Since its introduction in 2008, blockchain technology has grown in leaps and bounds. Businesses and governments all over the world have adopted the technology, making more and more people want to learn more about it.
However, despite its popularity, blockchains are difficult to grasp. In this guide, we’ll break down what blockchain is so you can better understand this revolutionary technology.
What is a Blockchain?
A blockchain is data. Specifically, it’s a digital, peer-to-peer network ledger that allows users to transact without third parties or centralized authorities.
Blockchains are made up of blocks that are stored linearly or connected to each other in order. Like a chain in other words.
A block is made of: Data + Nonce + Hash
The data can be any number of things as we’ll get into detail a bit later. Family pictures, virtual cats, and Rick Astley have all made it into the blockchain so far.
A nonce is a 32-bit whole number that is randomly generated when a block is created. Nonces are very small numbers, with lots of zeros before them.
A hash is a 256-bit number that is joined into a nonce. A hash is used to determine a block’s authenticity and whether a block should be added to a previous block. If a block’s authenticity is verified, the block is added; if not, the transaction does not go through.
When several blocks are joined together, they form a chain. As the size of a chain increases, it becomes difficult to revert, manipulate, or disrupt the chain.
Blockchains are completely decentralized. To achieve decentralization, the database is stored on a blockchain and distributed across multiple nodes located all over the globe. The more nodes, the more secure. Nodes help maintain a blockchain’s integrity by ensuring that no central organization can control the blockchain.
Characteristics of a Blockchain
Blockchains are immutable. Once transactions are stored on the ledger, they cannot be changed.
Blockchains are decentralized, meaning that they don’t have a central authority to govern them. Instead, a group of nodes maintains the network by verifying transactions, and adding new blocks.
Without a central governing authority, blockchains tend to be transparent and safe to use. Additionally, all the data on a blockchain is cryptographically encrypted, which adds another layer of security.
As long as your cryptocurrency wallet is not tied to your identity, all transactions you perform on the blockchain will remain anonymous. However, the transactions are not private. Anyone can see what is happening on the blockchain, but they cannot link the actions to you unless you have taken steps to link your identity to your wallet.
The design of the Bitcoin blockchain (and most blockchains) is public knowledge. Anyone can code open source apps for the blockchain.
Types of Blockchains
There are three main types of blockchains: public, private, and consortium blockchains.
A public blockchain is a blockchain that allows anyone to participate in the network. All transactions on the blockchain are available for everyone to see. However, this is not to mean that everyone can see the private data on transactions. Some of the most well-known public blockchains are Bitcoin, Ethereum, and LiteCoin.
A private blockchain is a blockchain that does not allow everyone to participate freely. Only the ruling nodes or the administrator of the blockchain can determine who will join the network. One of the popular private blockchain is Ripple.
A consortium or federated blockchain is a blockchain that combines the features of a private and public blockchain. This type of blockchain is heavily controlled and is better suited for enterprise blockchains. The most well-known consortium blockchain is hyperledger.
Benefits of blockchain technology
Blockchains are Global
One of the major benefits of blockchain is that it is global. Users from all over the world are free to use and benefit from blockchain technology, as long as they have internet access.
Transparency is an issue that has plagued businesses and governments for years. These institutions have tried implementing rules and regulations to solve this problem, but transparency is yet to be achieved. That is because of the centralization, and potential human error and corruption associated with centralization.
However, with blockchain technology, organizations can operate using a decentralized network where there are no authorities or middlemen, avoiding human error, corruption and censorship.
Typically, a blockchain has nodes that validate transactions. All nodes are free to participate in validating transactions through a consensus mechanism (more about transaction mechanisms later). Once a transaction is validated, each of the nodes keeps a record of the transactions. This dramatically enhances transparency because no one, in particular, has control of the data.
Better still, blockchains are immutable: once a transaction is validated and recorded on the blockchain, it cannot be changed.
As we have mentioned, each node in a blockchain keeps a record of all transactions. This means that at any given moment, every node on the blockchain has a record of all transactions that have taken place since the blockchain was created. And because blockchains are immutable, this record is distributed across all nodes. We can even get a hold of it.
Immutability and decentralization greatly enhance security, as half or more of all nodes have to agree. When compared with any other record-keeping methods, blockchain is the most secure.
Having exact copies of the data distributed among thousands of separate nodes located all over the globe also helps make blockchain difficult to hack, making the technology much more secure than other record-keeping methods that rely on centralized servers.
The use of a blockchain leaves behind an audit trail that documents every step on the journey of an asset.
You can find out all sorts of interesting things this way. For example, a consumer could trace the journey of a piece of jewelry they are purchasing all the way back to where the mineral was mined. Supply chains wouldn’t be anywhere near as confusing, and it would make corporate decisions easier for everyone to comprehend.
Traceability is crucial in industries where consumers are concerned about human rights, animal rights, and environmental conservation issues surrounding a product or industries surrounded by fraud and counterfeiting.
Industries such as fashion, cosmetics, jewelry, food, and agriculture could benefit by being able to share data about provenance with regulators and customers more directly.
Increased Speed and Efficiency
Many business processes and work flows are time-consuming and prone to human error. Many of them also require the intervention of third parties.
When transferred to the blockchain, they take less time to complete, and human error is eradicated. Blockchains exist to store document and transaction details, so they eliminate the need for paper records. Blockchain also eliminates the need to reconcile multiple databases (ledgers), allowing for faster clearing and settlement.
Double spending refers to the difficulty of verifying the ownership of a digital token.
It’s fairly easy to avoid double-spending with fiat currency in real life because when a transaction happens, the cash physically changes hands. Once someone has given their money to someone else it’s not theirs anymore. A digital payment or transfer goes through the bank to verify and the records of each person are updated accordingly.
However, it is more difficult to prevent double-spending with digital files because data are easily copied, cloned, replicated, and shared infinitely. This was the story of Napster where people could easily copy and share audio files thanks to the internet.
Now with the introduction of blockchain technology, it is possible to use digital currencies without the problem of double-spending. Once a transaction takes place, it is recorded on an immutable ledger that is broadcasted to a decentralized network of nodes. All nodes of the blockchain can see a new transaction and determine if the criteria are being met. For example, does Steve have the required funds and the permissions (ownership) to send them to Bill. If anyone attempts to change a transaction, every node on the network can see what is happening and reject the fraudulent transaction.
Blockchain technology benefits many industries today and many more are getting on board. For instance: healthcare, supply chains, and logistics, real estate, art and property management, and finance, to mention a few.
Financial Institutions were some of the earliest adopters. Millions of forward thinking investors have put billions in these new investments, as cryptocurrencies and blockchain technology is competing with most stock exchanges. Are there negatives as well as positives to all this progress? Only the future will tell.
Proof of Stake vs Proof of Work
Let’s go over the concept of mining. For a new block to be added to a blockchain, transactions must be approved. Every blockchain must come up with a way of verifying transactions known as a consensus mechanism.
The two most common consensus mechanisms are proof-of-work (PoW) and proof-of-stake (PoS).
Proof-of-work is a consensus mechanism that requires nodes known as miners to solve complex mathematical equations to validate transactions. Each cryptography equation is different, so when it is solved, the transaction is deemed correct, and it is added to the blockchain’s public ledger.
Miners compete to solve these equations. Whoever solves the equation first gets to add a new block to the blockchain and is rewarded with a percentage of the blockchain’s cryptocurrency. For instance, a miner on the Bitcoin blockchain is rewarded in bitcoin every time they successfully add a block to the bitcoin blockchain.
Bitcoin, which was the first blockchain ever, was also the first to use a proof-of-work consensus algorithm. However, developers, including Satoshi Nakamoto – the creator of bitcoin, soon realized that this algorithm consumed a massive amount of electricity and computing power. As this could be said to damage the ecosystem, they got creative and created other consensus algorithms that did not require the use of sophisticated machinery. One of the most well-known consensus algorithms created to solve proof of work problems is the proof-of-stake consensus algorithm.
In proof of stake, the nodes on blockchain are not required to solve complex mathematical problems. Instead, they must hold a certain amount of the blockchain’s native token to gain the right to validate financial transactions. Ethereum, one of the most popular blockchains and cryptocurrency projects, is currently planning to move to a proof-of-stake consensus algorithm. Once the shift is made, nodes on Ethereum will have to hold a specific amount of Ether in their wallet in a process known as Staking to gain the right to validate transactions on the blockchain.
Proof-of-stake is better than proof-of-work since it leaves a smaller carbon footprint in the real world and allows for faster validation of transactions than proof-of-work. However, there are concerns that proof-of-stake validators with large amounts of coins can influence the blockchain work, this is because as a validator gains the right to validate a transaction, they are likely to validate even more transactions which eventually reduces decentralization in a proof-of-stake blockchain.
There are several other Proofs used by different blockchains and more being developed.They all secure and validate their networks slightly differently and have advantages and concessions compared to each other. Speed could be improved for example, but at the expense of decentralization.
Scaling is one of the problems that has faced blockchain technology since it was established. Scaling refers to the ability of a blockchain network to increase its throughput (measured by transactions per second).
Most blockchains are unable to scale fast enough to accommodate more transactions as they increase. The best example of lack of scalability is the Bitcoin blockchain, which can only process one block of transaction every ten minutes. This is a very slow rate especially when compared to centralised payment systems such as visa, which can process hundreds of transactions per second.
The problems of blockchain scaling must be solved if blockchain will continue to disrupt industries. If it is to ever challenge the credit card for convenience, it will need to be solved. Currently, a few solutions have emerged to help eradicate blockchain scaling problems. They include:
A state channel is a scaling solution where two or more individuals create a line that they can use to send each other funds. Transactions sent via a state channel are not recorded on the blockchain. Examples of projects that allow blockchain users to create state channels include the Lightning Network for Bitcoin, and Raident for Ethereum.
A sidechain is a blockchain that is linked to another blockchain through a two-way peg. The two-way peg facilitates the transfer of digital assets between the two blockchains. To send assets from one chain to another, you send the assets from the source chain to an address that locks them. You then notify the recipient blockchain about the transaction. The recipient blockchain creates and releases an equivalent amount for the user to spend. Mediation between different sidechains is achieved through the use of a group of servers known as a federation. The federation determines when tokens are locked up or released.
Most of the blockchains that exist today do not communicate with each other. However, if they did communicate, they would solve the issue of scalability by allowing an idle blockchain to process transactions for another blockchain that is getting clogged. Some protocols are being designed for this purpose. They include Wanchain, Cosmos and Polkadot.
As we’ve mentioned previously, each node on a blockchain works to maintain its ledger. Sharding proposes that a blockchain’s ledger be broken down into sections known as shards. Nodes could then be divided into groups and each group assigned the responsibility of maintaining a specific shard. Sharding would help a blockchain scale significantly, but the blockchain would still continue to function as a whole. Zilliqa (ZIL) is the first public blockchain to implement sharding.
Alternative cryptographic algorithms
Unspent transactions, commonly known as UTXOs on Bitcoin, contribute to high fees, and a higher payload, hence reducing the amount of transactions that can be confirmed per second. In other words, the rest of the bitcoin that remains in your account has to be given back to you after each transaction. However, each new transaction comes from unspent outputs of previous transactions which makes UTXOs vital for time stamping, mining and block creation. Using a new cryptographic algorithm that reduces the amount of data that comes from UTXOs can help a blockchain scale quickly. Some of the alternative cryptographic algorithms that are solving this problem include Threshold signatures, Multisignatures, Schnorr signatures and Ring signatures.
If these solutions actually address the problems of the blockchain, it might actually live up to the hype.
More Use Cases for Blockchain Technology
Identity theft keeps growing each year – according to Identity Force there’s a new victim of identity theft approximately every two seconds. However, with blockchain technology, governments can store important documents such as birth certificates, social security numbers, and other sensitive documents on a decentralized ledger, minimizing identity theft.
Simply put, Non-Fungible Tokens (NFTS) are digital tokens representing items such as videos, GIFs, and art that are sold on the blockchain. NFTs allow consumers to own some of the most desirable digital assets out there, which is impossible without blockchain technology.
The media currently faces problems in the areas of copyrights, data privacy, royalties, and piracy of intellectual properties. Blockchain can be instrumental in solving these problems. For instance, blockchain can prevent a video from existing in multiple places. The video can still be shared and distributed, but it will not change ownership. The use of blockchain’s ledger system can help to prevent piracy.
For example Theta (THETA) is a blockchain powered network of computers purpose-built for video streaming.
Retail Loyalty Rewards
Blockchain is an excellent choice for retailers who wish to create a token-based blockchain system for rewarding their customers. Retailers can incentivize their customers to shop repeatedly by creating a token-based rewards system and using the blockchain database to store the tokens. Such a loyalty program would also eliminate the waste and fraud associated with paper and card-based loyalty programs.
Possible Future of Blockchain Technology
According to a recent forecast by Gartner, the business value added by blockchain will grow to about $176 billion in 2025 and then skyrocket to $3.1 trillion by 2030.
These estimates show that blockchain technology has a bright future. Here are some of the areas that blockchain is expected to make a major impact.
The Internet of Things (IoT) where blockchain will improve security and provide a scalable framework for communication between IoT devices. Blockchain will also allow IoT devices to make automated micro-transactions and leverage smart contracts.
We can also expect to see more government agencies, including central banks, using blockchain work for effective data management and the introduction of national cryptocurrencies by governments around the globe. Your bank account may already be on one.
Blockchain will also continue to disrupt industries such as finance and supply chains where new blockchain applications are discovered every day. It’s already making a major impact. IBM has taken it on full bore, because it recognizes that a 3 trillion market cap is realistic.
The blockchain uses and bitcoin uses may only be limited by your imagination.
In a nutshell, blockchain is a disruptive new technology that introduces efficiency and trust in transactions. Here are the key takeaways:
- A blockchain is a digital peer-to-peer ledger that allows users to transact without third parties or centralised authorities.
- Blockchains are immutable, decentralised, secure and anonymous.
- There are three types of blockchains, public, private and consortium blockchains.
- The main benefits of blockchain is their ability to enhance security, traceability and transparency.