Crypto 101: What is blockchain and how does it work with crypto?
Feb. 24, 2022 • 7 min read
What we'll cover
Blockchain and its transactional fuctions
Types of blockchain technology
Risks of engaging with cryptocurrency
Cryptocurrency continues to be a hot topic in financial circles. Whether you hear about it via news headlines or in a subreddit you check daily, you may be considering investing in it … even if you’re unsure how it works.
If this sounds like you, learning about blockchain can be a great place to start. Blockchain is the core technology behind Bitcoin and several (though not all) cryptocurrencies. With its ever-increasing list of uses, blockchain has the potential to change the financial world and beyond.
A blockchain is a decentralized digital ledger that records transactions in one continuous record (hence, “chain”). It’s maintained across multiple computers (a.k.a. nodes) that are linked in a connected network and can be operated by institutions or individuals. This network of linked nodes helps make the blockchain difficult to hack or alter, thus offering a relatively secure way for individuals to deal directly with one another, without a go-between like the government, bank or third party.
Although it was developed to support Bitcoin, blockchain technology is also the power behind many cryptocurrencies, and it has numerous applications outside of digital currency. You might have heard of blockchain for property sales, medical records, legal contracts and any other industry that requires you to record and authorize a series of actions or transactions.
Ok, but how does blockchain work?
Blockchain technology allows you to record and distribute digital information (and transactions) without being able to edit them. The transaction sequence typically consists of the following steps:
A new transaction is requested
The transaction is then communicated to the network of computers (nodes) that maintains the blockchain
Every node on the network must validate the transaction
After validation, a data “block,” containing all the transaction information (sender, receiver, time, etc.), is created
The data block is then “chained” to the rest of the existing blockchain, creating an unchangeable record of the transaction
The transaction is complete
What’s the difference between blockchain and Bitcoin?
Blockchain and Bitcoin are two separate things, but they are closely related. Without getting into the nitty gritty, Bitcoin is a type of digital currency, while blockchain is a ledger for recording and tracking transactions and assets. Bitcoin is powered by blockchain technology, but blockchain has found many uses beyond Bitcoin.
When Bitcoin was released as open-source code back in 2008, blockchain was foundational to its technology. Since Bitcoin was the first application of blockchain, people often confuse the two, using “Bitcoin” to mean blockchain. But don’t let that throw you off! Remember, you just learned the difference between the two.
What is blockchain technology?
Simply put, blockchain is a record-keeping technology, and its uses are ever-growing across a variety of industries. It’s a decentralized, digital ledger that records transactions and tracks assets, and is maintained by a linked network of computers (“nodes”). This network of nodes also helps keep the ledger secure because each separate node must validate a transaction before it can be recorded on the blockchain.
Why “blockchain”? Once a transaction is validated by every computer in the network, the information is contained in a “block” of data. Each block is then chained together, creating a chronological “blockchain” of historical transactions.
Distributed ledger technology
All network participants have access to this shared ledger and its transaction history, which can’t be altered. With this distributed ledger, transactions are recorded only once, ensuring there aren’t any version control issues that sometimes exist with traditional business networks.
You can’t alter or meddle with a blockchain transaction after it’s been recorded. This is because the other computers in the network would reject any alterations as invalid since the changes wouldn’t match the existing records. In the event of a true error, a new transaction would be added and validated by the network of computers to reverse the error, and both the new and old transactions would then be visible across the shared ledger.
This set of rules stored on the blockchain and executed automatically speeds up transactions. Smart contracts are simply programs stored on a blockchain that run when predefined conditions are met.
Permissionless vs. permissioned blockchains
You can characterize all blockchains as permissionless, permissioned or both.
Permissionless blockchains allow any user to join the blockchain and become a “node” of the network. These types of blockchains don’t restrict the rights of nodes on the blockchain network.
Tip: You might have heard that permissionless blockchains are entirely anonymous, but that’s only the case if there is absolutely no link between you and your wallet address (for instance, your IP or email).
On the other hand, permissioned blockchains control access to the network and may also restrict access of nodes that join. The identities of the users of a permissioned blockchain are known to other users on that network.
What are the different types of blockchain?
Public, hybrid, private and consortium are the four types that describe the variety of ways that you can build a blockchain network.
One of the most innovative things about public blockchains is that everyone in the world has equal rights to view, send transactions, be included and participate in the verification process. It’s worth noting they are also completely decentralized.
The many supporters of public blockchains are drawn to them because of their anonymity. Since they are open, many organizations are likely to adopt them without third-party verification. Currently, public blockchains are primarily used for the exchange and mining of cryptocurrency. Some popular public blockchains you likely have heard of include the networks behind Bitcoin and Ethereum.
Also known as managed blockchains, private blockchains are permissioned blockchains controlled by a single organization. The central authority determines who can join the network and gives each member of the network equal functional access and rights. Private blockchains are only partially decentralized as public access is restricted.
Unlike private blockchains, consortium blockchains are permissioned blockchains governed by a group of organizations rather than a single institution. They enjoy more decentralization, which gives them higher levels of security.
Setting up a consortium isn’t easy, though, as it requires cooperation between several organizations.
Hybrid blockchains are digital registries controlled by a single organization, but with a level of oversight from the public blockchain required for specific transaction validations.
Is blockchain technology safe? The pros and cons of blockchain and cryptocurrency
The more decentralized and widely distributed the blockchain becomes, the more secure it is. With many digital “eyes” watching and validating, the shared record is trickier to manipulate.
What are the advantages of blockchain?
Decentralization: The lack of a central authority in a public blockchain helps ensure no single point of failure.
Accuracy and security: Decentralization also makes the transaction record incredibly accurate and challenging to corrupt. Because every node in the network must validate a transaction before it is recorded, it would be incredibly difficult to fool the whole network.
Traceability and transparency: Because data in the blockchain is essentially unchangeable, it’s a trustworthy record-keeping tool in which to track a chronological history of transactions.
What are some of the risks of crypto?
Hacking or losing your digital wallet: Just like any online information, your digital wallet is susceptible to hacking and needs to be kept secure via encryption and strong passwords. You might opt to store your cryptocurrency offline on a hard drive instead, but be sure not to misplace or damage it … or forget the password!
Cryptocurrency is volatile: Crypto is still highly speculative, and it’s not uncommon to see swings in its value. It has exhibited high levels of volatility over time, and its newness makes its risk less understood.
Environmental concerns: Bitcoin mining requires a good deal of electricity. However, some mining firms are looking for ways to use recycled or creative energy sources to reduce carbon emissions. For instance, El Salvador is building mining operations powered off heat from volcanos.
By offering transparency and verified trust, the applications of blockchain technology continue to grow well beyond the world of cryptocurrency. Blockchain tech is already being used across industries — for instance, in healthcare to maintain patient information, in supply chain management to track shipments, and even in estate planning to record wills.
This continually growing list of use cases for this innovative digital ledger show that blockchain is poised to vastly change how we live and work.