What Is Blockchain?
|—Blockchain networks provide the foundations for cryptocurrency, allowing peer-to-peer transactions.|
— A blockchain is an immutable digital ledger that records every single transaction ever made.
— The trustless capabilities of blockchain technology sparked off an entire DeFi industry that could challenge traditional banking.
Blockchain technology may seem overwhelming at first, but understanding some of its key features will help you become a web3 expert in no time. You may think that all blockchains are as secure as Bitcoin, or perhaps that all blockchains are as capable as Ethereum. However, in fact, blockchain networks have huge differences. From their governance to the creation of new coins, even down to who can join the network; blockchains can have features that alter the way the whole network functions.
Some blockchains are better than others for specific use cases, but they each have their strengths and weaknesses. Thus, in this article, Ledger Academy will cover everything you need to know about what a blockchain is and how it works, plus, the different types of blockchains and what they are for.
But before we dive into the technicalities, let’s start with the basics of basics.
What Is a Blockchain?
In simple words, a blockchain is a distributed and immutable digital ledger that is responsible for recording transactions and tracking the movement of digital assets on its network. Primarily, blockchains were used to track financial assets but today, there are a growing number of use cases as the blockchain is a fantastic way to store value. Blockchains have some key features that open up a new world of functionality, a concept often named ‘Web3’. So what are these key features?
Key Features of a Blockchain Network
Blockchains have a lot of other interesting features. However, they all start with these two main pillars: distributed Ledger technology, and immutable records.
Distributed Ledger Technology
Instead of hosting its information on a single centralized server, a blockchain distributes its ledger to each and every computer in the system. These computers are called nodes and they are responsible for storing, sharing, and recording information and the transfer of digital assets. This is the basis of “distributed ledger” technology, and it’s the only way in which blockchains can store information securely.
Next, a blockchain has a unique way of storing that information: within blocks. These blocks of new information are arranged in a chain, which is distributed across the network, hence the name ‘blockchain’. To clarify, this specific data structure ensures that it is impossible to alter information once included in the blockchain. These features make blockchains almost impossible to hack.
What Are Blockchains For?
You might be wondering why all this is such a big deal – you probably make digital transactions all the time. But sending money digitally is very different from sending information, such as an email or picture.
For any currency to have value, its supply needs to be finite. In a successful digital transaction, value needs to be received by the receiving party, while the exact same value disappears from the sender’s account. If it doesn’t happen that way, it’s called double-spending.
That term might be unfamiliar to you, but it’s the lynchpin for our entire financial system and our reliance on banks. Blockchain technology solves the double-spending problem without involving a centralized entity to verify transactions. This means it’s possible to transfer transparent, secured, and anonymous peer-to-peer exchange of value at scale. But what does that mean?
Well, simply solving the double-spending problem means blockchains allow you to exchange value with a friend in the confidence your assets will go from one person to the other. Importantly, it must be able to do this without creating new assets in the system by allowing participants to spend them twice.
Types of Blockchain
There are several ways to build a blockchain network and there’s likely a bit more to it than you thought. When most people think of blockchains, they are referring to decentralized blockchains like Bitcoin. But is worth mentioning this technology can also build centralized systems.
Just because blockchains allow for the peer-to-peer transfer and decentralized exchange of value, that doesn’t mean all blockchains operate in this way. Some blockchains are public, private, permissioned, or built by a consortium. Some are even a combination of some of these types.
So let’s understand the difference between different types of blockchain networks and why it matters.
Private, Permissioned, and Consortium Blockchains
A permissioned blockchain is run by a single entity, such as a government or a company. As a result, the central entity can limit access to the system and who can operate a node. Plus, those who do operate nodes have a lot of power – power they could misuse.
Next, you get private blockchains. By definition, these blockchains are always permissioned. But they actually take it one step further. Private blockchains don’t just limit who can operate a node, they also limit who can access the system. This is a completely centralized system and it allows entities to protect users’ identities and data. As a result, these systems are preferred by governments or trade groups aiming to keep control over the system and its data.
A good example of a private blockchain is Hyperledger. In this case, it uses a private system in order to keep user data (such as shipping information) away from prying eyes. In this case, having a transparent blockchain would pose a privacy risk.
Then, Consortium Blockchains are also permissioned blockchains, but instead of being governed by a single entity, it’s a group of organizations responsible for its management. This method is popular for financial systems which would like to cooperate. These blockchains can process transactions quickly as they verify changes using a voting system.
However, all of these are very centralized options – This means there is a single point of failure, which isn’t very secure at all.
Permissionless and Public Blockchains
Conversely, a permissionless blockchain will allow anyone to operate a node in the network. In this system, there tend to be more participants and they could live anywhere in the world.
This does make them slower than their private and permissioned counterparts. However, the bigger the system is, the easier it is to police participants with bad intentions. Thus, a permissionless blockchain’s decentralized nature makes it much more secure than its private counterparts.
There are also public blockchains that are, by definition, permissionless. Not only do they allow anyone to join the network, they treat all nodes equally and all of the network’s data is readily available to every participant. Public Blockchains are great for cryptocurrencies as they are transparent, secure, and auditable. A good example of a public blockchain is the Bitcoin Network.
How Does A Blockchain Work?
As mentioned, a blockchain network stores data on all of the computers participating in the network, otherwise known as nodes. Nodes contribute to the security of the network by taking part in the transaction validation process. Each of these nodes stores information in blocks. Then each of these blocks is arranged in a chain. Every time the network processes a transaction, the chain grows.
However, nodes don’t store information in a way you could read it. Instead, it uses a cryptographic hash. To protect sensitive information included in a transaction, the node converts the information into a string of numbers and letters and then stores it in each block.
This cryptographic hash doesn’t just include the information of the block it corresponds to, it also includes information on the previous block in the chain. This means if anyone alters one block, it will also alter its hash and therefore every subsequent block in the chain. This makes any potential edit very noticeable to the whole network, meaning it is secure. The earlier the transaction is in a blockchain’s history, the harder it becomes to alter the data. This capability means blockchains are a unique medium for storing valuable data. If you want more details, make sure to read the full article on blockchain transactions and nodes and how to operate them.
So now we understand how a blockchain stores its information.
But you might be wondering, “What’s to stop a node from lying about the state of the network for its own gain?”
Well, all of that comes down to a blockchain’s type and its consensus mechanism.
How are Blockchains Secured?
For permissioned and private blockchains, the controlling entity will usually organize a vote. However, public blockchains, such as Bitcoin or Ethereum, have found a method to stay secure in a more decentralized way: by using a consensus mechanism.
What Is a Consensus Mechanism?
This is the cleverest part of a public blockchain: There are thousands of nodes scattered across the planet, and the majority of them must verify each new transaction before it can join the blockchain. Once the block is added, every node in a blockchain must arrive at the same state. This is called achieving consensus.
With the management of the blockchain ledger distributed so widely, no single entity can gain control of the network or validate false information. This makes the whole network secure. But the way in which these nodes process transactions differs slightly depending on the consensus mechanism the blockchain uses. Plus, each method has its advantages and disadvantages.
To understand their differences fully, make sure to read the full Ledger Academy on what consensus mechanisms are.
Different Consensus Mechanisms
Public blockchains have two main categories of consensus mechanisms; Proof-of-work and Proof-of-stake. However, there are also several other methods of consensus that are more centralized and less-used.
Proof-of-Work (PoW): A slower, secure consensus mechanism, which uses miners to create new coins and process transactions by solving complex puzzles which take a lot of computational power. This keeps the network secure as it makes the system pointless for miners to try and cheat – the cost of using that much energy is simply too expensive to make it worth it. A good example of a PoW blockchain is Bitcoin.
Proof-of-Stake (PoS): A faster, energy-efficient consensus mechanism that uses validators to process transactions. Instead of using computational power to prove their trustworthiness, validators in a PoS blockchain use significant amounts of crypto as collateral. To learn more, read the full article on crypto staking, but basically, validators are incentivized to behave honorably. In short, they receive rewards for acting well and are punished for acting maliciously. A good example of a blockchain that uses this system is Ethereum.
Blockchain: What’s the Excitement About?
While you may correspond blockchain technology directly to cryptocurrencies, there’s actually a lot more to it than that. Blockchain isn’t just about crypto and finance, these networks are also capable of some other novel uses.
For example, some blockchain networks are capable of executing smart contracts, which are like the blockchain’s version of a computer program. Without getting too technical, smart contracts opened up a whole cultural revolution in blockchain technology.
These computer programs make it possible to create blockchain apps with a variety of use cases.
For example, decentralized finance apps which allow lending and borrowing are only possible due to this capability. Plus, blockchain games and blockchain art in the form of Non-fungible tokens become possible too. These programs also opened up the possibility of decentralized metaverse platforms, such as The Sandbox and Decentraland.
Then, Blockchain technology even has the power to change the way we govern things. That’s because tokens and coins make it possible to create complex decentralized voting systems in the form of Decentralized Autonomous Organizations (or DAOs).
As the innovation in the web3 industry grows, the potential for more and more use cases grows along with it. Put simply, Blockchain technology is here to stay and who knows what else it could do in the future.