Beginner’s Guide to Blockchain

What is Blockchain

Blockchain is typically defined as a distributed database (ledger) that is shared throughout the nodes of a vast computer network. Blockchains, in their purest sense, store information in a digital format, and are best known for their crucial role in maintaining networks of cryptocurrencies such as Bitcoin and Ethereum.

Bitcoin, Ethereum, and all other crypto assets by definition, utilise blockchain as a secure and decentralized means of transacting pier-to-pier, with a guarantee of fidelity, security and trust between parties.

Blockchains, distinct from traditional databases, operate in ‘blocks’, which groups together and stores sets of information from a given period in time. Each block has a certain storage capacity, and, once filled, is closed, joining the ‘chain’ of blocks. Once blocks are closed, all transactions made in that block are inherently irreversible as you cannot alter any data that is already in the chain of existing data.

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Blockchain vs. Bitcoin — What’s the Difference?

This is a common point of confusion among new entrants to the cryptocurrency space. Is Bitcoin blockchain and is blockchain Bitcoin? The simple answer to both questions is no.

Bitcoin is a protocol built on its own blockchain, but it is not a blockchain in of itself. The Bitcoin protocol simply utilises blockchain technology as a tool to transparently record its ledger of payments. Bitcoin is an example of one use case for blockchain technology, which is a peer-to-peer, ‘trustless’ payment network that eliminates the need for a middle-man. Blockchain can theoretically be used for myriad other applications, however, including election voting, deeds to homes, smart contracts and more.

Bitcoin is not the only payment system that utilises blockchain. Just like any other innovative idea, eventually, competitors come along and offer an alternative to the original iteration of the technology. Common critiques of Bitcoin as compared to other payment protocols are its higher fees, and lower transaction speeds relative to newer projects.

How Does it Work?

Using the example of a Bitcoin transaction, we can intuitively demonstrate how the blockchain validation and data storage process works. For simplicity, here’s a step-by-step process of a Bitcoin transaction:

When was it Developed, by Who?

Though some confuse the origination of blockchain with that of Bitcoin, which was famously developed by an anonymous entity who is solely known by the pseudonym ‘Satoshi Nakamoto’, blockchain technology was in fact first described in 1991.

It was first proposed by Stuart Haber and W. Scott Stornetta, two researchers who wanted to implement a system that made it impossible for timestamps on documents to be tampered with. It wasn’t until decades later, in 2008, when Satoshi Nakamoto released a white paper establishing the model for a blockchain based network of transactions — what is known today as Bitcoin.

The first public ledger for transactions conducted through blockchain began in 2009 when Nakamoto released the Bitcoin protocol to the public.

Advantages of Decentralization

Decentralized blockchains, when compared to the traditional banking and finance system, have an array of distinct advantages in areas ranging from lower transaction fees, to faster transaction speeds and an increased level of privacy.

See below a shortlist of advantages blockchains maintain over traditional banking:

AreaAdvantages of DecentralizationTx FeesBlockchains utilise variable Tx fees that are determined by miners and users through a complex process. Fees may range from $0 to $50, however, users can determine the highest fee they’re willing to pay.Tx SpeedsTransactions on some blockchains are almost instantaneous, while others may take a few minutes.KYCAnyone has the ability to transact through blockchains without needing to identify themselves according to ‘Know Your Customer’ rules.Opening Hours24/7, 365 days a yearPrivacyBlockchain transactions can be as private as the individual desires. Although they’re traceable, its impossible to assign ownership if assets were purchased anonymously through a DEX, using a decentralized wallet.Account SeizuresIf assets are purchased using decentralized wallets, its very difficult for governments to track down and seize these funds.

Security Considerations

Blockchain is a trustless, permissionless technology that achieves decentralized security in a number of ways. Chiefly, blocks are stored chronologically, meaning they are always added to the ‘end’ of the chain, making it extremely difficult to alter the contents of a past block unless there is a consensus to do so from the majority of the network.

This is because each block contains its own ‘hash’, on top of the hash from the block previous to it. Hash codes are created mathematically, turning digital information into a string of numbers and letters. If the data is altered in any way after the block is finalised, the hash code must change as well.

For a hacker to succeed in altering hash data in the blockchain, they would need to complete what is referred to as a ’51 percent attack’. This requires extensive amounts of capital, knowledge and resources, and can occur when a single entity gains control of 51% of the network, earning a majority vote. This requires the entity to somehow purchase 51% of the total circulating supply of the currency. For reference, the current market cap of Bitcoin is $325bn, meaning hackers would require at least $162.5bn to seize control of the network.

Not only does such an attack require unrealistic amounts of resources, but its also unlikely to ever work. Participants in the network will notice the movement of such a large share of the native currency to a single wallet, and conduct what’s known as a ‘hard fork’ to a new version of the chain that hasn’t been affected by the attack. This results in the attacked version of the token dropping in value drastically, meaning the hacker would have control of a near worthless asset.

Blockchain Use Cases

Banking and Finance
It’s unlikely that any one industry will be revolutionized more by blockchain technology than the banking and finance industry. Retail banks operate during standard business hours, typically five days per week, meaning retail clients are likely to experience delays in transaction approvals and find it difficult to even get into the bank at times to lodge a transaction.

Through the implementation of blockchain, these transactions can not only be handled 24/7, 365 days a year, but can also be settled, typically, in less than ten minutes and sometimes instantly. Banks themselves also stand to benefit as decentralized ledgers simplify the inter-bank and international transaction process drastically, driving significant increases in their operational efficiency.

Currency
As previously discussed, blockchains are the underlying technology behind cryptocurrencies like Bitcoin, meaning they could act as a replacement for traditional central banks.

Under the fractional reserve system, the direction the federal currency takes is completely at the behest of the central bank, leaving millions of citizens of any given country operating under this system at the whim of a handful of centralised decision-makers.

Through implementation of blockchain technology, we allow the blockchain to completely replace the need for central banks, reducing systemic risk for those holding the currency, eliminating many processing and transaction fees, and offering a more stable model for currency. This is applicable globally, however, most significantly in countries such as Argentina who have experienced hyper-inflation as a result of their central bank’s decision-making.

Smart Contracts
Smart contracts are computer codes built into the blockchain to facilitate, verify and negotiate contract agreements between two parties. They operate under terms set and agreed upon by both parties before entering into the contract. Quite simply, once conditions are met, the terms of the smart contract are fulfilled automatically.

Smart contracts effectively eliminate the need for a middle-man in negotiations and contractual agreements.

Vending machines provide a simple model of how a smart contract operates. A customer presses A6 (chips), inserts $2 into the machine, and the machine dispenses the chips for the customer.

In this example, both parties have submitted their half of the agreement upfront — the customer has inserted their $2, and the vending machine operator has supplied the snacks. Once the trigger of the agreement occurs (customer selecting A6), the contract is carried out in full, i.e. the machine receives the $2 and the customer receives their chips.

Simply, the customer doesn’t receive the chips without offering their $2 to the machine, and the machine doesn’t receive payment without the customer being certain they’ll receive their chips upon payment.

Voting
As a final example of the possible use cases for blockchain technology, let’s examine the potential for the modern democratic system as we know it to be revolutionized.

In a theoretical example, each voting-age citizen of a country may have a unique token (NFT), representing their vote, airdropped to their wallet. Voters can then send this token to a wallet designated to receiving votes for their preferred candidate, completing the voting process.

This means of electoral voting not only improves the efficiency of elections, removing the need for voting centres, vote counters, recounts etc., but also essentially eliminates the risk of electoral fraud or malicious intent in the election process, given that each vote is submitted to a block as a transfer between wallets, which is then submitted into the chain, making it completely immutable.