What is Blockchain?

Understand the definition of a Blockchain, learn what’s behind the technology, how we can benefit from it and where the limitations are.

A little bit of Blockchain History

Blockchain technology was first outlined in 1991 by Stuart Haber and W. Scott Stornetta, two researchers who wanted to implement a system where document timestamps could not be tampered with. But it wasn’t until almost two decades later, with the launch of Bitcoin in January 2009, that blockchain had its first real-world application. (Coinbase, “What is Bitcoin”)Bitcoins founder, Satoshi Nakamoto, refers to his invention as “a new electronic cash system that’s fully peer-to-peer, with no trusted third party.” (Bitcoin Whitepaper). Since then, countless other blockchains, sidechains, and para-chains have been developed. And while the idea of an electronic alternative to cash remains a dominant factor, numerous other use cases for blockchains have emerged. Think of ownership verification (NFTs), smart contracting, supply chain management, and voting, to name a few. But to understand why blockchain technology is gaining traction, we need to know how it works and what sets it apart from traditional databases.

Blockchain vs. Traditional Database

First and foremost, Blockchain is not cryptocurrency. Blockchain is a Database Technology. Cryptocurrency is merely one way of using the Blockchain. Unlike a traditional database, a Blockchain is not controlled through a single entity but through a network of participants. The data is stored encrypted and in a ledger format where entries are continuously added and rely on each other. Let’s take a closer look at the main difference between a traditional database and the structure of a blockchain.

Traditional Database

A traditional database stores all data in a single place, usually a server. Servers are centralized and often controlled or hosted by a single entity. Users can add, modify, and delete information depending on the permission level. This single access point can make the server vulnerable to attacks and misuse. Data can be manipulated, deleted, lost, or destroyed without sufficient control. A controlling entity can unlawfully withdraw access to a database at any time.

The Blockchain

A blockchain tries to mitigate the issue of a single point of entry and replaces it with a network of computers that form the data into encrypted blocks. The information is now not only encrypted but stored across many storage points. In turn, each new block of information has to be verified by the network and added to the database. Since the encryption process of each block is based on information contained in the previous block, we end up with an immutable string of data since a change in one block would affect all subsequent blocks and require re-validation by the network.

What is Hashing?

The process of creating a block is called Hashing. Hashing takes any data and translates it into a string of fixed-length code. This unique string is an exact translation of its data. Hence no block can carry the same hash unless the data within is the same. This is where the immutability of a blockchain comes in, but more on that later. A block contains four elements:

1. Timestamp
2. Nonce (number only used once) as a unique identifier
3. Input Data
4. Hash of the previous block

The combination of those four elements is encrypted and translated into a line of code called a Hash. Hashing transforms data into a line of code, resulting in a (Data)Block. Blocks are chained together and kept on record in a Ledger. Hence the name Blockchain. After creating or hashing a new block, it will be sent to the network for validation. Once validated, the new block is added to the chain. Hashing blocks is rewarded to incentivize participants to maintain the network.

Blockchain Consensus Mechanisms

The way blocks are hashed and validated on the blockchain is defined by the Consensus Mechanism. Today’s most commonly known types are Proof of Work (PoW) and Proof of Stake (PoS). Other types exist, but for simplicity, we will focus on PoW and PoS.

Proof of Work (PoW)

A blockchain that uses PoW uses Nodes and Miners. Nodes govern the PoW blockchain, maintain a ledger of all transactions and collect data on new transactions. Nodes collect the latest data and send it to a network of computers highly efficient computers called Miners. These computers group the data and race to group it into blocks via hashing. The stronger the miner’s computing power, the higher the chance that he is the first to create the block, which in turn earns him a reward. An example of a blockchain that uses PoW is Bitcoin.

Proof of Stake (PoS)

Although creating blocks and adding them to a chain remains the same, a PoS blockchain takes a different approach to create blocks. Instead of sending data to miners and letting them compete against each other, the node will randomly select a network participant called a Validator to generate the block. After the block has been created, it is sent to other validators to confirm the block. Once approved, the block is added to the chain, and the process starts again. Examples of PoS chains are Cardano and Solana.

Proof of Work vs. Proof of Stake

There are claims that a PoW blockchain is causing an impact on sustainability. The computing power required has led to a dramatic increase in demand for powerful IT equipment by miners, resulting in supply shortages for high-end graphics cards (GPUs). GPUs draw immense amounts of energy, causing an ecological impact. There is also an argument that mining works against the concept of decentralization as miners aim for evermore market share to mine blocks and earn rewards. Miners have little incentive to keep the rewarded tokens and tend to sell them to buy additional mining equipment. PoS aims to limit the impact on sustainability by random selection of block validators based on their share of network participation and not computing power. Although less energy and material intensive, a PoW blockchain incentivizes participants to hoard tokens, thus restricting liquidity. Reduced liquidity tends to increase the price of the token, but at the same time, risks limiting the usability as participants have less incentive to transact with the token and instead sit on it for expected value increase. Now that we understand how data is hashed into blocks, encrypted, and strung together, let’s look at the different types of blockchains.

Types of Blockchains

Blockchains, like traditional databases, can have different types in terms of accessibility.

Public Blockchains

A public blockchain has no access restrictions, and everyone with internet access can participate. Examples of public blockchains are the Bitcoin and the Ethereum Blockchain.

Private Blockchains

A private blockchain requires permission to be accessed by an administrator. For example, an industrial company sets up an in-house blockchain for its supply chain management.

Hybrid Blockchains

A mixture of private and public blockchains has both centralized and decentralized components.

Sidechains

A sidechain uses a primary blockchain as a reference but runs parallel to the main chain. This allows for creating a new chain based on an already existing concept but enables incorporating additional features. For example, Polygon is an Ethereum sidechain. Sidechains are also called Layer 2 chains.

Use Cases For Blockchains

In the beginning, I mentioned that blockchain provides a variety of use cases besides cryptocurrency. Over the past years, we have seen numerous new real-life applications, and more are likely to come. And while not all of them are likely to change how we go about our days, some have revolutionary potential. Let’s take a look at some fields of application beyond cryptocurrencies.

Healthcare

Storing medical records on a blockchain allows patients proof and confidence that these records can’t be tampered with. Thanks to encryption, patients can control who can access this highly confidential data. For healthcare providers, it means that the data is readily available online in case of need. Furthermore, the records are held in a universal language (code) that can easily be deciphered by end-user software.

Property

An immutable property register on a blockchain provides regulators and property owners transparency. Smart contracts can execute property transfer, producing a clear record of when, where, and under what conditions the property has been transferred. Transactions require little to no interaction from a middleman like a notary. The decentralized nature also means that it will only be possible to alter records unnoticed; think of places with unstable or corrupt governments.

Smart Contracts

Smart contracts are lines of code built into a blockchain. Through a set of coded conditions, smart contracts can control, negotiate, facilitate or even verify transactions. This can automate trade and transactions to the highest degree, reducing the need for intermediaries and third parties and thus increasing efficiency and cutting costs.

Supply Chains

Blockchain can track and trace goods throughout their lifetime, from the initial raw material all the way to the wasteyard and in real time. This can help improve supply chains and deliver valuable information about the product’s lifecycle to producers and consumers alike. The data can be used to hold manufacturers responsible for production flaws and the breach of rules and regulations.

Voting

The immutability of the blockchain allows it to be used to facilitate voting. Voting on a blockchain provides transparency and efficiency. Counting the votes can be done electronically, reducing the possibility that the results can be tempered.

Digital Identities

Confidential data such as medical records, birth certificates, passports, biometric data, credit records, tax data, property deeds, diplomas, and other qualifications can be used to build a digital identity. Paired with a private key, the data owner is in complete control of his information and to whom he grants access. The data can be accessed from anywhere, in any language, and help to restore the owner’s real-world identity. Think of a refugee arriving in a country where he does not speak the language and cannot prove his identity with a physical document.

Benefits and Drawbacks of Blockchains

Limitations

In theory, the applications of a blockchain are limitless. But there are also some significant disadvantages and drawbacks, at least for now. However, these limitations should not be seen as a dead end but encourage us to overcome them.

Cost

Adopting blockchain can come at a significant development and maintenance cost. Data must be formatted and migrated. Special IT equipment is required, and programs must be written to interact with the chain. Depending on the blockchain technology used, high energy costs are involved, which cause environmental impacts.

Efficiency & Scalability

In areas where transaction speed is crucial, many blockchains can’t compete with existing “traditional” systems. Imagine waiting 10 minutes for your coffee-to-go just because your payment must be added to the blockchain first. Blocks can only contain a certain amount of data, meaning the more data has to be processed, the more blocks are needed,  slowing the processing speed and congesting the network.

Regulation

How do you regulate a decentralized entity where no one is in control? And how much power is needed? Who is held responsible if something goes wrong and who can help? These and many other questions are topics of fierce debate. While overregulation will limit the benefits of blockchain applications, no regulation will cause uncertainty among participants. Think of it this way; Governments and regulators tend to overregulate things they don’t understand, and market participants won’t adopt a technology where they risk getting in trouble with the authorities. Thus, creating an open and constructive discussion around benefits, risks, and limitations is vital.

Key Takeaways

• Blockchain is a database technology
• On a Blockchain, data is compiled into encrypted blocks and added to a ledger, each block after the next. Hence the name Blockchain.
• A Blockchain is immutable since each new block depends on the previous one. If a block is altered, all following blocks don’t add up.
• Proof of Work (PoW) and Proof of Stake (PoS) describe how a block is created.
• A Blockchain can be public (anyone can participate), private (regulated participation), or hybrid.
• Although the data is encrypted, it can be easily deciphered by anyone with permission.
• Although providing countless benefits for storing and managing data, blockchains have some significant drawbacks that limit widespread adoption.

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