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What Is Blockchain Technology?

November 15, 2021 · 11 minute read

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What Is Blockchain Technology?

Blockchain technology is a persistent, transparent, append-only digital ledger that can be used to track or record almost any type of asset, from goods and services to patents, smart contracts, and more. Blockchain technology relies on cryptography and a system of peer-to-peer verification to secure transactions and, in the case of cryptocurrency, to mine coins and tokens.

Although most people think of crypto when they think of blockchain, in fact the way blockchain technology works lends itself to many applications. Blockchains run on a decentralized network of computers, called nodes, which enable a form of consensus (peer-to-peer) confirmation that can drive faster, more secure transactions that are visible to everyone on the network — making fraud and duplication more difficult.

The combination of speed, security, and transparency has enabled many organizations to explore blockchain’s applications and uses. Keep reading to learn more about the pros, cons, and potential of blockchain.

What Is Blockchain?

Although the word blockchain has become synonymous with cryptocurrency, and is sometimes described as “the blockchain,” there is no single blockchain. Rather, there are many different blockchains that have been developed by a wide range of organizations. So “the Bitcoin blockchain” or “the Ethereum blockchain” are indeed separate entities.

Why is it called blockchain?

Another way to phrase the question is: What is blockchain technology built with? Blockchain got its name from two of its key components: blocks of data that are appended together in chronological order to make a chain of transactions that are visible to everyone on the network.

For this reason, blockchain is considered a type of distributed ledger technology (or DLT). Once a block is updated, the new data is visible to everyone on the blockchain simultaneously.

What are nodes?

Distributed ledger technology typically relies on thousands of powerful computers, called nodes. As new data gets added, it becomes part of a block of transactions that are then verified by the nodes, which use complex mathematical calculations known as cryptography to create a hash or a cryptographic record of each transaction that cannot be reversed or deleted.

The majority of nodes must agree on each transaction before it can be added to the blockchain. Thus, no single person or computer can update the system without buy-in from the larger network. This form of consensus verification is a big reason why blockchain technology is considered more secure than most standard record-keeping systems.

Recommended: What Are Nodes? 7 Types of Blockchain Nodes

What is mining, and what are miners?

The term miners may bring to mind an actual person doing the mining (for cryptocurrency, say). And while individuals can be miners if they have powerful enough hardware, a miner is basically shorthand for any entity that verifies blocks of transactions on the blockchain network. When a miner is successful in being the first to verify a block of transactions, they are typically rewarded in the native crypto of that blockchain.

For this reason, crypto mining has become a highly competitive space.

3 Main Characteristics of Blockchain

Blockchain has three main characteristics that distinguish it from other types of digital recordkeeping.

It’s decentralized

When you think about traditional digital forms of accounting and record keeping, what might come to mind is a central authority, like a traditional corporate structure, that monitors and manages a primary record keeping source.

In contrast, blockchain relies on a network of computers or nodes, as described above, to verify data and blocks of transactions — a system that requires consensus among a majority of nodes before new blocks can be added to the chain. Thanks to this peer-to-peer verification, it’s possible to avoid reliance on third party services, and there is no need for a central authority to keep tabs on transactions and asset movements.

It’s transparent

Transparency is one of the hallmarks of blockchain technology, because as each block of transactions is verified, it’s visible to everyone on the network. That way, each node has a chronological record of the data that’s been stored on the blockchain, and no single node can alter that information. If a blockchain is breached in some way, or there is an error in one node’s data, the other nodes can identify and correct it.

This transparency, in addition to other features, have helped develop the technology that smart contracts need to function on a blockchain network.

It’s super fast

Modern business operations increasingly require real-time updates and responsiveness that require highly sophisticated digital networks (like Internet of Things, or IoT) or artificial intelligence to function. Blockchain enables greater speed and accuracy that can support many business operations.

How Blockchain Came to Be

Using cryptography as part of a distributed, digital system for payments and other transactions emerged in the early 1980s, thanks to the work of cryptographer David Chaum.

In the early ‘90s, other researchers, including Stuart Haber and W. Scott Stornetta sought to enhance the verification process by adding timestamps to blocks of transactions that could not be altered, as well as a Merkle tree structure for encoding data. By the late ‘90s, data scientist Nick Szabo was working on a currency based on blockchain technology.

But it wasn’t until 2008 that developers working under the pseudonym Satoshi Nakamoto published a white paper laying out a more clear-cut case for the use of blockchain in relation to digital currencies — paving the way for Bitcoin, and soon after many other forms of crypto.

Among its many breakthroughs, Nakamoto’s research overcame a persistent hurdle in digital finance: the so-called double-spending problem. Although you can’t spend a $10 bill twice, it’s possible to duplicate the coding of digital currencies and “spend” those funds more than once. But thanks to the way blockchain is built, with timestamps and other codes that establish a payment’s validity, as well as the consensus mechanism that governs all transactions, it’s virtually impossible to execute the same financial transaction twice.

Today, not only are many cryptocurrencies also built on blockchain platforms, but a growing number of them utilize blockchain technology to create smart contracts, non-fungible tokens, and many other applications.

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Is Blockchain Safe?

One of the chief appeals of blockchain is its ability to keep transactions secure, without the use of middlemen or third parties to verify identities or confirm the exchange of property. Blockchain technology is often called “trustless” because there is no need for one entity to confirm the validity of another entity — the blockchain itself takes care of that.

As each new block of data is added to the blockchain, it’s appended in chronological order, with the latest block at the end of the chain. On the Bitcoin platform, for example, a new block is added every 10 minutes, adding to its “height.” The height of a block can refer to the location of a transaction on the blockchain, or the current length of the blockchain. As of April 2021, the Bitcoin blockchain height was over 677,350 blocks.

That doesn’t mean cyber criminals can’t attack a blockchain platform — there are several examples of blockchains being hacked — but the decentralized nature of blockchain platforms does offer a form of protection. To alter a block on the chain, a hacker or criminal would need control of more than half of all the computers in the network — a feat that’s nearly impossible. And because most blockchains are public, anyone with the right equipment can access the information stored on each block on the blockchain, adding to the transparency.

Some of the largest and best-known blockchain networks, such as Bitcoin, Litecoin, Dash, XT, and Ethereum, are public or permissionless, and typically allow anyone with a computer and an internet connection to participate. Instead of creating a security crisis, having more people on a blockchain network tends to increase security. More participating nodes means that more people are checking one another’s work and calling out bad actors.

That’s one reason why, paradoxically, private or permissioned blockchain networks that require an invitation to participate might be more vulnerable to attack and manipulation. Private blockchains may not have the same security because they lack peer-to-peer verification.

Pros and Cons of Blockchain

Blockchain’s potential seems almost unlimited, and there are a growing number of industries exploring new use cases for blockchain. Many believe that blockchain technology could transform commerce and economics. Here are some of the pros and cons of blockchain technology.

Advantages of blockchain

The upsides of using blockchain include enhanced user privacy, transactional security, lower costs, and more.

Transparency

A public blockchain uses open-source code, accessible to virtually anyone who has the necessary equipment. The technology of the blocks themselves, which are permanently linked together on a chain, permits greater visibility for all involved, which can aid peer-to-peer verification and help prevent fraud.

Cost efficiency

In traditional transactions such as using credit cards to make payments, users typically pay a fee. Eliminating third-party verification means lower costs per transaction. The use of smart contracts potentially reduces time costs as well as actual fees.

Accuracy

By using thousands of computers on the blockchain network to confirm and validate transactions, the potential for human error is all but eliminated. This leads to greater accuracy in the recording of data.

Helps prevent hacks

Decentralization makes it harder to tamper with any particular block of data, because all data is secured using peer-to-peer verification, rather than a central authority. This self-policing, so to say, contributes to the security of the blockchain.

Financial alternative

Blockchain potentially provides a banking alternative for those who are unbanked (a common problem in many developing nations), and a way to secure personal information for citizens of countries with unstable governments.

Disadvantages of blockchain

The obstacles facing blockchain’s growth and adoption aren’t only technical — especially for businesses adapting their existing operations — but in many cases regulatory.

Sustainability issues

Because blockchain relies on vast networks of super-powerful computers for almost any function (e.g. mining cryptocurrency), the technology typically uses significant amounts of energy that many believe can be harmful for the environment. In particular, crypto mining that relies on a “proof of work” system is particularly inefficient, using quantities of energy comparable to some countries.

Assuming electricity costs of $0.03~$0.05 per kilowatt-hour, mining costs (not including the cost of hardware) can be as much as $7,000 per coin. Miners who are compensated for their efforts with coins may recoup those costs, but it’s a factor for many others.

Recommended: Exploring NFTs and Their Environmental Impact in 2022

Speed bumps

Although blockchain can speed up transactions, they may not be as fast as legacy systems (like credit cards), which can process thousands of transactions per second.

Illicit activity

The security and privacy that are hallmarks of blockchain technology cut both ways, in effect, as both legal and illegal activity can take advantage of these features. Indeed, blockchain has a history of being used as part of illegal networks like Silk Road, considered part of the dark web.

Changing regulation

Blockchain technology and its many applications — especially cryptocurrency — still exist in a gray zone, as governments and businesses seek to establish new laws and policies, as well as best practices. This is changing, though, as financial institutions and other organizations begin to embrace both cryptocurrency itself as a legitimate form of payment, and explore new ways blockchain technology can be used.

What Is the Difference Between Blockchain and Bitcoin?

The reason it’s hard to separate blockchain technology from Bitcoin is that Bitcoin’s crypto (BTC), like so many types of cryptocurrency, would not exist without blockchain technology. But in the case of Bitcoin, the emergence of blockchain was critical to launching this new currency nearly 13 years ago. So although Bitcoin is built on a blockchain and relies on blockchain technology, the two entities are quite distinct.

A blockchain, or blockchain technology, is a type of digital ledger that can be used by any company. Although bitcoin was the first crypto to successfully use blockchain technology, since then thousands of other cryptocurrencies have made use of blockchain platforms.

How blockchain and bitcoin work together

In 2008, an individual or group of individuals going by the pseudonym Satoshi Nakamoto, published a paper called, “Bitcoin: A Peer-to-Peer Electronic Cash System.” Although various digital currencies had been attempted in previous decades, as discussed earlier, this was perhaps the first to propose “a system for electronic transactions without relying on trust,” and depending instead on a peer-to-peer system of verification via a blockchain.

In January 2009, the first Bitcoins were created using a blockchain platform, and the bitcoin mining system was established.

How does crypto mining work with blockchain?

Unlike fiat currencies like the dollar or euro, cryptocurrencies typically aren’t issued or regulated by a central authority like a bank. Rather, miners use special computer hardware to do the complex mathematical cryptography required to confirm each item on the blockchain — a process called a “proof of work” that involves literally billions of calculations. When a miner successfully confirms a block of transactions on a certain platform, they’re typically rewarded with coins or tokens native to that platform.

What Is Blockchain Technology Used For?

From its roots as a platform for cryptocurrency, blockchain is now emerging as a potent force for many different kinds of businesses. Following are just a few of the current use cases that are emerging as organizations explore blockchain’s potential.

Smart contracts

Smart contracts are part of what makes many other blockchain platforms possible. The contracts that exist on the blockchain can be executed without an intermediary, only occur when specific conditions are met, and can’t be altered. (Cardano (ADA) is an example of a smart contract platform.)

The development of smart contracts has fueled a rise in different blockchain applications. Insurance companies, health care companies, governments, and more are exploring ways to use this technology to their advantage.

Finance

In the last year or so, one of the most disruptive new blockchain applications might be the rise of decentralized finance or DeFi. In many cases, DeFi removes the need for traditional financial institutions by giving users more control over their transactions.

Peer-to-peer lending is a popular DeFi application. Instead of getting a loan from a bank, people can make loans to each other in the form of cryptocurrency and other digital assets. The terms of the loan will be enforced by programs written in smart contracts, holding both parties accountable.

Supply chains

Increasingly, blockchain is being used to track goods as they move from one end of the supply chain to the other, verifying quality, provenance, and even food safety in some cases.

Also, by using blockchain businesses can help identify inefficiencies within their supply chains more swiftly, while also being able to pinpoint where any item is at any given time.

Insurance

The way the insurance industry conducts business today leaves room for error and increases the risk of fraud. Indeed, false property and casualty insurance claims cost the industry more than $40 billion every year. Blockchain could offer insurance companies a way to store information securely and potentially reduce incidents of fraud via smart contracts, authentication of claims, and by creating a permanent, immutable record of all transactions.

Recommended: Blockchain in Insurance: Evaluating the Pros & Cons

Equity and currency trading

A decentralized exchange (DEX) is a peer-to-peer marketplace where transactions aren’t managed by banks, brokers, payment processors, or any other intermediary. On a DEX, for example, crypto traders can simply trade with each other.

Some of the most popular DEXs run on the Ethereum blockchain, and are part of the growth in DeFi apps and tools that are making more financial services available to users via a crypto wallet. In just the first quarter of 2021, DEXs saw some $217 billion in transactions. This trend could one day revolutionize the way people buy, sell, and trade assets of all kinds.

Recommended: Blockchain in Finance: What Does it Mean for Fintech?

Does Blockchain Have Naysayers?

While the excitement surrounding blockchain’s ascendance gets a great deal of attention, there are, of course, skeptics as well.

Although blockchain promises to revolutionize how transactions are done, how contracts are executed, and much more, some industry analysts compare blockchain’s status to the earliest days of the internet, pointing out that it was close to two decades before the majority of people incorporated internet use into their daily lives.

In the coming years, governments and businesses would need to reconceive their basic operations, as well as their technical needs — and be prepared to make new investments in those structures — in order for widespread use of blockchain to take hold.

Certainly, the potential benefits of blockchain are compelling enough that many people are betting that there could be something akin to a blockchain revolution in the future, but it’s hard to predict when or what that will look like.

The Future of Blockchain

While the future of blockchain isn’t 100% clear, new approaches and innovations are emerging every day. For example, dozens of central banks worldwide are exploring ways to create digital currencies themselves — with China, Sweden, and the Bahamas in the lead.

The coins would likely be issued on centralized blockchains controlled by the central banks themselves, giving them greater control over monetary policy and the financial system at large.

The Takeaway

Blockchain may have entered the digital landscape as a kind of technological sidekick to Bitcoin, but the many advantages of this transparent, peer-to-peer distributed ledger technology have fueled a seemingly unlimited number of possible new use cases. Although blockchain technology will always be known for its ability to power cryptocurrency platforms, these days organizations are considering all kinds of new applications, from using blockchain to shore up supply chains, end voter fraud, support health care privacy for patients, and more.

That said, one of the most compelling applications of blockchain technology continues to be in the crypto realm, where blockchain is enabling more than digital currencies, powering far-reaching innovations like DeFi apps and tools, smart contracts, and more. You can be part of the ongoing crypto evolution when you open an account with SoFi Invest® and explore the dozens of cryptocurrencies available to buy and sell.

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