Blockchain Fully Explained — An Overview of The Technology That Is Transforming the Financial World

Blockchain technology is to 2021, what the Internet was to the late 1990s. It feels more like science fiction than reality. No more queues at banks and signing of forms to make deposits, or paying ridiculously high bank fees.

To many, blockchains are a fad that will come and go. But just as how the Internet stuck around, blockchains do not look like they are leaving anytime soon either.

Cryptocurrency, an application of blockchains, has changed the financial system. Yet, few understand the technology that has made this possible.

In this article, we will be looking into blockchain and its usefulness in detail.

What Is Blockchain?

Thousands of cryptocurrency transactions are made per second. These transactions are recorded in a digital ledger. The ledgers are in turn put in data structures called blocks. Blocks are immutable, which means that once the ledgers are recorded, they cannot be changed.

Each block has a hash and a timestamp which contains information from previous and subsequent blocks. Because these blocks are immutable, the information obtained can also not be changed. The block receiving them becomes immutable by default.

All the blocks stacked together in a chain are what we call a blockchain.

History of Blockchains

The idea of a blockchain was first proposed by a cryptographer named David Chaum in 1982, and the concept of consortiums was introduced by Stuart Haber and W. Scott Stornetta in 1991.

The first blockchain was developed by Satoshi Nakamoto in 2008 although the name ‘Satoshi Nakamoto’ is a pseudonym and its owner is still unknown.

In 2009, Satoshi founded the Bitcoin network which implemented blockchain technology, and bitcoin became the world’s first digital currency.

How It Works

To understand how a blockchain works you would have to be familiar with some concepts.

Decentralization

A database needs a computer to store its data. In a tech company like Facebook, there are hundreds of computers stored in a central room that serves this purpose. The company also has full control over the data.

However, this poses a huge security risk. If the room is breached and the computers are tampered with, the data that would be lost (or stolen) would be huge. The company could also tamper with the data and this could affect the entire information stored.

Blockchains evade this risk by having the computers (which are called nodes) distributed across the globe. Different groups control these computers and none have full control. This is decentralization.

Each node has a complete record of all data on the network. Thus, if an error occurs in one node, it can simply access the data from another node and make corrections. If the data is breached, the other nodes can easily identify it too.

Hash

To understand a hash, think of a written text that is held in front of a mirror. The text is converted to an anagram that has to be decoded. A hash is a mathematical algorithm created through cryptography, that encodes certain information in a block.

A hash cannot be reversed. It is also impossible to find multiple data that will give the same hash.

Attempting to decode a hash is infeasible. In the bitcoin network, the cost of decoding the hash is so large that no one would even try to attempt it.

Timestamp

A timestamp is critical for the security of cryptocurrencies. It is a method of ascertaining the exact time a transaction is made.

A timestamp is created from a hash, so once created, it cannot be altered — even by the owner of whatever has been stamped.

Security

The hash and timestamp make a blockchain very secure but could a hacker still manage to hack it?

Although it is difficult, blockchains can be hacked.

https://twitter.com/PolyNetwork2/status/1425073987164381196?t=RUvgqlr3Az-i8tMdNNUEzw&s=19

To do this, the hacker would have to simultaneously alter 51% of the blocks. If they were to alter just their copy, it would be easily identified and rejected by other copies. But if a minimum 51% of all copies of the blockchain are changed, they get the majority and can manipulate the blockchain.

However, to execute a hack like this would require a colossal amount of money and resources.

Also, the Bitcoin network grows rapidly each day. When members notice an alteration, they would simply fork (move) to another chain. This would plunge the monetary value of the stolen Bitcoins, making them worthless.

Ethereum forked and created Ethereum Classic (ETC) after it was hacked. It forked again to create Altair though it was not because of a hack. Bitfly announced the then-forthcoming fork in a tweet:

https://twitter.com/etherchain_org/status/1445399457831456771?t=l9bVKSllgbsOn7ojHq7KfA&s=19

Consensus

The most important function of blockchain is that there is no need for a third party during transactions, all transactions are peer-to-peer.

This is achieved using consensus mechanisms. The major types are:

Proof of Work

This is informally known as mining. PoW makes use of Cryptography when validating transactions.

PoW requires a lot of electricity. It also has a low number of transactions that can be processed at the same time. In Bitcoin, this number is seven.

These transactions take about ten minutes in Bitcoin but could take longer if the network traffic is congested. Bitcoin and Ethereum use PoW but Ethereum intends to switch to Proof-of-Stake in 2022.

Proof-of-Stake

In this method, a validator is chosen based on the number of coins they have. This is called a ‘stake’.

Cryptography is also used in PoS for validations but this is not mining. The chances a person has of being chosen as a validator increase with an increase in stake.

Proof-of-Stake transactions are done in seconds. The NEO and Dash are examples of cryptocurrencies using PoS.

Advantages of Blockchain

It is trustworthy:

Blockchains can automatically make trusted transactions between two or more parties that are not related.

It is unstoppable:

There are programmed conditions that must be met before transactions are executed. If these conditions are met, a transaction is initiated. Once a transaction is initiated, it cannot be stopped.

It is immutable:

The blocks in a blockchain cannot be altered — Bitcoin has never been hacked. This makes the records in a blockchain secure and safe.

Low cost:

Unlike banks that charge high fees for transactions, blockchains have no third parties and the fees are much lower.

Universal banking:

There are security risks posed by having cash in physical locations. In blockchains, there is no need for a physical bank and a bank account.

Disadvantages of Blockchain

Environmental impact:

Bitcoin consumes a huge amount of electricity during mining and this affects the climate. According to researchers, Bitcoin consumes more energy than small European countries. Here is a comparison of Bitcoin’s energy consumption of some countries.

Personal responsibility:

The biggest advantage of Blockchain technology is that it makes YOU a bank. You fully own and control your money. But this is also a big disadvantage. If you lose your Seed phrase (the password to your account) you lose all your money and there is no means of retrieving them.

Getting a basic understanding of blockchains is useful to both the Wall Street financier and the small-time crypto investor. Both need it to make faster transactions and better decisions.

With the increasing use in real-time applications such as smart contracts, it is safe to say blockchain technology is here to stay. As companies realize their potentials and commit their resources, the future beneficial uses of the technology are limitless.