What is Blockchain?
Definition
A Blockchain is a digital database that offers a secure way of storing & sending money, data & virtually anything of value, without the need for a third party like a bank.
Understanding Blockchain
Blockchain is the technology behind cryptocurrency which offers us a safe & trustworthy way to do business with complete strangers, without the need for a trusted third party like a bank or real estate agent.
At its core, a Blockchain is a highly secure digital record that can store financial transactions, balances and virtually anything that can be digitised (land titles, ID, bank balances, medical records, insurance policies, etc.)
Why 'Blockchain'?
The name ‘Blockchain’ comes from its structure, in which transactions are grouped into ‘blocks’ and are then timestamped and linked together in a transparent & unalterable chain.
All records stored on a Blockchain are public, irreversible & distributed across a global network of computers, unlike banks who keep their record of transactions & balances in one centralised location that only they have access to.
What makes Blockchain so special?
In the past, whenever a serious exchange of value needed to occur (buying a house, sending money internationally, claiming an insurance policy), we would need to bring in a trusted third party (real estate agent, bank, insurance company, etc.) to oversee the process. And we would pay them for their service.
Blockchain allows you to safely trust & do business with complete strangers because trust is inbuilt into the network. For the first time in history, people who have never met before can safely exchange and transact virtually anything of value directly with one another (peer-to-peer).
Blockchain has many applications beyond finance & cryptocurrency, including:
- Online voting
- Supply chain management
- Digital Identification
- Food safety
- Music & video streaming
- Corporate Social Responsibility
- Medical record-keeping
- Tax regulation & much more
Who controls/owns a Blockchain?
- Blockchains (& the cryptocurrencies they power) are completely decentralised, meaning no single person, company or government owns or controls them.
- Instead, Blockchains are maintained and kept secure by cryptography and the collective computing power of everyone participating in the network around the world.
- Blockchains use wallet addresses (a long string of numbers & letters) instead of people’s names, so while it is a public ledger, privacy is not compromised.
Benefits of Blockchain compared to the traditional banking system
- Improved efficiency & transaction speed
- Better traceability and security (no single point of failure)
- Reduced costs and no bank fees
- Records are public, transparent and continually verified & reconciled
- Increased accountability and less fraud & corruption
- The removal of fee-charging third parties like banks
- A more efficient system with true privacy & ownership over our assets & information
- A secure way for the billions of people who do not have a bank account to send, store & receive money
Blockchain in action
If you have ever sent money overseas, you know your payment generally needs to pass through a trusted third party (usually a bank).
This means the transaction will not be instantaneous, taking up to 3 days or longer. It also means the bank will slap you with a currency conversion cost or some other transaction fee – or both!
Blockchain technology does away with this clunky and unnecessarily expensive system, allowing you to send money directly to the digital wallet of any recipient with an internet connection in a fast and efficient way, without ever passing through a bank.
EXAMPLE
Here’s a simplified explanation of how sending money on the Blockchain works.
- Joe wants to send money to Amy. He sends the money along a Blockchain and the transaction is recorded online as a ‘block’.
- The block is then broadcasted to computers, or ‘nodes’, across a Blockchain network (a global network of computers) who use cryptography to verify and collectively come to an agreement on whether the transaction is valid or not.
- After the majority of the nodes in the network agree that the transaction is indeed valid, the block is timestamped and added to the chain, and the money is sent from Joe to Amy.
- Everyone’s version of the Blockchain is updated in real-time and the transaction is permanently recorded, showing how much everyone now has.
For international money transfers, Blockchain is a faster, cheaper and a more efficient method as money transfers can be simultaneously verified on both ends and made directly from person to person.
As cryptocurrency & data on a Blockchain does not exist in physical form, it is the unalterable record of transactions and balances that underlies a person’s ownership of their assets. To learn about why the world needs cryptocurrency and Blockchain, click here.
Key Takeaways
- Blockchain is a technology and Bitcoin & cryptocurrency are just one of its applications.
- Blockchain allows you to safely trust & do business with complete strangers because trust is inbuilt into the system.
- Blockchain is a peer-to-peer network that is not controlled or owned by any single entity or government, but rather by everyone participating in the network.
- Cryptocurrency does not exist in physical form, so it is this unalterable record of transactions and balances that underlies a person’s ownership of their crypto.
- Blockchain is shorthand for a wide range of distributed ledger technologies (DLTs) that can be used to store, record & track not just money but virtually anything of value.
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What is the difference between Bitcoin and Blockchain?
Although Bitcoin and Blockchain work together and are often conflated with one another, they are actually two separate things.
- Bitcoin is a cryptocurrency, while Blockchain is a distributed database and the technology that powers Bitcoin.
- Bitcoin relies on Blockchain technology, but Blockchain has many uses beyond Bitcoin & crypto.
Bitcoin transfers money between users, while Blockchain can transfer and record virtually anything of value, including things like financial transactions, medical records, property ownership rights, electoral votes and much more.
What is the process of making a transaction on the Blockchain?
- First, you create a transaction which is then verified and collectively secured by cryptography and the computing power of everyone in the network.
- After your transaction is verified, it is recorded in a shared, public database which functions kind of like a shared Google Doc.
- Instead of banks having a single private copy of all transactions and balances of who owns what, the Blockchain (like a Google Doc) acts as a shared database of this information that is visible to everyone and can be updated instantaneously and in real-time.
- This makes the process of international payments far cheaper and more efficient as bank transfers can be simultaneously verified on both ends and made directly from person to person, without a bank convoluting the process.
- Additionally, as everyone in the network has their own copy of the record, the Blockchain system is incredibly hard to hack or tamper with as there is no single point of failure (like a bank). You would have to alter more than 50 percent of people’s copy of the record for an attack to be successful. To this day, the Bitcoin network has never been hacked.
How are transactions recorded on a Blockchain?
- A transaction is requested
- A block representing that transaction is created
- The block is sent to every participant or ‘node’ in the network
- Nodes validate the transaction through mining (solving a mathematical puzzle)
- Nodes receive a reward for validating the network (usually in the native crypto of that Blockchain)
- The block is added to the existing Blockchain
- The transaction is processed and updated across the entire network
Why is Blockchain more secure than other databases?
Some of the reasons that a Blockchain is so secure when compared to other databases and ledgers include:
- Decentralisation – No single person, government or entity owns the network. Blockchain is a completely decentralised, peer-to-peer network, meaning anyone is allowed to participate and it is impossible to hack like a traditional database.
- Cryptographic hashing functions – This allows each block to have a unique identifier that is extremely difficult to tamper with. (More on this later.)
- The Proof-of-Work (PoW) system – A creative system that harnesses the collective interest of people in the network to keep the network secure, and that utilises ‘mining’ to limit the number of blocks that can be added to the chain (around 1 every 10 minutes for the Bitcoin network). (Keep in mind that one block can store many transactions.)
- Public/private key cryptography – Each crypto wallet has a public and private key which are used to receive money and generate digital signatures for transactions, making it possible to authenticate ownership of the coins that are being sent.
What does ‘decentralised’ actually mean in terms of Blockchain?
Decentralised refers to a network or system run by the people, for the people.
In terms of the Blockchain, the system is spread over the entire network of users, making it almost impossible to hack or destroy.
No individual, entity or company has ownership of the network and there is no central point of control, meaning everyone can participate in real-time – like Wikipedia or a shared Google Doc.
In traditional centralised finance (CeFi), almost everything related to money is done through non-transparent central entities and intermediaries (e.g. banks and governments). While this has worked well enough up till now, decentralised systems offer a far more democratised and efficient way of storing data and doing business.
What is hashing in a Blockchain?
Each transaction made on the Blockchain generates a hash, which is a unique string of numbers and letters that is based not only on the transaction but the previous transaction’s hash. This is crucial to the Blockchain’s security.
Transactions are entered into the ledger in the order in which they occurred. Even the smallest alteration or change in a transaction creates a completely new and unique hash. For a transaction to be successfully verified, nodes in the network check to make sure a transaction has not been changed by inspecting the hash and checking it against the previous hash in the Blockchain.
(In order to fool the system, you would have to change all the hashes of all the previous blocks in the chain (which the Proof-of-Work system makes very time consuming) as every hash depends on the hash of the block that came before it.
In over a decade of Bitcoin’s Blockchain existing, this system has never been compromised. And as you might imagine, many have tried.
So, if the majority of nodes in the network sees that the hash matches up then the transaction is approved, written into a block and added to the chain, storing a permanent record of the transaction and how much crypto each party has.
Given that cryptocurrency does not exist in physical form, it is this unalterable record of who owns what and who has sent what that underlies people’s ownership of their cryptocurrency.
How do hashing functions make Blockchains so secure?
If any changes are made to the information of a transaction, the hash automatically changes as well. Let’s say a hacker wants to alter the Blockchain and steal some crypto. If they were to change their own single copy, it would no longer align with everyone else’s copy.
When everyone else cross-references their copies against each other, they would see this one copy stand out and the altered version of the chain would be easily revealed as illegitimate.
What is mining and ‘Proof of Work’ (PoW)?
In order for a block to be added to the chain, a complex mathematical puzzle needs to be solved and the ‘Proof of Work’ needs to be verified by the network.
Solving this puzzle and completing the Proof of Work takes around 10 minutes on the Bitcoin network. This is referred to as the process of ‘mining’, where ‘miners’ are rewarded with cryptocurrency for helping verify transactions and keeping the network secure.
What is mining?
Miners use powerful computers to compete against one another in the race to solve the puzzle and find the answer that will give them the privilege of adding the newest block to the chain. The first miner to solve the puzzle, broadcasts their answer to the other nodes who verify the Proof of Work, creating a consensus. The successful miner gets rewarded (in crypto) for their contribution to keeping the network secure.
This system creates an in-built trust in the network and incentivises users to keep the network secure. This system also makes it computationally infeasible to attack the network, given how long it would take to do the Proof of Work for every single Block in the chain (which is required to tamper with just a single block). Pretty genius, right?
While the mining and PoW system is effective at allowing a shared ledger to be reliably and truthfully maintained among a huge number of people who don’t know each other, it is, however, incredibly energy/resource intensive and there is now a popular alternative called Proof of Stake (PoS) that provides a similar function.
What is Proof of Stake (PoS)?
Proof of Stake is an alternative to Proof of Work and mining where users secure crypto networks through a process called ‘staking.’
Staking is a system where users are encouraged to participate in the network by ‘staking’ or ‘locking up’ a certain amount of cryptocurrency in the network and agreeing to validate legitimate transactions, earning a reward for their participation in the network (often in the form on interest on the cryptocurrency they have staked – similar to savings rates in a traditional bank).
How does staking work?
From the user’s perspective, staking is a way of being rewarded (through passive income) for participating in the network ecosystem and keeping it secure.
- Staking involves participants who lock up their coins and are then randomly selected at specific intervals to create a block – the more coins you stake the higher the chance you will be selected to create and validate the next block.
- The ‘stake’ is what incentivises validators to maintain network security. If they fail to do that, the network would be insecure, and their entire stake might be at risk.
- Usually, there is a minimum amount needed to stake your crypto (or you can use a staking pool).
- Validators lose part of their stake if they double-sign or attempt to attack the network.
Staking is essentially a way of generating income on your crypto investments through being rewarded for participating in the Blockchain’s ecosystem. While it serves the same function as mining (creating trust in the network, adding blocks to the chain and keeping all the transactions validated and secure), it requires a hell of a lot less computing power/energy and minimal upfront costs when compared with mining.
Why is Blockchain and decentralisation so important?
Blockchain creates trust and security on a whole new level to anything we have seen before. Information stored on the Blockchain is accessible to all peers on the network, making data transparent and immutable.
Going back to the housing bubble crash in 2008, it’s easy to see how greed and the lack of transparency of institutions can have catastrophic consequences. This would never occur with a transparent, decentralised exchange like the Blockchain which has trust built into the system.
What is DeFi?
If you’re learning about Blockchain, then you need to know about DeFi.
Decentralised finance (DeFi) is the notion that crypto entrepreneurs can recreate traditional financial services (insurance, loans, legal contracts, etc.) outside the control of banks, governments and companies, thus offering everyday people a huge number of advantages.
“Central banks are just people, and people make mistakes. Decentralised financial applications can make our financial systems more transparent, more resilient and less fragile,” – Salil Deshpande
How will Blockchain help the developing world?
Considering there are literally billions of people in the world without a bank account (hard to imagine what that would actually be like, right?), Blockchain and cryptocurrency will be an incredibly empowering force for the developing world.
Some areas likely to see huge positive change include (but are not limited to):
- Efficient money transfers (without the greedy third party)
- Land title proof
- Safe place to store assets
- Ability to earn interest without a bank account
- More effective humanitarian aid
- Better access to loans, capital and real estate investments
- Micro loans and small business funding
- Access to insurance and other financial services
What are some examples of how Blockchain can be used in the world?
There are a number of Blockchain-based projects that can help society beyond just finance.
- Voting
Along with making the actual voting process easily accessible from your smart phone, the nature of Blockchain’s immutability means that fraudulent voting would become far more difficult, making the system more secure and better protected from outside manipulation (as the ledger is not controlled by an entity and is completely transparent and unalterable). Counting votes would also take a lot less time and would allow us to see, in real time, what is happening as votes are cast.
A simple example of how Blockchain and crypto can make this work is as follows: A citizen of a country is issued a single cryptocurrency or token. They would then be given a specific wallet address and directed to send their token or crypto to whichever candidate’s address they wish to vote for, thus creating a safe, simple, fair and trustworthy way to vote (especially when compared to the current system).
- Real estate & property ownership
Blockchain technology removes the need for intermediaries in real estate, offering a more efficient and direct way for buyers and sellers to connect with one another. Along with transaction costs being greatly lowered, Blockchain technology also allows for fractional ownership of real estate, making the barrier to entry far more accessible.
Land titles and property ownership is another area that Blockchain could greatly improve. While Blockchain isn’t going to replace the government anytime soon in regards to how land is registered and monitored, it will make the actual ownership and governance of land more secure and freer from corruption than ever before.
For many in the developing world, proving property ownership and land titles can be extremely difficult. By having a permanent, secure and highly accessible database to store land titles, the Blockchain will make this process a whole lot easier, empowering countless individuals across the globe in a very real way.
- Food supply chain, safety & provenance
Inefficiency in the food system is a pervasive global problem. This was made painfully apparent by the COVID-19 crisis, which put incredible stress on the global supply chain. On top of that, sustainability matters more than ever to the consumer of today and many only want to engage with companies that source their products in an ethical and environmentally responsible way
Tech giant, IBM, has embraced Blockchain technology and has created a food trust where harmful, ‘business as usual’ practices of dubious sourcing, manufacturing, distribution and recycling processes are being replaced by complete transparency, responsibility and accountability.
Solutions built on the IBM Blockchain offer consumers the ability to follow the life of a product from its very beginning to end in a way that has never been done before. In terms of corporate social responsibility, the Blockchain is undoubtedly a massive step towards a trustworthy system that keeps corporations accountable for their actions.
How Google Docs can help you understand the Blockchain?
This analogy filled article compares Google Docs and Microsoft Word to show the collaborative and collective benefits of the Blockchain over traditional databases and financial systems.
This is because Google Docs allows multiple people to share, view, edit and collaborate on a single shared document in real-time (like the Blockchain’s shared public ledger). Microsoft Word on the other hand (like most databases in the world) only allows access and edits to be made by one person at a time, while everyone else is locked out (credit to William Mougayar, the author of The Business Blockchain who came up with this metaphor).
With Google Docs, both parties have access to the same document at the same time. There is only one version of the document that is always visible to both of them. Just like the ledger of a Blockchain.
What are some of Blockchain’s issues?
Blockchain is still in its early days and, like any new technology, it comes with its issues. Here are some of the issues that Blockchain developers are trying to resolve:
- Scalability – Put simply, the more people or nodes joining the network, the slower the network becomes (though there are plenty of projects working to resolve the scalability problem)!
- Immutability – Both a blessing and a curse. While Blockchain offers an unalterable way to store data that is extremely hard to tamper with and not everyone wants their transactions and information set in stone.
- Interoperability – Different Blockchains work differently and try to solve the DLT (distributed ledger technology) problem in their own unique way, causing interoperability issues where these chains are not able to communicate effectively, or with certain traditional systems trying to integrate these Blockchains.
- Energy consumption – The Proof-of-Work consensus algorithm relies on ‘mining’ to do a lot of the network’s heavy lifting, which can consume a lot of energy and electricity (which is where the Proof of Stake method comes in to save the day).
- Users are their own bank – Both a pro and a con. While individuals will have full control and ownership of their assets like never before, they will also gain the burden and responsibility of keeping their funds safe and secure. Usually this means being on top of safely storing the public/private keys of your crypto wallet.
While Blockchain definitely has its hurdles to overcome, the technology itself is only a decade old. Like any game-changing technology, it will take some time to iron out the kinks and mature into its full potential.
That being said, mainstream adoption is on the rise and it is hard to imagine a future where Blockchain does not play an integral role in the way we do business and interact as people.
Did this answer your question?
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Crypto-curious? The time you spend here will be the best investment you ever make.
Enjoy effortless trading today
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