Blockchain Facts: What Is It, How It Works, and How It Can Be Used

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Blockchain Facts: What Is It, How It Works, and How It Can Be Used

Investopedia / Xiaojie Liu

A blockchain is a distributed database or ledger that is shared across computer network nodes. A blockchain, like a database, saves information electronically in digital format. Blockchains are well recognized for their critical function in cryptocurrency systems like Bitcoin, where they keep a secure and decentralized record of transactions. The blockchain’s novelty is that it ensures the accuracy and security of a data record and produces trust without the requirement for a trusted third party.

The way data is organized differs significantly between a traditional database and a blockchain. A blockchain accumulates information in groupings known as blocks, which store sets of data. When a block’s storage capacity is reached, it is closed and connected to the previous full block, producing a data chain known as the blockchain. All new information that follows that newly added block is assembled into a newly formed block, which is then added to the chain once it is complete.

A database typically organizes its data into tables, but a blockchain, as the name suggests, organizes its data into chunks (blocks) that are linked together. When implemented decentralizedly, this data structure creates an irreversible data timeline. When a block is completed, it becomes permanent and forms a part of this timeline. When a block is added to the chain, it is assigned a precise timestamp.

Key Takeaways

  • Blockchain is a sort of shared database that varies from traditional databases in the way data is stored; blockchains store data in blocks that are then connected together using encryption.
  • As new data arrives, it is added to a new block. Once the block has been filled with data, it is chained onto the preceding block, putting the data in chronological sequence.
  • A blockchain may hold several sorts of data, but its most popular use to date has been as a transaction ledger.
  • In the case of Bitcoin, blockchain is employed decentralizedly, such that no one person or organization has control—rather, all users keep power collectively.
  • Because decentralized blockchains are unchangeable, the data inputted is irreversible. This implies that Bitcoin transactions are forever recorded and viewed by anybody.

How Does a Blockchain Work?

Blockchain’s purpose is to enable digital information to be recorded and disseminated, but not altered. A blockchain, in this sense, serves as the basis for immutable ledgers, or records of transactions that cannot be changed, erased, or destroyed. As a result, blockchains are also known as distributed ledger technologies (DLT).

The blockchain idea was initially suggested as a research project in 1991, and it preceded its first popular use in use: Bitcoin, in 2009. Since then, the usage of blockchains has grown exponentially, thanks to the development of multiple cryptocurrencies, decentralized finance (DeFi) apps, non-fungible tokens (NFTs), and smart contracts.

Transaction Process

Attributes of Cryptocurrency

Blockchain Decentralization

Consider a corporation that has a server farm with 10,000 machines that are utilized to manage a database containing all of its clients’ account information. This corporation owns a warehouse facility that houses all of these computers under one roof and has complete control over each of these systems and all of the information they hold. However, this creates a single point of failure. What happens if the power goes out at that location? What if its Internet connection fails? What if it catches fire and burns to the ground? What if a malicious actor wipes out everything with a single keystroke? The data is either lost or damaged in any situation.

A blockchain allows the data in that database to be distributed across several network nodes in different places. This not only adds redundancy but also ensures the accuracy of the data stored—if someone attempts to change a record in one instance of the database, the other nodes are not affected, preventing a bad actor from doing so. If a single user tampers with Bitcoin’s transaction record, the other nodes will cross-reference each other and readily identify the node with inaccurate information. This method aids in the establishment of a precise and visible sequence of occurrences. This manner, no one node in the network may change the information stored inside it.

As a result, information and history (such as bitcoin transactions) are irreversible. Such a record may be a list of transactions (as with cryptocurrencies), but a blockchain could also include a range of other information such as legal contracts, state identifications, or a company’s goods inventory.

To verify new entries or records to a block, a majority of the processing power in the decentralized network must agree. Blockchains are protected by a consensus method such as proof of work (PoW) or proof of stake to prevent bad actors from confirming bogus transactions or duplicate spending (PoS).These procedures allow for consensus even when there is no one node in command.

Transparency

Because of the decentralized structure of Bitcoin’s blockchain, all transactions may be openly watched by owning a personal node or utilizing blockchain explorers, which enable anybody to witness transactions taking place in real time. Every node maintains its own copy of the chain, which is updated when new blocks are verified and added. This implies that you could follow Bitcoin wherever it went if you wanted to.

Exchanges, for example, have been hacked in the past, and customers who stored Bitcoin on the exchange lost everything. While the hacker is completely anonymous, the Bitcoins they stole are readily traceable. It would be known if the Bitcoins stolen in any of these attacks were relocated or spent someplace.

The records recorded on the Bitcoin blockchain (as well as the majority of others) are, of course, encrypted. This implies that only the record’s owner may decode it and disclose their identity (using a public-private key pair).As a consequence, blockchain users may stay anonymous while maintaining transparency.

Is Blockchain Secure?

In numerous ways, blockchain technology delivers decentralized security and trust. To begin, new blocks are always kept in a linear and chronological order. That is, they are always appended to the blockchain’s “end.” It is exceedingly difficult to go back and change the contents of a block once it has been put to the end of the blockchain unless a majority of the network has achieved an agreement to do so. This is due to the fact that each block includes its own hash, as well as the hash of the block preceding it and the previously stated date. A mathematical function converts digital information into a string of numbers and characters to generate hash codes. If that information is changed in any manner, the hash code will change as well.

Assume a hacker, who also operates a node on a blockchain network, wishes to change a blockchain and steal bitcoin from everyone else. If they changed their single copy, it would no longer be in sync with everyone else’s copy. When everyone else compares their copies to each other, this one copy will stand out, and the hacker’s version of the chain will be dismissed as invalid.

To be successful, the hacker must simultaneously possess and change 51% or more of the copies of the blockchain, such that their new copy becomes the majority copy and, therefore, the agreed-upon chain. Such an assault would also need an enormous amount of money and resources, since they would have to rewrite all of the blocks due to the varied timestamps and hash codes.

Because of the magnitude and speed with which many cryptocurrency networks are developing, the expense of accomplishing such a feat would very certainly be impossible. This would be not only exceedingly costly, but also likely futile. Such an action would not go unnoticed by network participants, who would detect such substantial changes to the blockchain. Members of the network would then hard fork off to a new version of the chain that was not impacted. This would lead the value of the attacked version of the token to collapse, rendering the attack ultimately futile since the bad actor now controls a worthless asset. The same thing would happen if a bad actor attacked the next Bitcoin split. It is designed in this manner so that participating in the network is significantly more economically encouraged than attacking it.

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Bitcoin vs. Blockchain

Stuart Haber and W. Scott Stornetta, two academics who aimed to develop a system where document timestamps could not be manipulated with, proposed blockchain technology in 1991. But it wasn’t until over two decades later, with the January 2009 introduction of Bitcoin, that blockchain saw its first real-world implementation.

A blockchain is the foundation of the Bitcoin protocol. Bitcoin’s pseudonymous developer, Satoshi Nakamoto, described the digital currency in a research paper as “a new electronic cash system that’s totally peer-to-peer, with no trusted third party.”

The crucial point to remember here is that although Bitcoin utilizes blockchain to transparently record a ledger of payments, blockchain may theoretically be used to immutably store any amount of data items. As previously said, this might take the shape of transactions, election votes, goods inventories, state identifications, deeds to residences, and much more.

Currently, tens of thousands of initiatives are attempting to use blockchains in ways other than transaction recording to benefit society—for example, as a safe means of voting in democratic elections. Because of the immutability of blockchain, fraudulent voting would become much more difficult. A voting system, for example, may be designed such that each citizen of a nation receives a separate coin or token. Each candidate would then be assigned a unique wallet address, and voters would transmit their token or cryptocurrency to the address of their choice. Because blockchain is transparent and traceable, it eliminates the necessity for human vote counting as well as the possibility of unscrupulous actors to interfere with physical votes.

Blockchain vs. Banks

Blockchains have been lauded as a disruptive force in the financial industry, particularly in payment and banking activities. However, banks and decentralized blockchains are not the same thing.

Let’s compare the banking system to Bitcoin’s implementation of blockchain to understand how they vary.

How Are Blockchains Used?

Blocks on Bitcoin’s blockchain, as we now know, hold data about monetary transactions. There are already over 10,000 additional cryptocurrency systems operating on blockchain. However, it has been shown that blockchain is also a viable method of recording data about other sorts of transactions.

Walmart, Pfizer, AIG, Siemens, Unilever, and a slew of other corporations have already used blockchain. For example, IBM has developed the Food Trust blockchain to track the path that food goods follow to reach their destinations.

Why are you doing this? There have been several outbreaks of E. coli, salmonella, and listeria in the food sector, as well as hazardous compounds being mistakenly put into meals. It used to take weeks to figure out where these outbreaks were coming from or what was causing individuals to become ill. Using blockchain, marketers can follow a food product’s journey from its origin through each stop along the way, and ultimately to its delivery. If a meal is proven to be tainted, it may be tracked back through each stop to its source. Not only that, but these firms can now see everything else with which they have come into touch, enabling the issue to be identified far sooner and perhaps saving lives. This is one example of blockchain in action, however there are many different ways to apply blockchain.

Banking and Finance

Perhaps no sector will gain more from incorporating blockchain into its business processes than banking. Financial institutions are only open during business hours, which are normally five days each week. That means that if you attempt to deposit a check on Friday at 6 p.m., you’ll probably have to wait until Monday morning for the funds to appear in your account. Even if you make your deposit during business hours, it may take one to three days for the transaction to be verified owing to the enormous amount of transactions that banks must settle. In contrast, Blockchain never sleeps.

By incorporating blockchain into banks, users may expect their transactions to be completed in as low as 10 minutes—basically the time it takes to add a block to the blockchain, regardless of holidays or time of day or week. Banks may also use blockchain to trade money across institutions more swiftly and securely. In the stock trading industry, for example, the settlement and clearing procedure may take up to three days (or more if dealing overseas), which means that the money and shares are frozen during that time.

Given the magnitude of the funds involved, even a few days in transit might incur enormous expenses and hazards for institutions.

Currency

Blockchain is the foundation for cryptocurrencies such as Bitcoin. The Federal Reserve controls the US currency. A user’s data and cash are theoretically at the mercy of their bank or government under this central authority structure. If a user’s bank gets hacked, the client’s personal information is compromised. The value of the client’s money may be jeopardized if their bank fails or if they reside in a nation with an uncertain government. Several insolvent banks were bailed out using government money in 2008. These are the concerns that led to the creation and development of Bitcoin.

Blockchain lets Bitcoin and other cryptocurrencies to function without the need for a central authority by distributing its activities over a network of computers. This decreases risk while also eliminating numerous processing and transaction expenses. It may also provide people in countries with unstable currencies or financial infrastructures with a more stable currency with more applications and a larger network of persons and organizations with whom they can do domestic and international commerce.

Using bitcoin wallets for savings accounts or payment is particularly important for individuals who do not have state identity. Some nations may be in the midst of a civil war or have administrations that lack the necessary infrastructure to offer identification. Citizens in such nations may lack access to savings or brokerage accounts, and hence no means of securely storing money.

Healthcare

Healthcare providers may use blockchain to securely keep medical records for their patients. When a medical record is created and signed, it may be stored on the blockchain, giving patients evidence and assurance that the record cannot be altered. These personal health data might be encoded and kept on the blockchain with a private key, making them available only to certain persons and maintaining privacy.

Property Records

If you’ve ever visited your local Recorder’s Office, you’ll be aware that the process of documenting property rights is both time-consuming and inefficient. A tangible deed must now be presented to a government employee at the local recording office, who manually enters it into the county’s central database and public index. Property claims must be reconciled with the public index in the event of a property dispute.

This method is not only expensive and time-consuming; it is also prone to human mistake, with each inaccuracy making property ownership monitoring less efficient. Blockchain has the ability to remove the necessity for document scanning and physical file tracking at a local recording office. Property owners may have confidence that their deed is accurate and permanently documented if it is kept and validated on the blockchain.

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It may be virtually hard to verify property ownership in war-torn nations or locations with little to no government or banking infrastructure, and definitely no Recorder’s Office. If a group of individuals living in such a region can use blockchain, then property ownership time lines may be constructed in a transparent and unambiguous manner.

Smart Contracts

A smart contract is a piece of computer code that may be embedded in the blockchain to help facilitate, verify, or negotiate a contract agreement. Smart contracts function under a set of agreed-upon criteria. When certain requirements are satisfied, the agreement’s provisions are immediately implemented.

Assume a prospective renter wants to lease an apartment using a smart contract. The landlord promises to provide the renter with the apartment’s door code as soon as the tenant pays the security deposit. Both the renter and the landlord would transmit their respective shares of the agreement to the smart contract, which would save the door code and immediately swap it for the security deposit on the lease start date. If the landlord fails to provide the door code by the lease expiration date, the smart contract returns the security deposit. This would avoid the expenses and procedures involved with using a notary, a third-party mediator, or lawyers.

Supply Chains

Suppliers, like IBM Food Trust, may utilize blockchain to track the provenance of products they acquire. This would enable businesses to validate not just their own goods, but also popular labels like “Organic,” “Local,” and “Fair Trade.”

According to Forbes, the food sector is rapidly using blockchain technology to monitor the course and safety of food along the farm-to-user journey.

Voting

As previously stated, blockchain technology might be utilized to allow a contemporary voting system. Voting using blockchain has the potential to reduce election fraud while increasing voter participation, as shown in the November 2018 midterm elections in West Virginia. Using blockchain in this manner would make tampering with votes almost difficult. The blockchain protocol will also ensure transparency in the electoral process by lowering the number of people required to conduct an election and giving authorities with near-instant results. This would remove the need for recounts and any serious possibility of electoral fraud.

Pros and Cons of Blockchain

Despite its intricacy, blockchain’s potential as a decentralized method of record-keeping is almost limitless. Blockchain technology may have benefits beyond those listed above, ranging from increased user privacy and security to reduced processing costs and fewer mistakes. However, there are some drawbacks.

Pros

  • Improved accuracy by eliminating the need for human verification

  • Cost reductions by eliminating third-party verification

  • Decentralization makes it harder to tamper with

  • Transactions are secure, private, and efficient

  • Transparent technology

  • Gives inhabitants of nations with unstable or undeveloped governments a financial option and a mechanism to safeguard personal information.

Cons

  • Significant technology cost associated with mining bitcoin

  • Low transactions per second

  • Use in illegal operations, such as on the dark web, in the past

  • Regulation varies by jurisdiction and remains uncertain

  • Data storage limitations

Benefits of Blockchains

Accuracy of the Chain

A network of thousands of computers approves transactions on the blockchain network. This eliminates practically all human participation in the verification process, resulting in reduced human error and a more accurate record of data. Even if a machine on the network committed a computational error, it would only affect one copy of the blockchain. That mistake would have to be made by at least 51% of the network’s computers for it to propagate to the remainder of the blockchain, which is almost impossible for a vast and expanding network like Bitcoin’s.

Cost Reductions

Customers often pay a bank to authenticate a transaction, a notary to sign a document, or a priest to execute a marriage ceremony. Blockchain removes the need for third-party verification, as well as the expenses connected with it. Business owners, for example, pay a tiny charge whenever they accept credit card payments because banks and payment-processing businesses must handle the transactions. Bitcoin, on the other hand, lacks a centralized authority and offers low transaction costs.

Decentralization

Blockchain does not keep any of its data in a centralized place. Rather, the blockchain is replicated and distributed over a network of computers. Every computer in the network updates its blockchain whenever a new block is added to the blockchain. Blockchain becomes more difficult to manipulate with by disseminating that information over a network rather than holding it in a single central database. If a hacker obtained a copy of the blockchain, just a single copy of the information, rather not the whole network, would be compromised.

Efficient Transactions

Transactions processed by a central authority might take several days to settle. If you try to deposit a check on Friday evening, for example, the cash may not appear in your account until Monday morning. Unlike financial institutions, which operate during business hours, typically five days a week, blockchain operates 24 hours a day, seven days a week, and 365 days a year. Transactions may be done in as little as 10 minutes and are secure within a few hours. This is especially helpful for cross-border transactions, which often take substantially longer due to time zone differences and the fact that all parties must approve payment processing.

Private Transactions

Many blockchain networks function as public databases, which means that anybody with an Internet connection may access the network’s transaction history. Although users may see transaction data, they cannot view identifying information about the people who made those transactions. It is a popular misconception that blockchain networks, such as bitcoin, are anonymous, whereas they are just secret.

When a user conducts a public transaction, their unique code—referred to before as a public key—is stored on the blockchain. Their personal information, however, is not. If a person buys Bitcoin on an exchange that needs identification, their identity is still connected to their blockchain address—but a transaction, even if attached to a person’s name, does not divulge any personal information.

Secure Transactions

Once a transaction is recorded, the blockchain network must validate its legitimacy. Thousands of computers on the blockchain race to certify that the purchase data are accurate. The transaction is added to the blockchain block once it has been verified by a machine. Each block on the blockchain has its own unique hash, as well as the unique hash of the previous block. When the information on a block is changed in any manner, the hash code of that block changes; nevertheless, the hash code of the block following it does not. This disparity makes it incredibly difficult to update information on the blockchain without being noticed.

Transparency

The majority of blockchains are completely open-source software. This implies that anybody with access to the code may see it. This enables auditors to examine the security of cryptocurrencies such as Bitcoin. This also implies that there is no genuine authority in charge of who controls Bitcoin’s code or how it is modified. As a result, anybody may propose adjustments or additions to the system. Bitcoin may be upgraded if a majority of network users believe that the new version of the code with the upgrade is sound and valuable.

Banking the Unbanked

Perhaps the most significant aspect of blockchain and Bitcoin is the potential for anybody to utilize it, regardless of race, gender, or cultural background. According to the World Bank, an estimated 1.7 billion individuals lack bank accounts or any other method of keeping their money or wealth. Almost many of these people reside in developing nations, where the economy is still in its infancy and is totally based on cash.

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These folks often make a little amount of money in cash. They must then conceal this actual currency in their homes or other places of residence, leaving them vulnerable to robbery or unwarranted violence. Keys to a bitcoin wallet may be written down, preserved on a piece of paper, or even remembered if required. Most people’s alternatives are likely to be more readily concealed than a little amount of cash beneath a mattress.

Blockchains of the future are also searching for ways to store medical information, property rights, and a range of other legal contracts in addition to serving as a unit of account for wealth storage.

Drawbacks of Blockchains

Technology Cost

Although blockchain technology may save customers money on transaction costs, it is far from free. The PoW mechanism, for example, which the bitcoin network employs to validate transactions, requires enormous amounts of processing resources. In the actual world, the electricity used by the bitcoin network’s millions of computers is comparable to what Norway and Ukraine spend yearly.

Despite the expenses of mining bitcoin, consumers continue to push up their power bills in order to confirm blockchain transactions. This is due to the fact that when miners add a block to the bitcoin blockchain, they are paid with enough bitcoin to make their efforts profitable. Miners will need to be compensated or otherwise encouraged to validate transactions on blockchains that do not employ cryptocurrencies.

Some solutions to these problems are emerging. Bitcoin mining farms, for example, have been set up to utilise solar electricity, surplus natural gas from fracking sites, or wind farm power.

Speed and Data Inefficiency

Bitcoin is an excellent case study for blockchain’s potential inefficiencies. A new block is added to the network by Bitcoin’s PoW mechanism in around 10 minutes. At such pace, the blockchain network is predicted to be capable of just seven transactions per second (TPS).Although other cryptocurrencies, such as Ethereum, outperform bitcoin, they are still constrained by the blockchain. Visa, for example, has a processing capacity of 65,000 TPS.

For years, people have been working on solutions to this problem. There are presently blockchains with more than 30,000 TPS. The merging of Ethereum’s main net and beacon chain (September 15, 2022) is expected to enable up to 100,000 TPS once the update adds sharding—a partitioning of the database so that more devices (phones, tablets, and computers) can run Ethereum. This will improve network participation, decrease congestion, and speed up transactions.

Another difficulty is that each block can only carry a certain amount of data. The block size argument has been and continues to be one of the most urgent challenges for blockchain scalability in the future.

Illegal Activity

While blockchain network confidentiality protects users from hackers and maintains privacy, it also allows for unlawful trade and activities on the blockchain network. The Silk Road, an online dark web illegal-drug and money laundering bazaar that operated from February 2011 until October 2013, when it was shut down by the FBI, is possibly the most referenced example of blockchain being used for unlawful activities.

By utilizing the Tor Browser and making illicit transactions in Bitcoin or other cryptocurrencies, users may buy and sell illegal things without being traced on the black web. Current rules in the United States require financial service providers to acquire information about their clients when they create an account, verify each customer’s identification, and check that they do not appear on any list of known or suspected terrorist groups. This method has both advantages and disadvantages. It enables anybody to access bank accounts, but it also makes it easier for criminals to trade. Many have claimed that the beneficial applications of cryptocurrency, such as banking for the unbanked, outweigh the undesirable uses of cryptocurrency, particularly as most unlawful behavior is still carried out using untraceable cash.

While Bitcoin was first utilized for such reasons, its transparency and maturity as a financial asset has resulted in criminal behavior shifting to other cryptocurrencies such as Monero and Dash. Illegal conduct now accounts for a very tiny percentage of all Bitcoin transactions.

Regulation

Many people in the cryptocurrency community are concerned about government regulation of cryptocurrencies. While it is becoming more difficult, if not impossible, to stop a decentralized network like Bitcoin, governments may conceivably make it illegal to hold cryptocurrencies or participate in their networks.

As huge corporations like PayPal begin to enable the ownership and usage of cryptocurrencies on their platform, this issue has diminished.

What Is a Blockchain in Simple Terms?

A blockchain is just a shared database or ledger. Data is stored in data structures called blocks, and each network node has an identical clone of the complete database. Because if someone attempts to amend or remove an entry in one copy of the ledger, the majority will not reflect this modification and will reject it, security is assured.

How Many Blockchains Are There?

The number of active blockchains is expanding at an alarming rate. There are about 10,000 active cryptocurrencies based on blockchain as of 2022, with several hundred more non-cryptocurrency blockchains.

What’s the Difference Between a Private Blockchain and a Public Blockchain?

A public blockchain, also known as an open or permissionless blockchain, is one in which anybody may freely join the network and set up a node. Because of their open nature, these blockchains need encryption and a consensus technique like as proof of work (PoW).

In contrast, a private or permissioned blockchain needs each node to be vetted before joining. Because nodes are trusted, the levels of security do not need to be as strong.

What Is a Blockchain Platform?

A blockchain platform enables users and developers to build new applications on top of current blockchain infrastructure. One example is Ethereum, which has its own cryptocurrency called ether (ETH).However, the Ethereum blockchain enables the development of smart contracts, programmable tokens used in initial coin offerings (ICOs), and non-fungible tokens (NFTs).These are all built around the Ethereum technology and safeguarded by Ethereum network nodes.

Who Invented Blockchain?

Stuart Haber and W. Scott Stornetta, two mathematicians who aimed to design a system where document timestamps could not be manipulated with, proposed blockchain technology in 1991. Nick Szabo, a cryptographer, suggested utilizing a blockchain to secure a digital payment system known as bit gold in the late 1990s (which was never implemented).

The Bottom Line

With numerous practical uses for the technology currently in place and being researched, blockchain is now creating a name for itself, thanks in large part to bitcoin and cryptocurrencies. As a term on the lips of every investor in the country, blockchain has the potential to make corporate and government processes more precise, efficient, secure, and cost-effective by eliminating middlemen.

As we enter the third decade of blockchain, the issue is no longer if older organizations will embrace the technology, but when. Today, we witness the growth of NFTs and asset tokenization. Blockchain will see significant expansion in the next decades.

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