What is Blockchain Technology? The Basics
The emergence of blockchain technology over the past decade has changed how businesses worldwide think about their approach to facilitating transactions. Blockchain technology was indirectly popularised thanks to the exponential growth of Bitcoin – yet the technology has much broader applications than cryptocurrency alone.
We’ll explore the concept of blockchain in detail, breaking down what it is and how it works. We’ll also cover the real-world uses of blockchain technology and how it compares to the traditional financial systems that are in place today.
What is Blockchain Technology?
Put simply, a blockchain is a ledger of past transactions. It’s called a blockchain because each page of the ledger is called a ‘block’, and each block has information about the previous and next block in the ledger – causing a chain of data.
These blocks are what contain the information on the transactions that occur within the network. So, if Person A sent Person B a sum of £100, there would be a block that has a note of that transaction. Through blockchain technology, transactions can be handled in a way that doesn’t require a third party to validate them. This means transactions are secure, reliable and tamper-proof.
Let’s visualise it. Imagine you decide to send some money to someone through the traditional banking system. Your request to make the payment will pass through a central authority, which is usually your bank. This central authority will then check you have enough money and then facilitate the transaction. This process is inherently centralised, as all data and transactions pass through a single point – the bank.
On the other hand, as blockchain technology is decentralised, there is no single point of authority within the system. The ledger mentioned earlier is ‘distributed’, which means that anyone within the network can see the transactions that have taken place.
Through this methodology, users on the network (commonly referred to as nodes) can self-validate the transactions that have taken place, ensuring the network’s reliability as a whole. And as the ledger is a permanent list of these transactions, blockchain networks are often referred to as ‘immutable’.
What is Centralisation and Decentralisation?
Traditionally, transactions require third-party banks to authorise that you have the funds necessary to purchase and then send those funds to the seller. This process is flawed, as it means all trust is on the third party not to change anything within that transaction. This means that banks hold a lot of power and control over your money and your transactions.
But what’s the alternative? Blockchain is a distributed public ledger, meaning anyone can maintain it. Every transaction is recorded in each ledger, meaning there is no specific owner of the data. The more people on the blockchain’s network, the more it becomes decentralised – meaning your money and transactions aren’t controlled by any individual entity.
Why was Blockchain tech invented?
There was a growing problem with financial control across the existing banking system. Blockchain as a theory was first proposed by the cryptographer David Chaum back in 1982 to help solve the issue of decentralisation. However, the idea came into the public consciousness following Satoshi Nakamoto’s whitepaper ‘Bitcoin: A Peer to Peer Electronic Cash System’ in 2009 with “second bailout for banks” as mentioned in a comment in the first block.
Within this paper, Nakamoto outlined his vision for Bitcoin, which revolved around blockchain technology. After the banking crisis in 2008, there was a large distrust in how the banks were operating. This sentiment was the reason blockchain technology had a huge spark in interest, and Bitcoin was starting to be used ahead of conventional methods due to the decentralised trust factor that it provides. As blockchain technology records information publicly, the threat of this information being altered is reduced dramatically.
The transparency offered by this technology has much broader applications than just Bitcoin and other cryptocurrencies alone. In the years that followed Nakamoto’s whitepaper, companies worldwide began to take note of blockchain technology and look into how it could improve their current methodology of executing transactions.
Is Bitcoin the same as blockchain? What’s the difference?
No, Bitcoin and the blockchain are different things. A common misconception is that Bitcoin and the blockchain are the same, but the reality is that the Bitcoin system simply uses blockchain technology to facilitate transactions.
Bitcoin is a digital currency with one specific use – to exchange value between two parties. However, the key thing to note is that blockchain technology has many potential uses. Although initially popularised by Bitcoin, this technology has many more applications than simple peer-to-peer transfers.
What is a Block?
The blockchain is a huge ledger that contains data on all of the transactions that occur on the network. Each ‘block’ can be thought of as a single page in this ledger and is made up of three distinct components.
Firstly, the block contains data on all of the transactions that are confirmed with that block. These transactions are public and witnessed by thousands of other people on the network.
Secondly, each block has a unique hash key that identifies that particular block. You can think of these hash keys as the block’s fingerprint.
Finally, each block has a hash that links to a previous block – a block only has information about transactions in that block. To find out about previous transactions, you can use the previous block hash to go back. This is why the technology is called ‘blockchain’.
What is a hash?
Hash functions take any input value of any size and create an output of a fixed length. They are usually a simple string of characters that make no sense to the human eye.
The hash acts as the encryption method for each individual block and is almost impossible to guess and if you change data on a block, you’ll produce a completely new hash key. Hashes are irreversible, sealing the block of information and as it is linked to existing data, it contains information about all the blocks that have come before it.
What is a node?
A node is essentially any electronic device that holds and maintains a copy of the distributed ledger. The primary function of nodes is to verify whether each block is valid or not. When a new block is added, its information is broadcast to all nodes within the network.
These nodes will then accept the block if it appears to be legitimate, or they will reject it if it does not – a majority of nodes need to say that the block is valid before its included into chain. This process is known as ‘block confirmation’ and enables nodes to take part in the verification of legitimate transactions across the blockchain network.
How are the blocks chained together?
When a new block is created and added to the network, it also contains the previous block’s hash key alongside the transactional data. Combined with its own unique hash key, each block has both a link to past transactions and a way of passing its own transactions forward.
This is what creates a chain of transactional history and means that every new block that is created can be linked back through all previous transactions that have ever happened. There are even some unique and interesting visualisations of the blocks in the bitcoin network such as:
How are transactions mapped to a block?
Before a transaction is added to the blockchain, it must be authenticated and authorised, plus one[BM1] [DK2] . Authentication is done using cryptographic keys, identifying the user via their private and public key. Their digital identity is verified via a digital signature, allowing the transaction to be unlocked.
Now, it must be approved. On a public blockchain, the ‘nodes’, or computers in the network, must agree the transaction is valid. Those who own these computers are incentivised to verify these transactions, which is completed via a complex mathematical calculation – this process is known as Proof of Work (PoW) in order to add the block to the chain.
What happens if a block is compromised or maliciously changed?
Every single time an edit is made on a block, the block’s unique hash is changed. This means that the block next in line in the chain would no longer contain the matching hash for the previous block.
At this point, there would be a conflict. The blockchain’s solution is to go with the mass response – meaning that the singular change that was made would be hugely outvoted by the thousands and thousands of nodes that contain the legitimate block. The system would then revert to the existing block and wouldn’t confirm the edited transaction that was falsified.
The more people running the blockchain, the harder and harder it would be to do anything malicious. At the time of writing, there are already over 83,000 nodes around the planet, making it essentially impossible for a falsified change to go through.
Can blockchain technology be implemented outside of cryptocurrency?
Yes, it can. Blockchain has a vast array of potential benefits for various business types. According to Statista, approximately $6.6 billion will be spent on blockchain solutions in 2021 – with this figure expected to triple by 2024.
Many practical uses for blockchain technology can be found within the financial sector. Perhaps the most apparent use is in speeding up transactions. The current system for receiving payments means that certain payment types can take up to five business days to arrive. This isn’t ideal, especially if you are processing a payment just before the weekend.
By implementing blockchain technology, payments can be validated much faster than the traditional banking system. Depending on the blockchain platform, transactions can be verified in minutes. Additionally, as blockchain platforms aren’t limited by conventional working hours, transactions could theoretically be completed over the weekend or during holidays.
Aside from the financial sector, blockchain technology could also have practical uses when it comes to real estate. When purchasing a house, there are vast amounts of paperwork involved in the entire process. Keeping track of this paperwork is complex and burdensome – and there is also the potential for costly human error.
Alternatively, in healthcare the potential for blockchain is huge. From encryption of patient data to cybersecurity and claims processing, historically costly processes can be significantly reduced, and efficiency improved by adopting the technology. As a case in point, 95% of Estonia’s health information is ledger-based since introducing blockchain into the healthcare system in 2012.
Finally, at Globacap we’re using the blockchain to overhaul the archaic processes behind private capital markets. Our aim is to use blockchain technology to automate the creation, management and transferability of shares and securities and to give back control to companies around the world.
Is blockchain transparent?
Yes, it is. Blockchain technology is inherently transparent due to the decentralised nature of the ledger. All of the nodes within the network have access to the ledger, allowing them to see every single transaction that has taken place. Each node’s copy of the ledger is also updated in real-time, allowing seamless live tracking of transactions.
Though it seems contradictory, blockchain is where transparency meets anonymity. Though transactions remain visible, they retain anonymity, and it is because of this that people are growing to trust and interact with the network.
Are transactions on the blockchain secure?
No system of facilitating transactions is 100% foolproof – yet blockchain technology does a fantastic job of improving on the drawbacks of traditional methods. Security on the blockchain is accomplished through the ‘linking’ of one block to the previous block. If the contents of a block (such as transaction data) were to be altered, it would then change that block’s hash key.
If a block’s hash key changes, the knock-on effect would be that the following block’s copy of that key would no longer be valid. The nodes on the network, who all have a copy of the ledger, would notice this change and then validate or reject it. So, if a cyber-attack occurred and someone attempted to steal funds, the data inside the block would change to reflect this attack. As such, the updated data would not align with what all the other nodes on the network would have – leading to the updated block being thrown out.
The acceptance or rejection of a block is brought about through a consensus algorithm. A minimum of 51% of the network’s nodes must accept any changes for any updates to be validated on the blockchain. When a majority of nodes agrees with a block, that block is considered the ‘genuine’ one and any different ones are rejected.
What is the difference between private and public blockchain?
Although the concepts are similar, there are some crucial distinctions between the two blockchain types:
- Public: A public blockchain is permissionless. This means that anyone can join the network and participate within the blockchain. Furthermore, public blockchains are decentralised, meaning that no single point of authority controls the network. Through this methodology, all transactions on the network are secure as they are validated by the nodes within that specific network.
- Private: In contrast to public blockchains, private blockchains are permissioned. These networks restrict the parties that can access the network – meaning that only certain people can participate. The parties allowed onto the network are facilitated through one or more authorities who control the network. As such, private blockchains are more centralised compared to their public counterparts but are still a step forward from traditional database systems.
What are the pros and cons of blockchain?
Blockchain technology is a huge step forward in enabling decentralisation of transaction records, but as with everything, there are still some drawbacks to the tech.
As all network participants hold a copy of the ledger, there is inherent transparency when using blockchain technology.
|Energy Expenditure: |
The nodes on a blockchain network use vast amounts of computational power to maintain the integrity of the network. As a blockchain network grows, more and more power is used – leading to substantial energy expenditures that can rival those of small countries. However it’s worth noting that this energy is often sourced from excess energy produced by power plants and renewables. Bitcoin miners can be placed anywhere in the world and miners chose to buy cheap excess electricity that otherwise would go to waste.
The decentralised nature of blockchain technology removes the middleman. This reduces the risk of trusting one single entity whilst also reducing costs.
There’s still a long way to go until blockchain matures and is standardised. Educating users is key to driving adoption.
As all nodes keep a copy of the ledger, the risk of it being destroyed or lost is essentially impossible. If one node were to disappear, it would not affect the security of the network.
|Highly Resistant to Tampering: |
Due to the consensus protocol used to validate new or altered blocks, it is tough for cyber-attacks to take place.
Blockchain technology isn’t restricted by the same working hours that traditional institutions abide by. As such, transactions can take place quickly and during weekends.