What Is Blockchain Technology and How Does It Work?

by?William Naranjo? on July 17, 2022

Blockchain technology has demonstrated a new method for processing, managing, and recording transactions that does away with elements previously taken for granted, including intermediaries, because to its decentralized design.

Up until now, we’ve thought that a worldwide computer network would require a hub and an administrator. Furthermore, the notion that a network might generate its own money was pure science fiction. Blockchain technology, on the other hand, has demonstrated that a sizable network may live just on the computers that use it, be accessible to anybody with an internet connection, and issue its own money.

Blockchain networks have created a new, secure method for distributing assets anywhere in the world by supporting cryptocurrencies like Bitcoin and Ethereum. The main advantage is that a bank or other middleman is not required to process the transaction.

What is blockchain?

In a nutshell, peer-to-peer computer networks that process and log online transactions are what blockchains are. A blockchain is a decentralized system, which means it isn’t run by any form of organization, agency, or body. Native currencies like Bitcoin and, in the case of Ethereum, digital files known as smart contracts that store assets and information are traded on blockchains. Like stocks, bonds, or index funds, investors can trade digital tokens.

Blockchains don’t need an intermediary or broker to complete transactions or offer financial services, unlike bank transfers or stock trades. Because of the strength of the program, each token is unique and cannot be replicated. Because of this, blockchains are frequently referred to as “permissionless networks,” which refers to systems that operate without oversight or a centralized body to vouch for the legitimacy of participants.

The immutability of blockchain technology is one of its novel qualities. For example, once a transaction is added to the Bitcoin blockchain, it cannot be deleted or modified. Due to this, blockchains are frequently referred to as systems that guarantee assets without the need for trust: There is no requirement to rely on a third party to verify the legitimacy of their transactions because they cannot be copied or fabricated.

Additionally, the Bitcoin blockchain is open for anybody with an internet connection to view transactions, even though users maintain their anonymity. This strategy has also been implemented by other blockchains. Blockchains are essentially digital ledgers, or logs of every transaction, that are stored on every computer involved in their upkeep. Distributed ledger technology, or DLT, is what proponents of cryptocurrencies refer to as a blockchain’s wide range of features and uses.

Are there different types of blockchains?

Blockchains occur in a variety of forms. A public blockchain network is the original one that underpins Bitcoin, and it is accessible to anyone who wants to download it. Ethereum is the second-largest blockchain in terms of users and value. It is also open-source, albeit the Ethereum Foundation oversees its development through analysis and updates.

Then there are blockchains that are private or have permission. These emerged in 2016, when Wall Street started to show interest in the technology but objected to its openness. Financial institutions customized blockchain technology so that only members may use it while keeping in mind regulatory requirements and client confidentiality. The world’s largest blockchain is now hosted by R3, one of the first consortiums to follow this route, for use by companies involved in the capital markets including Nasdaq and Amazon’s AWS cloud computing division.

How does blockchain technology work?

The concept that a database might be spread across a network rather than centralized in one place is the foundation of the digital ledger that the enigmatic Satoshi Nakamoto first proposed in a white paper in 2009. Blockchain, as its name suggests, is made up of data blocks that each record a Bitcoin transaction that takes place worldwide around every ten minutes.

Those that solve challenging mathematical puzzles first are rewarded with Bitcoin, which motivates miners to hash, or put together blocks of data that are uploaded to the chain. This method is known as proof of work (PoW). As a result, the Bitcoin blockchain operates independently of any centralized authority. Numerous imitation blockchains with their own digital tokens have been created as a result.

Blockchains vs. traditional databases

Traditional databases typically reside in vast industrial parks filled with servers and storage computers, and they are run by governments, businesses, and other organizations with the customary staff of senior administrators, programmers, and technicians. Tables, not blocks, are used in traditional databases. Additionally, access is only permitted for registered individuals and is not available to anybody with an internet connection. Most of the time, the public cannot see them either.

What is a blockchain used for?

Despite being the largest blockchain, the one for Bitcoin has a very simple purpose: to make it easier to create and use Bitcoin, an alternative currency whose proponents believe will challenge the dominance of the US dollar and other fiat currencies.

In contrast, the Ethereum blockchain is made to make it easier to create and spread so-called smart contract applications. These decentralized apps are capable of dispersing vast amounts of data to users. Ether, the virtual money at the center of Ethereum, makes them possible. Unlike Bitcoin, ETH isn’t meant to be used as money in and of itself; rather, it’s a software tool to encourage the development of apps and to help connect them; it’s not meant to take the place of the US dollar.

To that purpose, a community of initiatives that create DeFi-focused apps is supported by the Ethereum blockchain. They offer services to allow users can exchange Ether for other tokens, give loans, and offer digital wallets. One of the largest DeFi players is Uniswap, while the other is MakerDAO.

Entrepreneurs can also create decentralized autonomous organizations, or DAOs, using the Ethereum blockchain. These cooperative groups function on the blockchain rather than in a physical location, and their members typically band together around a cause like creating art or making investments.

Blockchain technology has also been adopted by conventional industries. The usage of logistics businesses allows for the real-time management of the digital ledger by all parties involved in supply chains as well as the tracking of items in transit. In order to prevent property theft and corruption, the national governments of Zambia and Georgia have experimented with employing blockchain technology’s immutability for land records. In a similar vein, some political scientists have promoted the use of blockchain technology to organize and record election results in order to encourage online voting and discourage vote-buying. Private blockchains are also viewed by healthcare practitioners as a potentially superior method of managing databases of medical records.

Auction houses and insurance companies have also used the technology to trace and document the provenance of fine art, wine, and other high-end antiques. Even the unique qualities of diamonds have been recorded using blockchain technology so they can be tracked from the time they are mined to the point of sale.

Potential advantages of blockchain technology

Blockchain technology does some things better than traditional networks.

1. Accuracy. Decentralized ledger technology can process and record transactions and other network activity with virtually no risk of alteration because the information is shared across many thousands of nodes.
2. Efficiency. Blockchain software permits parties to participate in transactions without the need for an intermediary.
3. Transparency. Public blockchain networks are accessible to anyone.
4. Security. Thanks to their decentralized structure, blockchains are extremely hard to hack because there’s no hub to attack.
5. Economical. As a permissionless network, a blockchain can move assets anywhere on the internet with minimal fees.

Potential drawbacks to blockchain technology

Blockchain technology’s innovations are offset by several weaknesses.

1. Energy consumption. Mining Bitcoin has become an industrialized business that requires massive computer farms and sources of electricity, potentially worsening global warming.
2. Scalability. While blockchains have removed intermediaries, the process of adding transactions to chains can be slower than traditional methods.
3. Lost assets. Users who misplace or lose the alphanumeric keys to Bitcoin and other digital tokens can almost never recover their assets.
4. Crime. Because blockchains are largely unregulated, they can be used to launder illicit wealth and facilitate illegal activity.
5. No watchdogs, yet. There is little recourse for investors and users who lose assets to fraud or hackers, but regulators such as the U.S. Securities and Exchange Commission are poised to crack down.

Blockchain hype and reality

A speculative bubble caused by blockchain technology reached $3 trillion at one point in 2021. International financial institutions, media giants, even the U.S. Federal Reserve, are vying to comprehend and implement blockchain in some way. Additionally, it is influencing popular culture by promoting the creation of NFTs, digital images that can be purchased and sold, and the metaverse, a virtual reality environment. Co-founder of Twitter and CEO of payments startup Square Jack Dorsey is such a strong proponent that in 2021 he changed the latter company’s name to Block.

Even said, ranking blockchain among digital engineering wonders like the web browser or search engine, both of which transformed how we use the internet and the global economy, may be premature. Despite all the excitement, blockchain technology has yet to take off and change the way we live. This is a major factor in the volatile and speculative nature of the cryptocurrency market. Blockchain technology has the ability to completely rewire the digital architecture of a wide range of businesses, but it must first show that it is a vast improvement over the status quo.

The bottom line

Blockchain technology has generated more excitement and controversy than any other recent advance in computer science. Blockchain has demonstrated that there is a new method for processing, managing, and recording transactions that does away with elements previously taken for granted, including intermediaries, thanks to its innovative decentralized design.

The innovation has also created a completely new asset class for the capital markets by using digital tokens to power the software. This has led to a wave of speculation unprecedented since the height of the dot-com boom in the late 1990s.

Blockchain will need to overcome a number of obstacles before it can be widely implemented, including governmental scrutiny and its inherent technical constraints. Convincing consumers and businesses that their preferred system is a significant upgrade over the status quo is perhaps the most significant obstacle that proponents of blockchain must overcome. Blockchain will remain a fascinating and, in some cases, valuable software tool up until that time. But it might not have the impact on the world that its ardent supporters hope for.

by?William Naranjo? on July 17, 2022