Introduction to Blockchain Technology: The Basics of Blockchain
Key Questions Answered
What Is Blockchain?
A blockchain is a distributed database, an integrated collection of databases that is physically spread across different locations. It’s also a public ledger that stores information digitally and is maintained by a network of computers or nodes. Most cryptocurrencies rely heavily on blockchain technology for two core purposes:
- Helping secure the networks and transaction records
- Maintaining decentralization, which allows money to be transferred without an intermediary
Distributed ledger technology (DLT) is considered the parent technology of blockchain. The infrastructure and protocols that form DLT allow for a digital system where users and systems can record, access, and validate information securely and immutably (unchangeably). A digital system built with DLT is decentralized, as the information is stored by multiple entities in different locations.
The security and immutability of the system are achieved via private and public keys and cryptographic signatures. The private and public keys are strings of randomized numbers and letters. The public key is derived from the private key and serves as the public address that others can see and utilize to send crypto to the user. The private key (also called a secret key) works like a password used for decrypting and encrypting the wallet, as well as signing transactions and proving wallet ownership.
While blockchain technology is sometimes referred to directly as distributed ledger technology, a blockchain is actually just one type of distributed ledger. Other types include the hashgraph used by Hedera Hashgraph (HBAR) and the directed acyclic graph (DAG) used by IOTA (IOTA).
How Many Blockchains Are There?
No one knows for sure how many blockchains exist around the world, but it’s safe to say the number is growing as blockchain technology is increasingly adopted. All blockchains can be categorized depending on their restrictions. The main types are as follows:
- Public blockchains are permissionless and decentralized, meaning anyone can join and become a node. This type of blockchain is primarily involved in exchanging and mining cryptocurrency. Examples of public blockchains include Bitcoin (BTC), Ethereum (ETH), and Solana (SOL).
- Private blockchains are permissioned blockchains managed by a single entity. This entity determines which user can be a node. An example of a private blockchain is Ripple (XRP).
- Consortium blockchains are a hybrid form of public and private blockchains. This type of blockchain is managed by one or a group of entities wherein each member owns a portion of the network. An example of a consortium blockchain is Quorum, which is developed by JP Morgan.
The different types of blockchains (Source: ResearchGate)
For more information, check out our guide to the different types of blockchains.
Who Invented Blockchain and When Was It Invented?
Many of the technologies that make up the blockchain were in development long before cryptocurrency was born. A preliminary version of blockchain was first described in 1991 by Stuart Haber and W. Scott Stornetta. The two scientists were developing a cryptographically secured chain of blocks.
The person (or people) who invented blockchain in its current form is only known by a pseudonym, Satoshi Nakamoto. In 2008, Nakamoto released a whitepaper detailing the principles behind blockchain and the first cryptocurrency, Bitcoin (BTC). The paper conceptualized blockchain as a public ledger that would facilitate Bitcoin transactions without the need for intermediaries. A few years later, Nakamoto exited the scene and passed leadership to other developers.
However, Bitcoin did not come without flaws. Many developers felt that Bitcoin could not fully leverage the full strength of blockchain technology. Among these developers was Vitalik Buterin, one of the founders of a new public blockchain launched in 2015 called Ethereum (ETH).
The Ethereum team’s biggest innovation was incorporating programs called smart contracts into the blockchain. Smart contracts automatically perform certain functions when a set of predetermined conditions are met, eliminating the need for a third party to ensure enforcement. The implementation of smart contracts allowed blockchain technology to expand beyond currency applications and into financial applications, giving rise to decentralized finance (DeFi).
What Can Blockchain Be Used For?
A blockchain’s primary functions are to store information digitally and secure the data using cryptographic encryption. Many companies are developing and incorporating blockchain-based solutions into their products and services. Here are two major examples of real-world applications of blockchain technology:
- Blockchain can be incorporated into a monitoring system for product deliveries. If a problem occurs during transportation, the blockchain-based tracking system allows companies to quickly identify the problem’s source. For example, Walmart Canada utilizes a blockchain-based automated system to manage invoices from and payments to third-party freight carriers.
- Blockchain can also be incorporated into financial services. Traditional financial institutions like banks only operate during business hours, and may take days to settle some services due to the large number of transactions these institutions process. With blockchain technology, these institutions can process transactions within 15 minutes and operate 24/7. For example, JP Morgan utilizes blockchain technology to enhance fund transfers between banking institutions globally.
For more information about blockchain applications, please check out this article.
How Does Blockchain Work and Remain Secure?
In a blockchain, the information is grouped into blocks, which are data structures that have specific storage capacities. Once a block is filled, it is closed and linked back to the previously filled and closed block. New information is loaded into the next block, and the cycle repeats, forming a chain of blocks called a blockchain. This process of creating and adding new blocks to the blockchain is called mining.
Each block consists of the following components:
- The data stored on the block is different depending on the type of blockchain. For example, it could be transaction records about the sender, the receiver, and the transaction amount.
- When a block is created, it generates a random number called a nonce. The nonce generates a block header hash — a “fingerprint” that’s unique to the block. If anything in a block is altered, its hash changes.
- The block also contains the previous block’s hash, which helps prevent tampering. When something does happen to a block, the hash changes. As a result, the following block no longer stores the previous block’s hash, making all subsequent blocks invalid. An attacker would have to regenerate the hash of every invalid block.
Characteristics of mined blocks in a blockchain (Source: ResearchGate)
For enhanced security, blockchains also utilize consensus mechanisms to authenticate transactions on a distributed ledger. A consensus mechanism is an algorithm that requires nodes to work together and agree on the legitimacy of any transaction made on a blockchain.
The most common consensus mechanism is proof of work (PoW), which slows down the creation of new blocks. In simple terms, PoW requires miners to use specialized computers and expend effort to solve a mathematical puzzle for each block. The miners continuously guess the solution to the puzzle until the correct one is found. The miner who guessed the right solution can then add their block to the chain and will receive a reward for their work. If an attacker tampers with one block, they will need to solve mathematical puzzles for all the following blocks, which will require a significant amount of computational resources.
Other more energy-efficient mechanisms, such as the proof of stake (PoS) model, have also been introduced as alternatives to PoW.
With the implementation of a consensus mechanism, even if an attacker successfully adds a malicious block, the block will need to pass verification. A blockchain is a peer-to-peer network where the nodes will need to verify the block’s validity before it gets appended to the chain. If the nodes discover a block is invalid, they can reject the block, and it will not be added to the blockchain.
The process flow of a blockchain network (Source: ResearchGate)
Is Blockchain Really Secure?
The cryptographically encrypted transaction records in a blockchain make it extremely difficult for attackers to alter the data. However, many users still wonder whether blockchains are immune to all malicious attacks. In reality, there are indeed some vulnerabilities, attacks, and mistakes that may affect a blockchain or cause a loss of assets:
- A 51% attack can happen when a single node or a group of nodes with over 50% of a blockchain’s computational resources tries to take control. The attacker(s) can perform malicious acts such as rewriting parts of the blockchain, reversing transactions, and stealing assets.
- Many security breaches happen due to human error. Common mistakes include the loss of private keys, transfers to the wrong address, and accidental installation of malware.
- Poorly written smart contracts, codes, and programs associated with the system provide attackers with possible weak points. For example, an attacker managed to target an accounting error built into MonoX Finance’s software, stealing $31 million worth of tokens.
All in all, is blockchain safe? The answer is the blockchain can be regarded as safe, but only to an extent. Users still need to properly care for their electronic devices and practice due diligence to avoid common pitfalls. Here are a few tips to keep in mind:
- Don’t invest in projects that do not have a diverse network of nodes.
- Always keep a copy of your keys.
- Only invest in projects that are backed by reputable teams.
How To Invest In Blockchain?
There’s no way to directly invest in blockchain or blockchain technology. However, you can invest in cryptocurrency by purchasing cryptocurrency on a cryptocurrency exchange like Phemex. If the cryptocurrency market’s volatility is too risky, you can buy shares of a cryptocurrency trust like Grayscale Bitcoin Trust or an exchange-traded fund (ETF). Users with a high tolerance for risk can also participate in an initial coin offering (ICO) where they purchase a new cryptocurrency currently in development to support the team.
Blockchain technology has garnered much attention in the past decade due to the increasing popularity of cryptocurrency. Many big companies, from Walmart to JP Morgan, are incorporating blockchain systems to improve and secure existing products and services. Nonetheless, blockchain is not entirely safe from malicious attacks, and the technology is still relatively new. Thus, any investor or company interested in making blockchain-related investments should discern whether the potential rewards outweigh the current risks.