HomeWhat is Blockchain?

What is Blockchain?

Idil Woodall
Idil Woodall
16th Feb 2023

It’s perhaps easier to start with what blockchain is not: it is not synonymous with cryptocurrency or Bitcoin, it is not merely a means of exchange, it is not a pure speculation-based investment network, and it is definitely not only a buzzword tossed around. Cryptocurrencies are based on digital currency that uses blockchain technology to record and secure every transaction.

Blockchain is a distributed ledger technology shared among the computers (nodes) in a network. It’s an open-source database with growing records, or blocks of records, tied together with cryptography. It is best known for, and mostly associated with, enabling cryptocurrency transactions in a secure manner without a need for centralized control.

Financial institutions are exploring how they could also use blockchain technology to upend everything from clearing and settlement to insurance.

Understanding Blockchain Technology

Blockchain (or blockchain technology) is essentially a shared system of records that is often referred to as a distributed ledger technology or a database. A blockchain network can store any digitalized information, from medical records to land titles, but its mostly known for its ability to record transactions and track assets. Its design renders blocks of information that are traceable, impossible to tamper with, and autonomously governed.

History of Blockchain, Recent Developments, and Rising Popularity

Blockchain’s history traces back to the early 1980s when cryptographer David Chaum first proposed a vault system for establishing a secure computer network, which encompassed the key elements of a blockchain network. In 1991, Stuart Haber and W. Scott Stornetta introduced the concept of timestamping digital documents. The following year, Haber and Stornetta partnered with Dave Bayer to improve the efficiency of the design by allowing several digitalized documents to be stored in blocks.

It wasn’t until 2008 that Satoshi Nakamoto, a mysterious individual or a group of people, brought these concepts together to conceptualize the first decentralized blockchain network. The following year, Nakamoto launched the first cryptocurrency Bitcoin, where blockchain served as the public network to host all transactions. The Bitcoin blockchain describes only the technology in which the currency is housed, while the Bitcoin cryptocurrency describes only the currency itself. The first Bitcoin transaction occurred on January 12th, and by November same year, it had its own trading platform and a handful of discussion forums for developers and enthusiasts. In 2010, a trader named Laszlo Hanyecz agreed to pay 10,000 Bitcoin for two Papa John’s pizzas, and history was made. Bitcoin is a digital currency that uses blockchain technology as its distributed ledger.

By 2014 cryptocurrency’s popularity was on a steady rise, but the potential of blockchain technology was not fully explored. Enter Vitalik Buterin, a then-20-year-old Russian programmer who launched the Ethereum network along with four other entrepreneurs. Ethereum introduced novel ways in which blockchain technology can be used other than crypto-based transactions: it introduced smart contracts, allowed programmers to develop decentralized applications (DAPPs), paved the way for non-fungible tokens (NFTs) to roar to take over the internet. But most importantly, this proved to be a turning point as larger firms and governments began to recognize blockchain’s true capacity.

Since then, cryptocurrencies gained tremendous popularity and monetary value while creating controversy left and right. Meanwhile, blockchain technology has become one of the main ventures to invest in, most notably to improve supply chain management, and has been picked up by major corporations including Walmart and Amazon. According to Deloitte's 2020 survey, 55% of respondents cited blockchain as a top strategic priority while 40% reported incorporating it into production.

Additionally, Blockchain technology is the foundation of Web 3.0

How Does Blockchain Work?

The name blockchain can be considered the metaphorical representation of the way in which information is organized within a network.

In a blockchain network, the information, which can be transactions, smart contracts, or other codified documents, is stored in batches, or blocks. These blocks are linked together in a chronological manner and form a continuous line, like a chain of blocks.

These blocks can only store a finite number of pieces of information, or within the context of cryptocurrency, a finite number of transactions. Transaction data would include the sender, receiver, and the amount of digital currency that changed hands, such as Y paid X 50 USD, X paid Z 70 USD, Z paid T 20 USD, and so on.

Each new entry to a block needs to be verified by the majority or all of the nodes in the network. Blockchain uses consensus mechanisms such as proof of work or proof of stake to prevent entering invalid transactions and ensure that each recorded transaction is correct.

Besides the data, each block also contains its own hash and the previous block’s hash. A hash is similar to a digital fingerprint, it identifies a block and all of its content, and it’s always unique. It constitutes a definitive number of alphanumerical characters. A hash code is calculated as a block is created, and any change in the block is reflected in the code. A chain is created as each block also includes the previous block’s hash code.

When the limit is reached, a new block is added to the chain. The process of adding and verifying new blocks to these distributed ledger technology is called mining.

There are a few things to happen for a new block to be added;

  1. Each new block must contain the answer to a complex cryptographic puzzle created by the hashing function.

  2. The node that has solved the puzzle then shares the solution with all other computers in the network.

  3. The network then needs to verify the calculation. If the calculation is correct, the new block, along with a timestamp, is added to the chain.

When a block is filled and stored on the blockchain, it’s unchangeable. It’s not possible to rewrite to block to record any changes made to the information embedded in it. Instead, a new block that shows a change such as “X was changed to Y at a particular date and time” is added as a new entry.

Key Characteristics of a Blockchain

A blockchain network has several properties that make the technology unique and distinguish it from traditional databases or ledgers.

A blockchain system is decentralized, meaning that there is not a single, central governing authority undertaking decision-making and setting rules. Instead, a group of nodes maintains and manages a given network. All nodes within a network hold a copy of the whole ledger, and this has a variety of benefits. Most notably, it solves the single point of failure problem and creates a fault-tolerant and tamper-free system. The nodes can always cross-reference the information and identify any mistake or wrongdoing. The network is also not dependent on a single entity to store all the data in a network, should a node fails, the remaining nodes continue to operate.

Blockchain constitutes a permanent digital ledger or database. All blocks of information are not only chronologically lined and timestamped, but also cryptographically sealed. Any changes to be made to a block result in a change in its hash code, and as every block contains the hash of the previous block, hashes stored in them become invalid. Thus, any edit to a particular block renders all following blocks, and by extension the chain, inoperative. Immutability is not only secured by the use of hash function but also consensus mechanisms like PoW or PoS, so unless a bad agent takes over the control of the majority of nodes in a given network, it’s near-impossible to tamper with any entry.

In a public ledger, every node of the network maintains a copy of the ledger, and they all must participate in the verification of each entry and block inclusion. This provides complete transparency and allows participating agents to manage and regulate the network. Everyone has to follow a standardized procedure, and equal distribution means every node holds equal power regarding the verification of each entry.

A centrally-governed system, such as a hospital database holding patient information, is maintained by an administrator that is responsible for updating the data and keeping it up to date. This person or group holds full authority in handling sensitive information. A self-governing system like a blockchain, on the other hand, distributes the updating and verifying of the data to every node participating in the network by using consensus mechanisms. This process refers to a set of rules helping nodes approve the authenticity of each entry. There are two common consensus mechanism algorithms;

Proof of Work (PoW)

Used by popular cryptocurrency networks, most notably Bitcoin, PoW is a consensus mechanism where each node or miner gets into the work of solving complex arithmetical problems using their computer power (GPUs) to verify the authenticity of the transactions and arrive at the consensus. Once the transactions are verified, they are added to the block and the miners are rewarded with the cryptocurrency of the network for their honest contribution.

Proof of Stake (PoS)

In the Proof of Stake consensus mechanism, the power to validate the transactions is in the hands of the cryptocurrency owners who validate the transactions based on the amount of crypto staked into the contract. This consensus mechanism is an alternative to PoW and doesn’t require the use of computation power to arrive at the consensus but only based on the stake positions of the validators in the network.

Some blockchain networks, most notably Ethereum, are programmable. This means that developers can program protocols, called smart contracts, that trigger responses as the predetermined requirements are met. Within the context of crypto-based transactions, smart contracts allow automated transactions such as the following: X will pay 2 ETH to Y when Z pays 3 ETH to X. Smart contracts may encompass as many stipulations as needed and may involve any number of participants.

Types of Blockchain Networks

There are four categories of blockchain networks categorized by the level of accessibility.

As the name suggests, public blockchain systems are completely open to anyone who wishes to participate. They are true to the decentralized property of a blockchain, are not owned by an individual or a group of individuals, and are managed by every node that is part of the network.

Every participant agent holds a copy of the ledger and everyone has the power to verify and authenticate new entries using proof of work or proof of stake consensus mechanisms. No limit in participation and total distribution means greater distribution of control, which enhances the security and trustability of the network. Bitcoin and Ethereum are the most notable examples of public blockchains.

A private blockchain consists of a permissioned network in which consensus can be achieved through a process called ‘selective endorsement,' where known users verify the transactions. Private blockchains only allow selected nodes to participate and operate as a closed network. As opposed to public systems, private networks have centralized governance and users can manually determine its size and scalability. It’s an ideal solution to use within corporations as it allows benefiting from blockchain technology with an option to not sacrifice confidentiality. Due to the limited number of nodes, the verification process is also significantly quicker in comparison to a public network. Finally, this private blockchain process is more similar to an in-house data storage system except spread over multiple nodes to increase security.

A hybrid blockchain architecture brings together elements of a public and private blockchain. A central entity reserves the right to keep some parts of the network private while allowing some parts of it to be public, but the said entity cannot tamper with the transactions recorded. The system may use smart contracts to define user access. Only a selected number of nodes have the power to verify the entries. Its seen as the most customizable type of blockchain architecture, and an ideal solution for governments or health organizations where the public can access certain types of data but the entities can still maintain confidentiality.

Also referred to as federated blockchains, consortium blockchains are maintained by a group of entities or representative individuals. Like hybrid blockchains, a consortium benefits from both permissioned and permissionless systems. Unlike hybrid blockchains, they are not governed by a single central entity. These governing entities, or the consortium, allow or restrict participants, and hold power to authenticate using a proof of vote mechanism.

Benefits of Blockchain

Due to its unique characteristics, blockchain offers greater trust, transparency, and traceability to its users.

Transparency and Trust

Perhaps the most striking attribute a blockchain network brings is its decentralized nature and unprecedented transparency. In a centrally governed system or database, the control of any given activity or organization is concentrated on a single person or entity. This means these entities act as gatekeepers for all data and users: they regulate the access and set the rules.

In a centralized banking system, for example, customers may have rejected payments or frozen accounts, and it’s not certain that the bank will take accountability. Or, a social platform such as Twitter, may censor certain discourses, close accounts, and may monetize users’ personal data.

A decentralized system takes away the authority from a central group and distributes it to the participants of the network, and every participant holds a complete copy of the database in its entirety and collectively decides how to manage it.

The elaborated verification system with which a blockchain network operates does the trust building for its participants. As opposed to a centralized system, participants have complete knowledge of what is stored and how it is managed.

No Need For Third-Party Verification

A tamper-free, distributed verification system also eliminates the need for intermediaries to verify transactions or the authenticity of documents, such as banks approving that the sender has the funds to perform the transfer, a lawyer carrying out a business contract ensuring both parties meet the requirements, or a notary signing a document. Blockchain networks waive the need for such parties to broker a deal, and by extension, the time and money spent on these third parties.

Faster Settlement for Transactions

Banking institutions operate within office hours and are closed during holidays. Blockchain, on the other hand, operates 24/7 and every day of the year. Countless nodes in a network rush to approve the transactions as they happen. A Bitcoin transaction, for example, takes an average of 10 minutes and may occur any time of the day and any day of the year. This could specifically solve cross-border payment problems, which are bound to not only high fees but also long transfer times due to differences in time zones and the involvement of several intermediary parties to facilitate communication between two corresponding parties.

Security of Blockchain

Blockchain’s creative use of a hashing function and consensus mechanism algorithms render the database completely immutable and tamper-free. This gives the database or distributed ledger complete immunity from any malicious attempts from bad agents.

Besides the intricate verification system with which every transaction is approved and authenticated, a blockchain is also open-source software, meaning that everyone can see its code. This allows developers to review the code and its levels of security, and make suggestions to approve it.

Blockchain Accessibility

According to the World Bank’s research, some 31% of the world’s population is currently unbanked, most of which reside in developing countries. The unbanked population not only has to mitigate the logistical challenges of not having a bank account, like paying for utilities or grabbing a paycheck but they are also excluded from the larger global financial network and their wealth is vulnerable to burglars when stored physically.

Cryptocurrency and blockchain technologies allow anyone, irrespective of gender, ethnicity, nationality, or credit note, to trade with anyone on the network and store their capital safely. This means unbanked people can use cryptocurrency if they choose to.

Current Limitations and Challenges of Blockchain

Blockchain’s complex and demanding nature brings about unique challenges that have not been tackled as of yet, most notably in accessibility and eco-consciousness.

Blockchain Development and Maintenance Costs

In maintaining a blockchain network, mechanisms like PoW, in particular, use tremendous amounts of computational power to solve the puzzles, which also drives up the nodes’ electricity bills.

More computational power improves the odds of solving the puzzle faster, hence, the miners are always upgrading their hardware capabilities by integrating more GPU cards in the system but this demands the use of more power.

Also, the life cycle of the GPU cards is short. On top of that, the heat generated from the power consumption also needs to be cooled off using fans or air conditioners. All these aspects combined together lead to high development and maintenance costs.

Not Environmentally Friendly

The transaction validation process via Proof-of-Work uses large amounts of energy, and besides fattening the bills, this also makes cryptocurrencies, and by extension blockchain, far from being green technology. Bitcoin mining, for example, releases 40 billion pounds of carbon emissions in the US alone. The cryptocurrency industry aims to be 100% carbon-free by 2030 and has started to invest in greener energy solutions to power mining activities.

Blockchain Implementation Struggles

Blockchain technology is insanely complicated and costly to pursue. It requires significant investment in infrastructure and talent. For a business to embrace a blockchain solution, they also need to train their existing professionals and ensure that the management is fully briefed on the blockchain technology so that they can fully utilize it and mitigate the challenges it brings about.

Blockchain Uses & Real-life Applications

Despite its most popular association with cryptocurrency trading, blockchain’s real-life applications stretch beyond facilitating the transaction of digital currencies.

Blockchain uses in Banking and Finance

Blockchain technology is seen by many as a natural fit to improve the operations of financial institutions. It can speed up transaction times significantly, improve communication between corresponding institutions, and reduce handling errors. Increased transparency will also optimize regulatory activities and enhance trust in auditing financial institutions.

Major banks like Wells Fargo and HSBC are the early adopters of blockchain. The banking giants make use of the blockchain technology to improve the settlement of cross-border payments and use a joint ledger to process the US dollar, Canadian dollar, British pound sterling, and Euro transactions.

Blockchain use in Legal Industry

The legal industry can leverage blockchain technology in automating its workflows, securely and immutably storing contracts, and rendering itself more transparent for clients. The use of smart contracts can cut the time preparing and altering documents significantly and hence prevent hefty fees to cover preparation that is typically covered by the clients.

While smart contracts are not yet recognized on a federal level, some states in the US, including Nevada and Iowa, now accept their legitimacy and recognize them as legally binding agreements between involved parties.

Blockchain use in Healthcare

Blockchain has a variety of applications within the healthcare industry, the most important of which are securely storing patient data and streamlined management of the pharmaceutical supply chain.

Data breaches continue to be a crucial problem within the industry, with over 600 data breaches being reported between 2021 and 2022. Services harnessing blockchain’s encryption potential allow secure transmission and storage of sensitive information. BurstIQ, for example, helps healthcare companies in safekeeping, sharing, or licensing data while maintaining strict compliance with HIPAA rules. It also allows real-time data access regarding patients’ healthcare activities, potentially helping to weed out prescription drug abuse problems. ​​

IBM and Sonoco recently partnered to minimize issues in transporting medications by allowing higher levels of supply chain transparency using blockchain networks. Pharma Portal, a blockchain platform, helps suppliers and buyers track temperature-controlled medications through accurate and real-time data.

Blockchain use in Property Management

Given its impeccable asset tracking abilities, blockchain is also set to disrupt the real estate industry. Blockchain technology may provide solutions to problems surrounding ownership disputes, the need for intermediaries for brokering a deal, hefty commissions claimed by real estate agents and solicitors, and more.

ATLANT, for example, created a blockchain platform in which properties are tokenized and can be traded much like cryptocurrencies. This streamlines transactions and cuts the need for a middleman to seal the deal between the seller and buyer while minimizing the transaction and brokerage fees.

Looking Ahead: The Future of Blockchain

Without a doubt, the most disruptive technology of the last decade or so, blockchain has already transformed the operations of several verticals in its brief existence. Its astronomic rise in popularity allowed developers to stretch the blockchain technology beyond just a means of buying cryptocurrency — allowing major players in markets, including governments, to recognize its potential of streamlining their data management system and take their services to the next level.

As its widespread adoption is looming ever more closely, it's crucial to formulate solutions to its current limitations and invest in bettering the technology to be more accessible and green.

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Author Bio
Idil Woodall
Idil Woodall
Idil is a writer with interests ranging from crypto and politics to fintech and media. She spent several years in publishing before becoming a full-time writer in the technology space, and learning the inner workings of an industry she loved ignited her interest in economics. As an English graduate, she cultivated valuable research and storytelling abilities that she now applies to make complex matters accessible and understandable to many. When she’s not writing, she can be found climbing or watching a movie.