Lesson 5 of 10
In Progress

5. What is Blockchain, and how does it work?

The term blockchain was born in 2008 with the founding of Bitcoin. However, it only became a marketing tool in 2015, representing a symbol of the economic, political and technological revolution. Find out what Blockchain is, how it works, and its usefulness.

Blockchain definition

Blockchain is a data storage and transmission technology that is secure, transparent, and operates without a central controlling authority. A blockchain is referred to as a chain of blocks. When we talk about blocks, we actually mean digital information that has been placed in a public database, or blockchain. It is shared by different users, without intermediaries, which allows everyone to check its correctness. Mathematician Jean-Paul Delahaye said that to understand what Blockchain is, you have to imagine “a large notebook that anyone can read freely and for free, on which anyone can write, but which cannot be erased and which is indestructible.”

When we break down the name >>blockchain<< into prime factors, we get two words. Block and Chain. Blocks are responsible for storing information associated with transactions – date, time, amount. So, what allows us to distinguish one block from another? The so-called hash, which is a unique, exceptional code. The whole chain starts with the genesis block – the first block.

Book definition of blockchain is more complicated. In the lexicon of terms on blockchain technology and cryptocurrencies, we can read that: “A blockchain is a distributed database that contains an ever-growing amount of information (records).  Grouped into blocks and linked together in such a way that each subsequent block contains a timestamp of when it was created and a link to the previous block, which is an encrypted >> summary << (hash) of its contents.” Admit it, the first definition somehow gets to us more …☺

Blockchain operation

The functioning of Blockchain to a layman may seem complicated. However, this is not the case at all. This distributed book contains information that will be stored in the form of interrelated blocks, the specifics of which are not to be stored on a central server, but on many servers called network nodes. 

Each block into which new data starts to arrive is added to the chain – under one condition. A verified transaction must be performed. What does that mean? Each block is verified by network nodes called “miners” using techniques that depend on the type of Blockchain (consensus algorithm). In the Bitcoin Blockchain, this technique is called “Proof-of-Work” and involves solving algorithmic problems.

Blockchain can be private or public; it is also used for different purposes:

Transferring assets (currencies, securities, stocks, etc.)

Better identification of assets and products

Execution of smart contracts, etc.

At this stage, you may ask yourself, is Blockchain secure? The issues of security and trust in this technology can be considered in several ways. First – when making a transaction on Blockchain, your data is limited to your digital signature or name alone. You do not provide your first name, last name, or home address. As we mentioned earlier, on such a blockchain, it’s hard to change the content of the previous block. So, it cannot be edited, which is an additional security factor. However, if editing of the transaction takes place, then the hash value will change. However, the next block will contain the old hash. So – by interfering with one block, you would actually have to make a change to all subsequent blocks, and that’s not possible without creating another version of it. Once a block is added to the Blockchain, it is impossible to remove and edit.

Consensus Algorithms:

Satoshi Nakamoto established a consensus algorithm to trust a network that had no centralized unit or infrastructure. We will introduce you to the two main protocols used in Blockchains: proof of work (PoW) and proof of stake (PoS).

Blockchain technology has unlimited potential that is still not fully exploited.

Proof of work (PoW)

Satoshi Nakamoto built Bitcoin on the Proof-of-Work (PoW) consensus protocol, which allows miners and their computing power to execute smart contracts. To ensure their interest, they are rewarded with a currency issued, for example in Bitcoin. It is a self-sufficient system.

Proof of work is energy consuming, so the miner’s energy usage is compensated by a reward consisting of 2 things: transaction costs, and block reward, which decreases every 4 years (Halving). When the first block of BTC was mined you received 50 BTC and you could mine on a computer; currently you receive 6.25 BTC and the next Halving will be in 2024. New consensus protocols, such as Proof-of-Stake , have been created to reduce energy consumption.

Proof of stake  (PoS)

Regarding the consensus mechanism, Proof-of-Stake, the staking system allows the blockchain user to participate in the creation of new blocks. They must own and stake (bring into action) a certain amount of a given cryptocurrency (or tokens) to prove that they have good intentions in securing the Blockchain.

The logical explanation is this: if you own large amounts of a particular cryptocurrency, you would have no interest in that currency losing credibility, as it would cause you to lose money.

The minimum amount of this “proof of stake” is variable depending on the blockchain. About Ethereum the minimum is 32 ETH, but in other cases there may not be a minimum amount. There are also stake pools that allow several players to join forces and pool their resources to share rewards, so you don’t have to have 32 ETH to participate in the network if you use a stake pool.

Advantages and disadvantages of Blockchain technology:

Pros: 

  • By using blockchain, we can transfer cryptocurrencies around the world – cheaply and quickly. 
  • The transactions performed are cheap – with Blockchain, there is no need for third-party verification. 
  • The most important feature of this technology is decentralization. Blockchain does not store location data. Such data is difficult to manipulate.
  • Accuracy – before a block goes to the chain, it must be approved by thousands or even millions of computers around the world. This ensures that the record is devoid of human error. 
  • No country, company, or entity controls the blockchain distributed across the network. 
  • Transactions are efficient, private, and secure. You can perform them 24 / 24 as long as you have internet access. 

Cons:

Limited number of transactions per second, of which Bitcoin is a prime example (it takes about 10 minutes to proof of work). 

Hacking attacks – although difficult and time-consuming in the case of blockchain, it is impossible to eliminate their probability.

This technology has applications in many areas of life. You will find it in, among others:

  • Banking sector – allows consumers to make transactions at any time of day or night. Alior Bank uses it to verify the authenticity of customer documents.
  • Real estate – use for property rights registration process.
  • Voting / Elections – eliminating fraud related to the falsification of electoral votes. The neOS operating system unveiled a Blockchain-based voting application. 
  • Healthcare – securely storing medical records of facility patients. Such records could be encrypted and stored on a data chain. Only authorized personnel would have access to them. 
  • Transportation – registering on the Blockchain the origin of purchased materials. This will also improve their verification. 

As you can see, Blockchain is not as scary as it may seem at first, and certainly has great possibilities and future.