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What is Blockchain and How Does it Work?
A blockchain is a distributed ledger used to store data or transactions. A blockchain works in a similar manner to a normal database, except that it is entirely decentralized. This means that data is stored across multiple locations and is not owned and operated by a single, centralized body. To truly answer the question, “what is blockchain?”, it’s important to understand how it works and why it’s used.
Below, I’ll break down some of the fundamentals behind blockchain technology and explain how it’s being used to create, track and store digital currencies.
- What is Blockchain?
- How Does Blockchain Work?
- What is Blockchain Used For?
- Types of Blockchain Networks
- Key Features of Blockchain Technology
- Bitcoin vs Blockchain
- Pros and Cons of Blockchain Technology
- Important Things to Know About Blockchain
- Final Thoughts
- More about Blockchain
- FAQs
What is Blockchain?
A blockchain is a decentralized digital ledger that records transactions. The ledger is stored across multiple points on a network and is secured using cryptography, making it much less susceptible to malicious attacks compared to a traditional database.
Blockchain technology is most commonly used within the cryptocurrency and decentralized finance (DeFi) space, but its potential use cases are actually much greater.
In theory, any industry that would benefit from the storage of sensitive data in a way that is immutable (unalterable) would benefit from the implementation of blockchain technology.
Within cryptocurrency, however, blockchain technology is used to enable safe peer-to-peer (P2P) transactions, using decentralized techniques to remove the need for third-party intermediaries.
How Does Blockchain Work?
Blockchain technology works by storing data in a “block”, which is then cryptographically secured and linked to the preceding block in a “chain”.
Blocks are the digital ledgers that are constantly being updated and added to. Think of them as containers of information with a limited storage capacity; once it is full of data, it is sealed and linked to the previous block.
Every time a cryptocurrency transaction takes place on a specific blockchain, for example, this information is permanently recorded and added to this database.
What are blockchain nodes?
Blockchains work using “nodes”, which are connected points within a network, used to receive, store and send information.
Within blockchain technology, I sometimes find it useful to think of a node as a computer or server on a network, working automatically to validate and process transactions. Nodes work to guarantee the integrity and security of the network by making sure that all participants are following the network’s rules.
Once a group of transactions (a block) is added to the blockchain, this information is broadcast between nodes.
The other nodes on the network validate the transactions on this new block, updating their own databases to ensure accuracy and consistency.
If all nodes agree that the data stored within this new block is accurate and has not been altered, a “consensus” has been reached and the block is sealed.
This process means that every blockchain node always has a complete, up-to-date version of all historical transactions on a network.
This system of decentralization (not having a single entity in charge of the data) makes it incredibly difficult for hackers to tamper with the information on a blockchain. If any code is changed or somebody attempts to double-spend or duplicate a cryptocurrency, this is flagged by the other nodes on the network.
How are blockchains secured?
Blockchains use cryptography to maintain network security. Once a block is complete and added to the chain, a “cryptographic hash”, a 256-bit (binary digit) whole number, is generated and attached to the block, almost like a digital fingerprint.
The block is permanently bound to those numbers and any time the data within a block is altered or changed, the hash value will also change. If the hash value doesn’t match the original data, the network will know that the information has been altered.
What is Blockchain Used For?
Blockchain technology is used to create a digital, distributed, unalterable record of data. As well as transactions, blockchain technology can track orders, accounts, payments and information, all with a built-in system for preventing unauthorized or inaccurate additions.
Although it is primarily used within Web3 and DeFi, blockchain technology has many use cases (although some of them are still theoretical!):
- Energy: Blockchain technology can be used to create P2P energy trading platforms. For example, households with excess energy can sell this energy to their neighbors in an automated, immutable fashion.
- Finance: Blockchain technology can be used within traditional finance to manage online payments, trades and accounts.
- Retail: Blockchain technology can be used to track the movement of goods, verify authenticity and monitor global supply chains.
- Healthcare: Blockchain technology can be used to streamline patient data management and automate medical billing.
Types of Blockchain Networks
Not all blockchain networks are the same. Below, I’ve broken down some of the most common types of blockchains used within the cryptocurrency space.
As the name suggests, a public blockchain allows anybody to join and participate in the network’s core activities. This means that all data, including information relating to transactions, can be audited by anybody at any time.
Public blockchains are considered an essential part in the push towards a self-governed, decentralized future.
Information is not stored in any one place on a public blockchain and is instead distributed across a peer-to-peer network. With that in mind, the more network participants that join, the more secure it becomes.
Public blockchains are permissionless, meaning that nobody can dictate how, and by who, they are used. Anybody with internet access can become an authorized node and access records.
However, while most public blockchains allow anybody to verify transactions and propose changes, some do not allow individuals to make actual changes to the blockchain itself.
A private blockchain is a blockchain network that can only be joined through invitation or is controlled by a single entity.
Day-to-day operations are not dissimilar to a public blockchain, it is usually run on a much smaller scale.
Private blockchains dictate who can participate in the network, run nodes or validate and authenticate changes.
With private blockchains, there is much less of a focus on decentralization.
They often operate within a company or organization, used for the benefits that come with a cryptographically secured database, rather than from a desire to remove control away from a centralized entity.
Permissioned blockchains are not publicly accessible. Similar to a private blockchain, users will need permission in order to access the network.
Participants can only perform specific actions, depending on the level of access they’ve been granted by the blockchain’s owner.
Users will also often need to identify themselves in some manner.
The permissioned nature of these blockchains is usually considered to be an additional level of protection. With only specific individuals able to make changes or access certain data, the entity in charge of the permissioned blockchain can be confident in who is involved in the network.
Consortium blockchains combine some of the features of both private and public blockchain networks.
Consortium blockchains are usually private, at least partially, with no single owner. Instead, multiple organizations can work together collaboratively, maintaining control over the network without allowing unrestricted access in the same way that a public blockchain does.
This system also helps to eliminate the risks attached to a blockchain being controlled by a single entity.
Limiting participation on consortium blockchains increases security and efficiency, while also promoting transparency, decentralization and collaboration.
Key Features of Blockchain Technology
There are many benefits of blockchain technology, including decentralization, transparency, immutability, scalability and consensus. I’ve broken down some of the key advantages of blockchain technology below.
Decentralization
A decentralized blockchain is one that transfers control of the blockchain to a distributed network of participants.
Decentralization provides a trustless environment, meaning that nobody on the network needs to know anybody else on the network, while also reducing points of weakness by distributing control across nodes.
This increases the network’s security, with a distributed network making it incredibly difficult for malicious actors to control the network.
If one element of the blockchain fails, the system can continue functioning. Unless more than 50% of nodes are hacked simultaneously, the blockchain network should continue to function as normal.
Transparency
Transparency is becoming increasingly important, although this is often difficult to achieve in traditional, centralized systems.
Blockchain uses distributed ledger technology (DLT), ensuring that transactions are recorded identically across multiple locations. Individuals are able to track transaction history, reducing the possibility of fraudulent activities which are becoming increasingly prevalent in the DeFi space.
Immutability
Cryptography ensures that blockchains are immutable, meaning that the data stored on the network cannot be altered. This ensures the integrity and accuracy of the information being stored on the blockchain, as it cannot be edited or deleted after it has been recorded. This makes blockchain technology an especially ideal solution for the storage of sensitive data.
Immutability also helps to prevent disputes. With all transactions being permanently recorded, it is possible to be 100% confident in the validity of a transaction between a buyer and a seller.
Consensus
Consensus is a fundamental part of any blockchain network, enabling decentralization and ensuring the information stored on a network is accurate. There are a range of different consensus mechanisms, but the most popular are “Proof of Work” (PoW) and “Proof of Stake” (PoS).
On a Proof of Work blockchain, validators (or miners) compete to solve a complex mathematical equation. The first person to complete the equation is able to validate the next block of transactions, and is usually rewarded a set amount of the blockchain’s native cryptocurrency for their work in securing the network.
On a Proof of Stake blockchain, validators will offer an amount of the network’s native cryptocurrency as collateral.
These validators will then be entered into a lottery, the winner of which will validate the next block of transactions. As is the case with PoW networks, successful validators are awarded an amount of the cryptocurrency as a result.
Bitcoin vs Blockchain
If you’ve ever struggled to understand the difference between “Bitcoin” and “Blockchain”, you’re not alone! The two have some fundamental differences, so I’ve defined them both:
- Blockchain: A blockchain is a distributed ledger designed to securely store data. Blockchain technology also enables the existence of cryptocurrencies.
- Bitcoin: Bitcoin is a public blockchain that is used to create and manage a cryptocurrency of the same name.
The Bitcoin blockchain enables and records transactions made using the bitcoin (BTC) cryptocurrency. It is therefore possible to buy bitcoin and send bitcoin around the world.
In other words, blockchain is the technology that the Bitcoin ecosystem is built around.
Other popular blockchain ecosystems include Ethereum and Solana (which also have native cryptocurrencies).
Pros and Cons of Blockchain Technology
There are a range of advantages and disadvantages to blockchain technology. As a relatively new, emerging technology, it’s clear that there are some teething issues that still need working out, but the potential for blockchain technology is immeasurable.
| Advnatages of Blockchain Technology | Disadvantages of Blockchain Technology |
| Immutability: The immutability of a blockchain makes it impossible to erase or replace data. This prevents data tampering and ensures accuracy of transactions. | Speed: Even the fastest blockchains are often considerably slower than traditional databases. This is because blockchains perform additional actions to verify and validate transactions. |
| Transparency: Most blockchains are decentralized, allowing any network participant to find and verify recorded data. This means that individuals can trust the network and the information recorded on it. | Cost: Blockchains usually have a high implementation cost compared to traditional databases. Many companies also do not have the infrastructure in place to integrate blockchain technology into their day-to-day processes. |
| Censorship Resistance: Blockchain technology is relatively free from censorship, with most blockchains not being controlled by a single entity. This means that the network’s operation cannot be interrupted by one person/group of people. | Environmental Impact: Some blockchains (but not all) can have a negative environmental impact. For example, Proof of Work blockchains require significant computational power to validate blocks, making them much less environmentally friendly than some traditional alternatives. |
Important Things to Know About Blockchain
Blockchain technology is constantly evolving, as are the industries looking to implement it. As a result, there are always new developments and blockchain news to be aware of.
- A research report in June 2024 considers the potential implementation of blockchain technology in the protection of private data for individuals living in smart homes. Given the sensitive nature of this data, researchers have suggested that permissioned blockchains could provide privacy through cryptography and consensus algorithms.
- Popular blockchain solutions provider Ripple has teamed up with the DIFC Innovation Hub, based in Dubai, to improve blockchain and digital asset innovation in the UAE. Ripple plans to connect developers to the DIFC Hub, which is home to more than 1,000 regulators, venture capitalists, digital labs and tech companies.
- The Blockchain Center, a center aimed at driving growth in the blockchain sector in Abu Dhabi, was launched in August 2024. The Blockchain Center is designed to cement Abu Dhabi as a global industry leader.
Final Thoughts
Blockchain is a revolutionary technology that securely records transactions across a distributed system of nodes. Focusing on decentralization, immutability and transparency, blockchain technology is highly secure and resistant to fraudulent activities.
Best known for its use within the cryptocurrency space, blockchain technology has a range of potential applications across finance, healthcare, education, and more.
Despite the challenges that it currently faces, I’m confident that blockchain technology will continue to evolve, redefining how we interact with data and data storage.
More about Blockchain
What is a Blockchain Explorer?
What is a Blockchain Ecosystem?
FAQs
What is the blockchain in simple terms?
To put it simply, blockchain is a distributed database that stores information relating to transactions. This information is stored in containers of information, referred to as “blocks”, which are linked together securely using cryptography.
What is an example of a blockchain?
Bitcoin is the most famous example of a blockchain. The Bitcoin blockchain is a distributed, public ledger that contains information relating to every bitcoin transaction. The Ethereum blockchain is another example of a blockchain.
What is the main purpose of blockchain?
The main purpose of a blockchain is maintaining a secure, decentralized record of cryptocurrency transactions. Blockchain technology is vitally important in removing the involvement of third-party intermediaries from financial transactions.
What is the blockchain trilema?
The “blockchain trilema” is a term coined by Ethereum co-founder Vitalik Buterin. It suggests that developers encounter three main issues when building a blockchain: decentralization, scalability and security. Buterin believes that developers will always need to sacrifice one of these three aspects in order to accommodate the other two.
What is Bitcoin blockchain?
The Bitcoin blockchain describes only the technology in which the currency is housed, while the Bitcoin cryptocurrency describes only the currency itself.
How does blockchain work?
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.
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