Blockchain Technology: A Guide for Beginners

Blockchain technology is still a mystery to a majority of people. Some find it exciting, and some find it intimidating, while others don't have a clue about it ๐Ÿ˜Š

And I get that since it's still in the early development stage, and there's so much to learn and implement.

This article aims to introduce you to the basics of blockchain technology, how it works, and its application.

For starters, imagine how easy life can become if you could send money to your family, staying thousands of miles away, in minutes without paying hefty banking fees.

Now, think about having complete control of your money without requiring any permission from your bank to view or transfer it. And you could store your money digitally in a wallet without a bank governing it.

All of these are not dreams; they are possible with blockchain that offers a lot of capabilities and advantages. This is the reason why people are interested in learning blockchain and embracing it. It's also estimated that corporate investment in blockchain is likely to reach US$12.4 billion by 2022.

But what exactly is blockchain?

Let's find out!

What Is Blockchain Technology?

Blockchain is an immutable (unchangeable) and shared digital ledger that stores records or transactions in several places on a network of computers. Here, each verified transaction is added in a space called a block that links with other subsequent blocks with the help of cryptography, forming a chain.

If that definition made you scratch your head, let's understand blockchain technology in simpler terms.

Blockchain is a kind of database that stores data (records) on a computer electronically.

Block = A space that contains records

Chain = A link connecting records

So, a chain of linked blocks containing records is called a blockchain.

All blockchains are databases, but not all databases are blockchains. The difference between a database and blockchain is how they store data.

Blockchain vs. Database

A database collects a vast amount of information and arranges it in a tabular format to allow users to modify data easily and simultaneously. Also, more extensive databases use servers with powerful computers to house massive data and perform computation. A company or an individual generally owns a database; hence, they control and manage its access.

On the other hand, blockchain collects data in groups or blocks with a specific storage capacity. When a block's capacity is filled, it attaches to another block, forming a chain. All the new records following the subsequent, newly added block are compiled into the new block.

Unlike a traditional database, a blockchain does not have a single owner; instead, it's accessible to everyone with permission. This is why it's also called a decentralized system, as there's no central hub to control the blockchain. Similarly, blockchain technology is called Distributed Ledger Technology (DLT). It is a distributed ledger of records and allows users to share data or perform transactions peer-to-peer with no central authority.

Blockchain technology was invented by an unknown entity โ€“ Satoshi Nakamoto (an individual or a group of individuals in 2008) as a public bitcoin transaction ledger. It aims to timestamp a digital document and ensure no one can tamper with it. It helps to solve the issues related to double records and perform secure transactions of assets without involving a third-party intermediary such as the government or bank.

This technology works on the internet and comprises different parts like databases, connected computers or nodes, software applications, and more.

Example: A company can leverage blockchain technology in its bookkeeping to record all transactions. Bookkeeping involves double-entry accounting for transactions that can be confusing and difficult to verify records by other parties. These records are also straightforward to tamper with, like edit, delete, or add a new record; hence, they may not be accurate.

This is where blockchain can help them by securing transactions with the help of cryptography. It offers a tamper-proof way of storing transactions in blocks.

What Are the Components of Blockchain?

The blockchain architecture comprises various layers, such as infrastructure or hardware, data, networking like nodes, verification, information distribution, and applications. Let's understand some of its components.

Block

As explained above, blockchain refers to a chain of different blocks that contain data or records. And the data in each block is based on the kind of blockchain. For example, a banking blockchain will have blocks containing information such as account number, account holder's name, branch name, etc.

The first block in a blockchain is known as the Genesis block, and all the blocks contain valid records encoded and hashed. Each block has a cryptographic hash of its own and that of the previous block in the same blockchain, linking them and forming a chain. This iterative process validates the previous blocks' integrity with digital signatures.

Hashing

A hash is like a fingerprint unique to every block. It is a code created using a mathematical function turning digital data into a long string of letters and numbers. This 64-digit hexadecimal number identifies each block and its content, and once it's created, any modifications in the block will change the hash. Blockchain technology uses Secure Hash Algorithm (SHA) 256 hashing and is highly useful to detect any change made in the transactions. It also makes it secure as all the blocks contain the hashes of the previous block.

So, if an attacker changes data in a block, its hash changes while the next block still has the old hash of the compromised block. Hence, all the succeeding blocks become invalid that can easily be tracked.

Assets

Assets can be tangible or intangible. Tangible assets are physical items such as land, house, equipment, etc., while intangible assets are non-physical items such as intellectual property contracts, copyrights, patents, etc. Interestingly, money can be both tangible and intangible.

Distributed Peer-to-Peer (P2P) Network

Every transaction in a blockchain works in a distributed Peer-to-Peer (P2P) network that has no central authority to control data. It allows everyone (having access) to join the blockchain, and every computer added to the network is a node.

So, when a user creates a new block, it goes to each user on the network, and each node must verify this new block to ensure no one has altered it. When the verification is complete, each node starts adding the new block directly to their blockchain.

All the nodes present in the network make a consensus, confirming the validity of blocks and rejecting the tampered ones.

Types of Blockchains

Blockchain is of different types, and users leverage this technology for many use cases depending upon its type. So, different types of blockchains are:

Public Blockchains

Blockchains facilitate a decentralized, open network of multiple computers that anyone can access to request or verify a transaction for accuracy. It allows users to create new blocks, access all the blocks in the blockchain, and validate the data.

As they are open and need excellent security, they use concepts like proof of stake or proof of work. The block miners who validate transactions are rewarded financially. Public blockchains are mainly used for mining and exchanging cryptocurrencies.

Examples: Bitcoin, Litecoin, and Ethereum blockchains.

Private Blockchains

Private blockchains are centralized and governed by a person or organization that decides who can access the blockchain, be added as a node, and verify records. Unlike public blockchains, private blockchains aren't open and offer access restrictions. If anyone wants to join a private blockchain, they must obtain permission from the administrator.

Example: B2B virtual currency exchanges like Hyperledger.

Consortium Blockchains

A group of companies or organizations govern these permissioned blockchains instead of one individual. They are more decentralized than a private blockchain to enjoy more security. It allows limited access and the present nodes determine the consensus process.

Furthermore, it constitutes a validator node to initiate, receive, and verify transactions while member nodes have permission to initiate or accept transactions. Here, users can transfer digital assets from one blockchain to another with improved efficiency and scalability.

Example: Consortium blockchains are used in payments and banking, such as Quorum and Corda.

Hybrid Blockchain

Hybrid blockchains combine the attributes of private and public blockchains. They can be centralized or decentralized and allow organizations to set up a permission-based private blockchain along with a public blockchain. Thus, the organizations can control the data access in the blockchain and what data to access publicly.

Example: It's used in real estate and retail industries, such as IBM Food Trust.

How Does A Blockchain Transaction Work?

This is how a typical transaction occurs in a blockchain:

Step 1: Transaction request

First, an individual requests a transaction involving real estate, banking, cryptocurrency, records, contracts, etc.

Step 2: Distribution

The transaction requested gets broadcasted in the peer-to-peer network through nodes located across the globe.

Step 3: Validation

The nodes in the network validate the transaction using algorithms and solving complex equations. If they find the transaction legitimate, the records are entered inside blocks.

Step 4: Adding blocks to the blockchain

After the transaction completes, the newly created block is chained with the previous block with cryptography and encryption. It has a hash code and contains the hash code of the previous block. Once this block has filled its allocated space, the next block starts filling and attaching to the previous block; hence a long chain of transactions is formed. This is immutable and transparent for everyone in the blockchain.

How Does Blockchain Ensure Transaction Security?

Blockchain has various techniques to ensure a transaction's security, such as cryptography, hashing, proof of work, etc. Some of the security techniques are as follows:

Immutability

Immutability in blockchain means no one can manipulate data entered in the blockchain. It's because every block has a unique hash code and another referencing the previous block. The cryptographic hash codes are not reverse-engineered. In case a transaction data has an error, you can enter a new record for correction. In this case, it will show both the records. Hence, there's no chance of errors or double-entry.

Chronological Structure

Every block in a blockchain is stored in chronological and linear order, meaning they always attach at the end of a blockchain. And each block has a hash and the hash of the previous one. This fashion is followed throughout the blockchain that may contain thousands of blocks. Hence, it's challenging to retreat all the way back to change the records.

Even if someone manages to alter a block, they will have to do it for all the other blocks, which takes considerable effort, resources, computational power, and time. This gives users time to verify the block and find if it is compromised. The cost of such a hack could be prohibitive, and most of the time, unfruitful.

Proof of Work (PoW)

Although hashing is an excellent way to mitigate tampering, attackers can still hack a blockchain using powerful computers to change a block and recalculate succeeding blocks, and make the entire blockchain valid.

To counteract this, blockchain uses Proof of Work, a mechanism to decelerate new block creation. It is a piece of complex computation that takes some effort to solve. And it also takes more time to solve the problem than verifying the results. Hence, calculating the proof of work and adding a new block becomes way more challenging than changing the block and the rest of the blocks after it. This is how proof of work makes blockchains secure.

Many times, people confuse PoW and PoS, so they quickly understand it.

Proof of Stake (PoS)

Proof of Stake uses cryptographic algorithms to validate transactions. For example, in mining, validation is done by a selected validator depending upon the number of coins they occupy, which is called their stake.

Users don't technically mine or get rewarded but forge blocks. Participants in the process gain coins, and those with more stake, have greater mining power. It increases their chance of getting chosen as the validator.

Advantages and Limitations of Blockchain

Advantages ๐Ÿ‘

The benefits of blockchain are:

Accuracy

All the transactions are validated by thousands of nodes on a blockchain network. It is powerful enough to eliminate errors and provide greater data accuracy. Even if a mistake is made, other computers can spot it quickly. And if this error is to prevail, a minimum of 51% of total computers in the network would have to make the same mistake, which is nearly impossible, especially when a massive blockchain like Bitcoin is involved.

Decentralization

No central hub controls or manages a blockchain; instead, it is decentralized. It means a network of thousands of computers can access it with no single person or organization to govern it. Any change in the blockchain immediately reflects on each node with permission in the network.

Cost-efficiency

Blockchain does not involve any third party to approve a transaction along with their processing costs. For example, banks or payment processors charge a small amount to process a transaction. Thus, businesses performing payment transactions using blockchain technology such as Bitcoin can save a lot of costs.

Speed

Traditional banking systems take a lot of time to process the payment, from its initiation to when the amount reflects on your account. In addition, financial institutions are operable only during their specified business hours and days. So, it may take days to reflect the amount on your bank finally. On the other hand, blockchain is unstoppable. It is active 24/7/365, and transactions can take a few minutes to complete. It is also highly beneficial for international payments.

Immutability

All the records are immutable or unchangeable on a blockchain due to the reliable encryption mechanism, cryptographic hashing, and chronological chaining of blocks. So, it's not possible to modify or delete data.

Security

Once a transaction is added to a blockchain, thousands of powerful computers verify the record's authenticity before adding it to a block. Blockchain technology uses complex calculations and algorithms for validation and assigns a unique hash to each block for identification.

And even if an attacker changes something, it immediately becomes visible to all the nodes, which can identify the error and render the block invalid and the blocks following it. Hence, it offers a high level of security.

Transparency

With no central authority, most blockchains, like public blockchains, are open-source software. It allows everyone to access the code and auditors to review for security. Anyone in the network can suggest upgrades or changes, and if the majority of users agree, it can be accepted. This way, blockchain offers higher transparency than traditional systems. In addition, you can also stay anonymous to protect your privacy.

Limitations ๐Ÿ‘Ž

Illegal activities

Blockchain attracts lots of illegal activities and trading despite offering security and privacy to users. There are many cases of theft and breaches related to blockchain-based currencies and services.

Environmental concerns

Blockchain networks such as Bitcoin consume massive electricity to mine and validate transactions, which impacts the environment.

Scalability issues

Although blockchains are faster than traditional financial institutions, scalability is still an issue. They are tough to scale globally and may cause inefficiencies in doing so. However, new developments are surfacing these days to improve scalability, like Ethereum's Innovative Layer 2 (L2).

However, many still argue the pros of blockchain overshadow the cons, and hence, blockchain is seeing increased adoption globally in various applications and industries.

Blockchain vs. Bitcoin

There's a lot of confusion and misconceptions regarding blockchain. Many confuse blockchain with bitcoin, thinking they are the same.

Well, they are definitely not the same!

Blockchain is a technology, while bitcoin is an application of blockchain. Blockchain allows recording and distribution of data but does not allow editing, making it secure for Bitcoin and other FinTech services.

Talking about Bitcoin, it is a digital currency (cryptocurrency) built on blockchain technology. It is a peer-to-peer system without a third party or governing body and uses blockchain to store a ledger of transactions (or payments). At present, mining Bitcoins and administrating transactions are done in the network collectively.

World's largest cryptocurrency, Bitcoin (BTC), has a public and open-source ledger. It allows you to send and receive Bitcoin payments with no bank involved or paying fees to them.

Uses of Blockchain

Blockchain is now spreading in various industry verticals to offer them the benefits of security, transparency, privacy, and many more. Leading companies that have already adopted blockchain are IBM, Siemens, Walmart, and more.

Let's look at some of the uses of blockchain.

Cryptocurrency

Bitcoin is not the only cryptocurrency out there. Cryptocurrencies are digital currencies that use strong cryptography to store transaction records securely in a ledger (blockchain). A central authority does not issue it, and its control is decentralized.

There are many other cryptocurrencies besides Bitcoin, such as Ethereum (ETH), Litecoin (LTC), Namecoin (NME), Dogecoin (DOGE), Ripple (XRP), TRON (TRX), and more.

Smart Contracts

Smart contracts are digital, blockchain-based proposed contracts. They can be enforced or executed without involving human interaction. It eliminates the need for an intermediary between two contracting parties; the blockchain takes care of it. As a result, it offers transaction automation and reduces friction between parties.

Banking and Finance

Some banks like UBS are interested in implementing blockchain due to its faster transaction speed and reduced costs. In addition, tokenization of various stocks is happening, and new financial services like Initial Coin Offerings (ICOs) and Security Token Offerings (STOs) are also surfacing. These services can help tokenize tangible assets like real estate.

Supply Chain

Blockchain is being implemented in supply chain areas such as food supply, furniture, software development, and mining precious commodities like diamonds.

Healthcare

According to The Wall Street Journal, Ernst & Young was using blockchain to assist governments, airlines, employers, and others in tracking people immune to the coronavirus and those who have undergone antibody tests. China also used blockchain to accelerate health insurance transactions.

Other uses: Blockchain is also used in video games like CryptoKitties, P2P energy trading, domain names, and verification of documents, shipments, and products.

History of Blockchain

Blockchain is a new technology, but some elements of this concept have existed for a long time. Certain notable events resulted in the foundation of blockchain technology. Let us get a brief timeline of such significant events.

blockchain history

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

Blockchain is not only about Bitcoin. Even though Bitcoin was the reason behind the immense popularity of blockchain in the earlier years, now, there is so much more to it. Currently, there are plenty of applications of blockchain technology in various sectors.

Conclusion ๐Ÿ‘ฉโ€๐Ÿซ

Blockchain is an advanced technology with a high level of security and transparency. With increasing awareness about blockchain, more and more organizations are adopting it across industries. Hence, this technology is likely to stay and will find many more uses in the future.

You may also be interested in reading: Cryptocurrency Mining for Beginners.