Your Guide to Understanding Blockchain Technology

Published on 16 August 2022 7 min read

Cryptocurrency is enjoying a renaissance. In the 12 years since the first cryptocurrency, Bitcoin was introduced, the digital currency has rapidly grown in popularity—in part due to Bitcoin’s reputation as one of the highest-yielding securities currently traded. According to Pew Research Center, 16% of Americans reported, as of 2021, that they have invested in or used cryptocurrency, with 86% attesting that they at least know a little about the technology.

For many, the interesting part of cryptocurrency is not its valuation. It is the innovation that drives cryptocurrency that is fueling the discussions and debates about the automatization of data and the future of this emerging technology. Vitalik Buterin, the co-founder of the cryptocurrency Ethereum, once said, “Instead of putting the taxi driver out of a job, blockchain puts Uber out of a job and lets the taxi drivers work with the customer directly.”

Simply put, a blockchain is a distributed digital ledger. The best way to think of this is a publicly downloadable database that – while allowing anyone to read past entries – only allows new records to be written to it. The platform that most cryptocurrencies are based on, blockchain allows for verifiable, unchangeable, and public records to be stored and shared. With most blockchains being decentralized or not controlled by a single person or company, the blockchain presents the possibility of a scalable database service that does not need to rely on trust for its veracity or security.

What is a Blockchain?

What is BlockChain — blockchain technology

One good way to think of a blockchain is a neighborhood bake club. Each of the members is expected to bake and sell a certain amount. However, none of the members trust the others enough to put them in charge. This forces the community bakers to come up with a system to record their own transactions—supply purchases, sales, donations, etc.—so that the others in the group can verify them without being able to change them.

The bakers come up with a ledger book, of which each member would have their own copy. Every week, the bakers would get a list of the group’s combined transactions, which they would add to the end of their books in ink.

This, however, would not be enough to secure the transactions. Each transaction would bear a secret code known only to the transaction’s owner. To ensure that no one can change the transaction, the entries are verified by an agreed-upon calculation based, in part, on the calculation before it. This way, if a greedy baker changes a transaction dishonestly, all the entries after it must also be changed.

The bakers would also be able to detect a bad actor in their group by simply comparing the books. Assuming the consensus among the books to be the truth, any books found to be in the minority would be rejected and corrected. Should a new baker join the group, all they would have to do is get a copy of the book that matches the consensus and start entering and verifying the group’s new transactions. Conversely, if a baker wants to leave the group, all they would need to do is to stop accepting new transactions.

The bakers’ transaction book is a trustless, distributed digital ledger. This type of ledger was first publicly theorized by Satoshi Nakamoto in their whitepaper, “Bitcoin: A Peer-to-Peer Electronic Cash System.”

In this model, a set of timestamped transactions are processed into “blocks,” which would be added in incremental order into a “chain.” Miners, or ledger holders that verify the veracity of the transactions, would compete to see who could verify the block first. The miner with the first fully verified block not only gets the honor of having their block be the officially accepted block, but also gets the mining reward attached to the first transaction in the block.

While different protocols have made changes to Nakamoto’s blockchain, almost all blockchains are blocks of transactions cryptographically encoded to both its transaction headers and its neighboring blocks.

How do Blockchains Work?

The way transactions are accepted and verified in the various blockchains depends on the consensus method the blockchain uses. Among these are:

Proof-of-work: The consensus system used by Bitcoin and by most Bitcoin clones, the system works by having the verifier calculate a hash that is within a given target. As this calculation system has a built-in difficulty that increases with each new block, and as this proof system constitutes guessing, requiring multiple attempts, proof-of-work is energy-intensive and dependent on innovations in processing speed and power. On the Bitcoin blockchain alone, the power needed to verify a single transaction is the equivalent of the energy needed to power an American house for a month and a half.
Proof-of-stake: A low-energy alternative to proof-of-work, proof-of-stake forgoes the hash calculation essential to the proof-of-work consensus model with an equity model. Instead of offering the blockchain to anyone who wants to mine, verifiers must stake a certain amount of the blockchain’s currency or coins. While this simplifies the consensus process and gives emphasis to those willing to stake more, it discourages the spending of the blockchain’s coins. Proof-of-stake is the consensus system Ethereum is transitioning to from proof-of-work. Due to the reward system being different in proof-of-stake blockchains, verifiers or miners are rewarded by transaction creators, who offer gas or payment to process the transaction. Gas is not mandatory; it is just an enticement to process a transaction first.
Proof-of-capacity: Proof-of-capacity is a newer consensus system that uses the hard-drive capacity of the verifier’s computer to determine who will mint a block. Before mining, a new hard drive is plotted with all possible solutions to the mining calculation. Each solution represents a minimum amount of time the miner must wait to claim a block. If the time limit elapses and no other miner has mined a block, the miner can claim the block.
Proof-of-activity: Proof-of-activity is a combination of proof-of-work and proof-of-stake, in which a block is created using proof-of-work. Once created, however, subsequent transactions involving the block are verified using proof-of-stake. This limits the energy consumption proof-of-work utilizes while using proof-of-work’s reward generation system.
Other consensus systems include proof-of-burn, which sacrifices small amounts of the blockchain’s cryptocurrency to vet verifiers, proof-of-history, and proof-of-elapsed time.

Depending on the protocol, blockchains can have programs encoded into the blocks as transactions. These decentralized applications, or dApps, can act as an agent creating and verifying transactions with users. Using self-executing contracts, these dApps can create, execute, and enforce any type of agreement among themselves or other party.

With the help of real-world-facing, information-gathering dApps called Oracles, a dApp can theoretically be programmed to do anything—from managing a car-rental fleet, to facilitating international money transfers, to tracking complex supply chains.

What are the Challenges Limiting Blockchain Growth?

Like any other nascent technology, blockchain has its flaws. Besides the heavy energy use, blockchains have created an arms race of sorts where the largest miners race to get the latest in computing hardware. This has created shortages in GPUs, CPUs, and computer memory. Many manufacturers, like Nvidia, have taken steps to limit their products’ usability in mining.

Blockchains also have a scalability issue. With potentially thousands of miners on the blockchain network verifying transactions, it can take significantly longer to process a cryptocurrency transaction compared to a bank transaction that has a single verifier. The reality of this is stark: Visa can process more than 1,700 transactions per second, compared to Bitcoin’s 4.7 transactions per second. Various improvements, such as side blockchains and sharding, can theoretically improve blockchain speeds.

Finally, there is the risk of data loss. Coins and tokens are protected by a public-private key system. The public key is contained in the block that created the coin. The private key is given to the coin owner after the coin is minted. These private keys are stored in a computer file called a wallet. To spend a coin, the private key must be matched to the public key and then passed to the new owner.

Private keys are not recoverable. If they are lost, the coin will no longer be spendable. This means that a lost or corrupted wallet can mean the loss of all the tokens and transactions the wallet's private keys support. It is like losing a real wallet; there is no feasible way to recover the fiat or government-issued money in that wallet unless someone returns it to you.

Embracing the Future

Despite the risk, blockchain technology offers an exceptional means to revolutionize—in ways just being realized—the way data is gathered and used. In one case use example, NFTs (non-fungible tokens) are changing how content is licensed. An artist or creator can publish a secure link to his/her work to a blockchain and sell tokens that allow access to that link. In this way, an artist can control the licensing of his/her content without the need for a third party.

With blockchains offering new ways to change the dynamics of how data is managed, stored and used, it is only our collective imagination and will that will limit how this technology will be utilized. Currently, blockchain is being used to manage voting systems, to allow for simplified mortgage searches, to run autonomous vehicle rental fleets, to trace transnational money transfers, and many other case uses.

Information is a commodity, and there will be those that will resist decentralized control of it. However, with the potential of this technology being as pronounced as it is, blockchain stands the potential to be a changing force in the economics and logistics of the world.