a public key, is recorded on the blockchain, while their personal information is not. Even if a person's identity is linked to their blockchain address, the transaction does not reveal any personal information.
Secure Transactions
Once a transaction is recorded on the blockchain, its authenticity is verified by the network's thousands of computers. After a computer validates the transaction, it is added to the blockchain block. Each block contains its unique hash and that of the previous block, making it challenging to alter information on the blockchain without detection.
Transparency
Most blockchains are open-source software, enabling auditors to review cryptocurrencies for security. Anyone can suggest changes or upgrades to the system. If a majority of the network users agree that the new version of the code is sound, then Bitcoin can be updated.
Banking the Unbanked
Blockchain and Bitcoin are revolutionizing the banking sector, enabling anyone to use them regardless of background or nationality. An estimated 1.7 billion adults worldwide lack access to bank accounts or means of storing their wealth. Most of these individuals live in developing countries, where economies are still reliant on cash. By providing an alternative storage system, blockchain technology can significantly reduce the risk of theft or violence that individuals face when storing cash.
FAQ
What Is Blockchain Technology and How Does It Work?
Blockchain technology has revolutionized the way we think about data management and security. In simple terms, a blockchain is a shared digital ledger that contains blocks of data, with each block linked to the previous one through cryptographic algorithms. This creates an unalterable chain of information that is transparent and secure.
But what makes a blockchain so special, and why has it become such a buzzword in recent years?
How Many Blockchains Exist and What Are the Differences Between Them?
As of 2022, there are over 10,000 active cryptocurrencies based on blockchain, with several hundred more non-cryptocurrency blockchains. Blockchains can be categorized as either public or private. Public blockchains, also known as open or permissionless blockchains, allow anyone to join the network and establish a node. These blockchains are secured through cryptography and a consensus system like proof of work (PoW).
In contrast, private or permissioned blockchains require each node to be approved before joining. Because nodes are considered trusted, the layers of security do not need to be as robust.
What Is a Blockchain Platform and How Does It Work?
A blockchain platform allows users and developers to create novel uses on top of an existing blockchain infrastructure. One example is Ethereum, which has a native cryptocurrency known as ether (ETH). But the Ethereum blockchain also allows the creation of smart contracts and programmable tokens used in initial coin offerings (ICOs) and non-fungible tokens (NFTs). These are all built up around the Ethereum infrastructure and secured by nodes on the Ethereum network.
Who Invented Blockchain Technology?
Blockchain technology was first outlined in 1991 by mathematicians Stuart Haber and W. Scott Stornetta, who wanted to implement a system where document timestamps could not be tampered with. In the late 1990s, Nick Szabo proposed using a blockchain to secure a digital payments system, known as bit gold, which was never implemented.
Why Is Blockchain Technology Important?
Blockchain technology has a myriad of practical applications and is finally making a name for itself, in no small part because of bitcoin and cryptocurrency. The use of blockchain technology can make business and government operations more accurate, efficient, secure, and cheap, with fewer middlemen.
Looking Ahead to the Future of Blockchain Technology
As we prepare to head into the third decade of blockchain technology, it is no longer a question of if legacy companies will catch on to the technology - it's a question of when. With the proliferation of NFTs and the tokenization of assets, the next decades will prove to be an important period of growth for blockchain technology.
