Crypto

What Is Blockchain and How Does It Work?

What Is Blockchain and How Does It Work?

Explanation of Cryptocurrency’s Technology

Blockchain is the technology that underpins bitcoin and dozens of other cryptocurrencies, and it has a lot of promise outside of digital currencies.

Blockchain technology is one of the most talked-about inventions of the twenty-first century. Blockchains, which were created to support Bitcoin, now power dozens more cryptocurrencies, and developers are seeking to integrate the technology into industries such as medicine, art, and banking.

Understanding how blockchain works, why it has value, and how it differs from other internet technologies might assist to grasp the growing interest.

The Definition of Blockchain

A blockchain is a digital log of transactions that are kept by a network of computers and is difficult to hack or alter. Individuals can transact securely with one another without the need for an intermediary like a government, bank, or another third party.

Cryptography is used to link the expanding list of records, known as blocks. Each transaction is independently validated, time-stamped, and contributed to a growing chain of data using peer-to-peer computer networks. The info can’t be changed once it’s been recorded.

While bitcoin, Ethereum, and other cryptocurrencies have gained popularity, blockchain technology has potential uses in legal contracts, property sales, medical records, and any other field that requires the authorization and recording of a series of activities or transactions.

What is blockchain and how does it work?

Here’s how blockchain, also known as distributed ledger technology, works using the bitcoin system as an example:

Bitcoin transactions are entered and broadcast by a network of powerful computers known as nodes.

Using computer algorithms, this network of thousands of nodes throughout the world competes to confirm the transaction. Bitcoin mining is the term for this. The miner that completes a new block first is rewarded with bitcoin for their efforts. These fees are made up of newly created bitcoin and network fees, which are passed on to the buyer and seller. Depending on the volume of transactions, the costs may increase or decrease.

The sale is added to a block on the distributed ledger after it is cryptographically confirmed. The transaction must next be confirmed by the majority of the network.

The sale is performed when the block is irrevocably chained to all prior blocks of bitcoin transactions using a cryptographic fingerprint known as a hash.

Blockchain technology was first mentioned in academic papers in 1982, in a dissertation on “the architecture of a distributed computer system that may be built, maintained, and trusted by mutually suspicious organizations.” But it was Satoshi Nakamoto’s pseudonymous paper “Bitcoin: A Peer-to-Peer Electronic Cash System,” published in 2008, that put an academic idea into practice.

Pros and Cons of Blockchain Technology

Here are some of the advantages and disadvantages of blockchain technology when used for cryptocurrencies, using bitcoin as an example:

Pros

Decentralization

While the Federal Reserve issues and oversees the US currency, no government entity issues or regulates bitcoin or other cryptocurrencies. This also means that no single government or agency will be able to decide the fate of a public blockchain. The lack of intermediaries lowers costs by eliminating the fees associated with third-party transactions. Another benefit of blockchain is its time efficiency: unlike banks and other intermediaries, the blockchain is open for business 24 hours a day, 365 days a year.

Transparency Combined with Anonymity

On the Bitcoin blockchain, all transactions are recorded on computers all around the world. Because the address and transaction history of bitcoin wallets, which hold the cryptocurrency, is publicly viewable, transactions are completely transparent. However, the owners of each wallet connected to those public addresses remain anonymous and are not recorded.

Precision and Safety

There is a lesser risk of error because the transaction involves little human involvement. Each transaction must be approved and logged by a majority of network nodes, making data manipulation and alteration extremely difficult. This also makes it impossible for someone to spend a bitcoin more than once.

Blockchain Applications, Both Public and Private

Blockchain technology has the potential to provide efficiencies that go well beyond digital money. Bitcoin, for example, is based on a public blockchain network, which means that anybody may join. However, many corporate applications may be built on private blockchain networks, which allow enterprises to regulate who joins:

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Blockchain supply chain: Companies like IBM Blockchain are already leveraging blockchain technology to provide private network solutions that track product supply chains more accurately. Companies can, for example, utilize the technology to swiftly determine where recalled food products were shipped and sold.

Health-care records: A statewide blockchain network for electronic medical data, according to Deloitte Consulting, “may increase efficiencies and support improved health outcomes for patients.”

Smart contracts: Using blockchain technology, contract terms can be automatically altered or updated if a set of circumstances is met.

Some developers are working on blockchain technology that could be used in elections.

Property transactions: Blockchain proponents claim that the technology may be used to sell a wide range of assets, including real estate, automobiles, and investment portfolios.

Underbanked People Have Options

In nations and places where financial institutions are weak or corrupt, cryptocurrencies based on the blockchain protocol enable the movement and storage of money without the involvement of unscrupulous third parties.

Cons

Crypto is Popular with Criminals

Some of the initial users of new technologies, like many others, have been criminal businesses. They use cryptocurrencies like bitcoin as payment as well as to target bitcoin holders for scams because of the secrecy they provide. Customers of Silk Road, a black market online shopping network for illegal narcotics and other unlawful services that were shut down by the FBI in 2013, utilized bitcoin, for example. Colonial Pipeline paid $4.4 million in cryptocurrencies to unlock its computer systems following a recent ransomware attack.

Meanwhile, bitcoin investment fraud has increased in lockstep with the currency’s recent record ascent. The Federal Trade Commission estimated that almost 7,000 consumers lost $80 million in quick-return scams between October 2020 and March 2021, a roughly 1,000 percent increase in reported losses year over year.

Cryptocurrencies on the Blockchain are Extremely Volatile

“Is blockchain a good investment?” some people wonder. This is dependent on your investment objectives and risk tolerance. Cryptocurrency’s popularity skyrocketed in 2021, with bitcoin hitting a new high of about $65,000 in April. However, due to its inherent volatility, bitcoin’s price had plunged nearly 50% by early June, before beginning to surge again.

Cryptocurrency Usage is Still Uncommon

Many more exchanges, brokerages, and payment apps now sell bitcoin, and many organizations accept bitcoin as payment, including PayPal and Microsoft. Purchases made with blockchain currencies like bitcoin, however, are still the exception rather than the rule. Furthermore, users must pay capital gains taxes on bitcoin sold for purchases on cash apps like PayPal, in addition to any state and local taxes paid on the product or service.

Bitcoin Mining Consumes a Lot of Electricity

Bitcoin mining is done via a network of high-speed computers that use a lot of energy. According to the University of Cambridge Electricity Consumption Index, if bitcoin were a country, it would be the 34th largest electricity consumer, after the Netherlands and ahead of the Philippines. Elon Musk, the CEO of Tesla, stated in May 2021 that the company would stop accepting bitcoin until it could find measures to lessen its carbon footprint. Other blockchain developers have come up with less energy-intensive alternatives.

The Bitcoin Blockchain is Quite Sluggish

The bitcoin blockchain can handle approximately seven new transactions per second. Visa, the world’s largest credit card operator, claims to be able to process 24,000 transactions per second.

This creates a scalability issue for the bitcoin system. This issue is being addressed by other types of blockchain-based cryptocurrencies. Ethereum 2.0, a widely awaited upgrade to the Ethereum system, is predicted to be capable of handling 10,000 transactions per second, up from the present rate of 30 transactions per second.

Blockchain technology’s Future

While the bitcoin system is the most well-known implementation of blockchain technology, it is just one of the thousands of other cryptocurrencies that are based on it. While it remains to be seen if bitcoin will succeed in displacing other types of traditional payment systems, blockchain technology’s applications are rapidly expanding, and proponents believe they will result in significant changes across industries.

The Author

Samuel Adeshina

Samuel is a financial reporter whose interests include blockchain, market, business, insurance, and Crypto to provide relevant information to all interested.