What Is Blockchain and How Does It Work?

Blockchain is an innovative database technology that is at the heart of almost all cryptocurrencies. Distributing similar copies of a database across an entire network makes blockchain systems very difficult to hack or cheat.

Although cryptocurrency is currently the most popular use for blockchain, the technology offers the potential to serve a wide range of applications.

What is a blockchain

At its core, blockchain is a distributed digital laser that stores any type of data. A blockchain can record information about cryptocurrency transactions, NFT ownership or DeFi smart contracts.

Although any conventional database can store this type of information, blockchain is unique in that it is completely decentralized. Instead of being maintained in one place by a centralized administrator – think of an Excel spreadsheet or a bank database – multiple identical copies of a blockchain database are stored on multiple computers spread across a network. These are referred to as individual computer nodes.

How does blockchain work?

The name blockchain is rarely accidental: digital lasers are often described as a “chain” made up of individual “blocks” of data. As fresh data is periodically added to the network, a new “block” is created and attached to the “chain”. This involves updating all node blockchain laser versions to be identical.

How these new blocks are created is why blockchain is considered extremely secure. Most nodes must verify and confirm the validity of new data before adding a new block to the laser. For a cryptocurrency, they can ensure that new transactions in a block are not fraudulent, or that coins have not been spent more than once. This is different from a separate database or spreadsheet, where an individual can make changes without supervision.

Duane Morris LLP is a partner in the Fintech practice area. Neil Gray says, “If agreed, the block is added to the chain and the underlying transactions are recorded in the distribution ledger.” “The blocks are securely connected together, creating a secure digital chain from the beginning of the laser to the present.”

Transactions are usually secured using cryptography, which means that nodes have to solve complex mathematical equations in order to process a transaction.

Public blockchain vs private blockchain

There are both public and private blockchains. In a public blockchain, anyone can participate which means they can read, write or audit blockchain data. Significantly, it is very difficult to change the transactions logged in the public blockchain because no single authority controls the nodes.

An individual blockchain, meanwhile, is controlled by an organization or group. Only it can decide who will be invited to the system and it has the power to go back and change the blockchain. This private blockchain process is like an in-house data storage system without having to spread across multiple nodes to increase security.

How is blockchain used

Blockchain technology is used for a variety of purposes, from providing financial services to operating the voting system.

Cryptocurrency

Currently the most common use of blockchain is the backbone of cryptocurrencies such as Bitcoin or Etherium. When people buy, exchange or spend cryptocurrencies, transactions are recorded on a blockchain. The more people use cryptocurrencies, the more the blockchain can expand.

Banking

Outside of cryptocurrencies, blockchains are being used to process transactions in fiat currencies such as the dollar and the euro. This can be faster than sending money through a bank or other financial institution because transactions can be verified more quickly and processed outside of normal business hours.

Transfer of assets

Blockchain can also be used to record and transfer ownership of various assets. It is currently very popular with digital resources such as NFT, which represents digital art and video ownership.

However, blockchain can also be used to process real-life asset ownership, such as real estate and vehicle documents. Two parties to a party will first verify using blockchain that one owns the property and the other has money to buy; They can then complete and record sales on the blockchain.

Using this process, they can transfer property deeds without having to manually submit paperwork to update local county government records; It will be updated instantly on the blockchain.

Smart deal

Another blockchain innovation is that self-executing contracts are commonly referred to as “smart contracts”. These digital agreements come into effect automatically once the conditions are met. For example, buyers and sellers may have to pay a price for a product as well as meet all the specified parameters for a contract.

“We see a lot of potential in smart contracts – using blockchain technology and coded instructions to automate legal contracts,” Gray said. “A properly coded smart legal contract in a distributed ledger can reduce or eliminate the need for an outside third party to verify performance.”

Supply chain monitoring

The supply chain involves a lot of information, especially when the product moves from one part of the world to another. With traditional data storage methods, it can be difficult to find the source of the problem, such as a seller coming from a low quality product. Blockchain will make it easier to store this information, and supply chain monitoring will be easier, as with IBM’s Food Trust, which uses blockchain technology to track food crops from consumption to consumption.

Vote

Experts are looking for ways to implement blockchain to prevent vote fraud. Theoretically, blockchain voting would allow people to submit votes that could not be rigged, as well as eliminate the need for people to collect and verify ballot papers manually.

The advantage of blockchain :

The higher the accuracy of the transaction

Because a blockchain transaction must be verified by multiple nodes, this can reduce errors. If one node has an error in the database, others will see it differently and catch the error.

In contrast, in a traditional database, if someone makes a mistake, they are more likely to go through it. In addition, the blockchain ledger identifies and tracks each asset individually, so there is no chance of double spending (such as a person overdrawing his bank account, resulting in double spending).

There is no need for intermediaries

Using blockchain, two parties to a transaction can confirm and complete something without having to work through a third party. It saves time as well as paying for intermediaries like a bank

“It has the potential to bring greater efficiency to all digital commerce, increase the financial empowerment of the world’s non-bank or underbanked population, and consequently empower a new generation of Internet applications,” said Schilman.

Extra security

Theoretically, a decentralized network like blockchain makes it almost impossible for anyone to make fraudulent transactions. To make fake transactions, they need to hack each node and change each laser. While this is not necessarily impossible, many cryptocurrency blockchain systems use proof-of-stack or proof-of-work transaction verification methods that make it difficult to add fraudulent transactions, as well as not in the best interests of participants.

More efficient transfer

Since blockchains operate 24/7, people can transfer more efficient financial and resources, especially internationally. They don’t have to wait days for banks or government agencies to confirm everything manually.

Disadvantages of blockchain :

Transaction limit per second

Given that blockchain relies on a larger network to approve transactions, there is a limit to how fast it can be moved. For example, Bitcoin can process only 4.6 transactions per second versus 1,700 visas per second. In addition, increasing the number of transactions can create network speed problems. Until it improves, scalability is a challenge.

High energy consumption

It takes significantly more power than a single database or spreadsheet to work all nodes to verify a transaction. Not only does this make blockchain-based transactions more expensive, it also creates a larger carbon burden on the environment.

For this reason, some industry leaders have begun to move away from certain blockchain technologies, such as Bitcoin: for example, Elon Musk recently said that Tesla would partially stop accepting Bitcoin because he was concerned about environmental damage.

Risk of asset loss

Some digital assets are secured using a cryptographic key, such as cryptocurrency in a blockchain wallet. You need to protect this key carefully.

“If a digital asset owner loses a personal cryptographic key that gives them access to their property, there is currently no way to recover it – the asset is permanently gone,” Gray said. Because the system is decentralized, you cannot call a central authority like your bank and ask them to restore access.

Potential for illegal activity

The decentralization of blockchain adds more privacy and confidentiality, which unfortunately makes it attractive to criminals. It is harder to track illegal transactions in a blockchain than a named bank transaction.

How to invest in blockchain

You can’t actually invest in blockchain, since it’s just a system for storing and processing transactions. However, you can invest in assets and companies using this technology.

“The easiest way is to buy cryptocurrencies, such as Bitcoin, Etherium and other tokens that run on the blockchain,” says Gray.

Another option is to invest in blockchain companies using this technology. For example, Santander Bank is experimenting with blockchain-based financial products and if you are interested in exposure to blockchain technology in your portfolio, you can buy its stock.

For a more diverse approach, you can buy an Exchange-Traded Fund (ETF) that invests in blockchain assets and companies, such as Amplify Transformational Data Sharing ETF (BLOK), which holds at least 80% of its assets in blockchain companies.

Bottom Line

Despite its promise, blockchain remains something of a special technology. Gray sees the possibility of using blockchain in further situations but it depends on future government policy.

Styleman compared the blockchain to the early stages of the Internet. “It took us about 15 years to get to the Internet before we saw the first version of Google, and it took more than 20 years for Facebook. It’s hard to predict where blockchain technology will be in the next 10 or 15 years, but like the Internet, it will significantly transform the way we transact and communicate with each other in the future. “

Barriers remain, especially with transaction limits and energy costs, but blockchain-based investments may be acceptable for investors who see the potential in technology.

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