What is Blockchain and How Does It Work?

Over the past few years, you might have consistently heard about Bitcoin, Ethereum, and other cryptocurrencies. Although most people know what cryptocurrencies are, they are not really aware of the technology behind them. Many financial specialists say Blockchain is the state-of-the-art database technology that is the heart of nearly all cryptocurrencies. But what exactly is Blockchain technology?

Lule Demmissie, president of Ally Invest, says, “Blockchain is the fundamental and revolutionary technology most cryptocurrencies depend on. Cryptocurrency is one of those renovations.”

Some believe Blockchain has the potential to transform almost every single aspect of our lives, far beyond crypto’s impact on our financial portfolios. Dr. Richard Smith, executive director of the Foundation for the Study of Cycles, calls it a “revolution.”

Chris Chen, CFP of Insight Financial Strategists in Newton, Massachusetts, says Blockchain is the real jewel. He believes Blockchain will possibly have more staying ability than popular cryptocurrencies like Bitcoin, Ethereum, etc., which he calls a flash in the pan. “Blockchain will keep on modifying how we do things.”

So if you are curious to know about the Blockchain meaning? How does Blockchain technology work? And more. Then this is the right platform to acquire strong foundation knowledge. In this article, you learn about what is blockchain technology? How does Blockchain work? Why it’s essential? And more. So let’s get started with Blockchain meaning.

What Is Blockchain?

As we have already discussed, Blockchain is the vital technology on which numerous cryptocurrencies like Bitcoin and Ethereum work. So let’s dive into understanding what is a Blockchain exactly? – It is a distributed digital ledger that stores data at its core. For example, we can record information about cryptocurrency transactions, NFT possession, or Defi smart contracts with blockchain technology.

While any standard database can collect this kind of data, what’s unique in Blockchain technology is that it is fully decentralized. Instead of being maintained by a centralized administrator in one location, Blockchain uses distributed ledger technology (DLT), in which identical copies of a blockchain database are held on multiple computers spread through a network, known as “nodes.”

Any Blockchain user can be a node, but it needs a considerable amount of computer power to function. Nodes authenticate, authorize, and collect information within the ledger. This is different from conventional record-keeping procedures, which collect data in a central place, like a computer server.

A blockchain categorizes data added to the ledger into blocks or data groups. Each block can only store a definite amount of information, so new blocks are constantly added to the ledger, developing a chain.

Each block has its unique identifier, a cryptographic “hash.” The hash safeguards the data inside the block from anyone without the mandatory code and protects its place along the chain by recognizing the block that came before it.

Vikas Agarwal, a partner in PwC’s Financial Services Advisory Practice, says about the cryptographic hash – “a collection of numbers and letters that can be up to 64 digits long. It is a unique code that lets the puzzle pieces interconnect.”

Once the information is stored in the Blockchain and encrypted with a hash, it is permanent and unchangeable. Each node has its record of the whole timeline of data and the Blockchain, going back to its beginning. If someone hacked into one computer and manipulated the data for their gain, it wouldn’t change the data stored by other nodes. The changed record can be simply differentiated and rectified since it doesn’t match the majority.

Agarwal states, “The process on which the system operates, it’s nearly impossible for someone to replicate the computing power that occurs on the back end to reverse engineer it and somehow comprehend what those hashes are.”

If it is still confusing, let’s understand Blockchain technology in simpler words – the digital ledger is like a Google spreadsheet shared among multiple computers in a network. The transactional records are stored on the basis of genuine purchases. The interesting angle is that anybody can see the data, but they can’t corrupt or modify it.

Now that you have a fair idea about what Blockchain is let’s dive into how Blockchain works?

How Does Blockchain Technology Work?

You may have seen numerous businesses worldwide incorporating Blockchain technology in recent years. But how does Blockchain technology work? Is this a noteworthy change or a simple addition? The progressions of Blockchain are still in their initial phase and might have the potential to be revolutionary in the future. So let’s start demystifying this technology.

Blockchain is a digital ledger defined as a “chain” comprising separate “blocks” of data. As new information is periodically added to the network, a fresh “block” is created and connected to the “chain.” This includes all nodes updating their version of the blockchain ledger to be alike.

The reason why Blockchain is considered highly secure? Because a majority of nodes need to authenticate and authorize the legitimacy of the new data before any new block is added to the ledger. For a cryptocurrency, they might include confirmation that recent transactions in a block were not fake or fraudulent or that they had not spent coins more than once.

Blockchain technology is different from a standalone database or spreadsheet, where one person can make modifications without oversight. “As soon as there is an agreement, the block is added to the chain. The underlying transactions are stored in the distributed ledger,” states C. Neil Gray – Partner in fintech practice areas at Duane Morris LLP. “Blocks are securely connected, forming a safe digital chain from the start of the ledger to the present.”

Transactions are characteristically protected using cryptography, meaning the nodes need to solve complex mathematical equations to process a transaction.

“As a return for their efforts in validating changes to the shared data, nodes are usually rewarded with new blockchain amounts of the native currency—e.g., new bitcoin on the bitcoin blockchain,” says Sarah Shtylman – fintech and Blockchain counsel with Perkins Coie.

If you find it difficult to understand how Blockchain works? Let’s understand with an example. Here’s how Blockchain can authenticate and store Bitcoin transactions.

• Suppose a customer buys Bitcoin.
• The transaction information is sent through Bitcoin’s decentralized network of nodes.
• Nodes authenticate the transaction.
• After authorization, the transaction is collected with other transactions to form a block, added to an ever-expanding chain of transactions.
• The finalized block is encrypted with a permanent transaction record, which cannot be eliminated or changed on the Blockchain.

Bitcoin’s Blockchain is public, which means anybody who owns Bitcoin can see the transaction record. However, it can be tough to track the individuality behind an account, the record shows which accounts are transacting on the Blockchain. Public blockchains also permit any user with the necessary computing power to contribute to authorizing and storing transactions onto the Blockchain as a node.

However, not all blockchains are public. They can be designed as private ledgers, so an owner can restrain who can make changes or add-ons to the Blockchain. While the participants may be lesser on a private blockchain, it’s still decentralized among those who contribute. In addition, private blockchains maintain the security of any data collected inside the database using the same encryption procedures.

The vision of a safe, decentralized permanent data record has drawn interest across several industries. It potentially holds solutions for several security concerns, record-keeping processes, and data ownership issues we face today. This raises one more question how is Blockchain technology being used in different sectors? Let’s find out.

How Is Blockchain Technology Used?

Blockchain technology is used for numerous purposes, from offering financial services to managing voting systems. But it makes Blockchain technology a reliable way of storing data about other types of transactions.

• Cryptocurrency

Today Blockchain technology is the backbone of cryptocurrencies. When people purchase, exchange, or spend cryptocurrency, the transactions are verified and stored on a blockchain. “Since cryptocurrencies are unpredictable, they are not yet used much to buying goods and services.

But that is shifting as PayPal, Square, and other money service businesses make digital asset services accessible to retailers and wholesale customers,” notes Patrick Daugherty, senior partner at Foley & Lardner and chief of the firm’s blockchain task force.

• Banking

Blockchain is being used to process transactions in fiat currency, like dollars and euros. This could be quicker than sending money across a bank or other financial institution as the transactions can be authenticated more rapidly and processed outside of regular business hours.

• Asset Transfers

Blockchain can also record and transfer the possession of different assets. This is presently very popular with digital assets like NFTs, representing the proprietorship of digital art and videos. However, we can also use Blockchain technology to process the possession of tangible assets, like legal documents of real estate and vehicles.

The two sides of a party would first utilize the Blockchain to authenticate that one owns the property and the other has the money to purchase; then, they could complete and record the sale on the Blockchain. Finally, using this procedure, they could transfer the property deed without physically submitting paperwork to update the local region’s government records; it would be promptly updated in the Blockchain.

• Smart Contracts

Another blockchain used case is self-implementing contracts, generally known as “smart contracts.” These digital contracts are automatically authorized once conditions are fulfilled.

“With blockchain technology and coded instructions to automate legal contracts, we see great potential in a smart contract,” says Gray. “A correctly coded smart legal contract on a distributed ledger can minimalize or remove the requirement for third parties to authenticate performance.”

• Supply Chain Monitoring

Supply chains include vast amounts of information, mainly as goods go from one part of the world to another. It can be tough to track the source of problems with traditional data storage techniques, like which vendor’s poor-quality goods came from.

Storing this information on Blockchain would make it relaxed to turn back and examine the supply chain, such as with IBM’s Food Trust, which uses blockchain technology to track food from its harvest to its consumption.

• Voting

Specialists are exploring ways to utilize Blockchain to stop fraud in voting. Theoretically, blockchain voting would permit people to submit votes that couldn’t be tampered with. In addition, it would get rid of the need to have people physically collect and validate paper ballots.

Advantages of Blockchain

1. Higher Accuracy of Transactions

Because multiple nodes must verify a blockchain transaction, this can reduce error. For example, if one node has a mistake in the database, the others would realize it’s unusual and find the error. In contrast, it may be more likely to go through if someone makes a mistake in a traditional database.

In addition, every asset is separately recognized and tracked on the blockchain ledger, so there is no chance of double spending it like an individual exaggerating their bank account, thus spending money twice.

2. No Need for Mediators

Using Blockchain technology, two parties in a transaction can authorize and execute without working through a third party. This saves time and the cost of paying for an intermediary such as banks.

“It can bring superior efficiency to all digital commerce, enhance financial authorization to the unbanked or underbanked populations of the world, and empower a new generation of internet applications,” says Shtylman.

3. Extra Security

Ideally, a decentralized network, like Blockchain, makes it almost impossible to make fraudulent transactions. The fraudsters would require to hack every single node and change every ledger to enter forged transactions.

While this isn’t essentially impossible, many cryptocurrency blockchain systems use proof-of-stake or proof-of-work transaction authentication methods that make it challenging and not in participants’ best interests to add fraudulent transactions.

4. More Effective Transfers

Since blockchains work 24/7, people can make more effective financial and asset transfers, especially globally. They don’t need to wait days for a bank or a government agency to confirm everything manually.

Disadvantages of Blockchain

1. Limit on Transactions per Second

Since Blockchain relies on a more extensive network to authorize transactions, there’s a limitation to how fast it can move. For example, Bitcoin can only process 4.6 transactions per second, contrasted with 1,700 per second with Visa. In addition, growing numbers of transactions can cause network speed issues. Until this recovers, scalability is also a challenge.

2. High Energy Costs

All the nodes working to authenticate transactions takes considerably more electricity than a single database or spreadsheet. This makes blockchain-based transactions more expensive and creates an enormous carbon burden on the environment.

Because of this, some industry heads are starting to move away from some blockchain technologies, like Bitcoin: For example, Elon Musk recently said Tesla would stop accepting Bitcoin partially since he was concerned about the harm to the environment.

3. Risk of Asset Loss

Some digital assets are protected using a cryptographic key, like cryptocurrency in a blockchain wallet. You need to guard this key carefully.

“If the digital asset holder loses the cryptographic key that provides them admittance to their asset, there is no method to recover it (the asset is lost permanently),” says Gray. Moreover, because the system is decentralized, you can’t call a central authority, like your bank, to ask to recover access.

4. Potential for Illegal Activity

Blockchain’s decentralization enhances secrecy and privacy, unfortunately making it appealing to criminals. In addition, it’s more challenging to track illicit transactions on Blockchain than through bank transactions that are attached to a name.

What Would Blockchain-Based Future look like?

Agarwal says, “Blockchain technology allows us to transfer data securely and have almost complete certainty in knowing the legitimacy of any data you want to safeguard. Consider, for example, the disaster girl meme that has spread in recent weeks of meme subjects and personalities who cashed in on digital property by selling NFTs (non-fungible tokens).

Since the underlying blockchain record is unchallengeable, NFTs allow retailers to authenticate a digital asset’s legitimacy. When buying an NFT, that transaction is added to the blockchain ledger and becomes a provable ownership record.

For those who need the capability to authenticate a digital work’s legitimacy, Blockchain helps value digital art and collectibles similar to their physical counterparts. Theoretically, this results in creators maintaining value through things earning royalties on copies made of digital art.

“That might look confusing to the rest of us who don’t value those things,” Smith says. “But it’s validating that you can hold a digital economy along with digital property privileges.” It allows you to say, ‘I own and control this piece of the digital economy,’ he says.

For most of us, one of the most impactful use-cases of blockchain technology may be safeguarding and securely transferring personal data.

Imagine if you stored your banking data on a blockchain. Then, when you open an account with a new financial institution or transfer data between institutions, a blockchain ledger could help rapidly and securely ensure the transfer or new account is correct and legitimate using your already-stored information. Agarwal says, “It can diminish many costs and overhead and become an effective way to reduce fraud.”

He envisages blockchain technology has potential across almost every industry “since every industry has some type of data that they’re trying to exchange in a very safe way.” So, for example, an election run on blockchain technology could benefit from a voting record that gets locked in and cannot be changed after the fact.

Businesses could maintain more precise inventory records using Blockchain. Blockchain could even help consumers make more knowledgeable buying decisions with enhanced transparency around product supply chains. For example, the technology may help food suppliers track recalled products more professionally or let consumers avoid goods created using misused labor practices.

Uses like this illustrate Blockchain’s appeal for security and what Chen calls the integrity of information. “Blockchain technology has got the huge potential to provide people more safety and self-assurance around that,” Agarwal says.

Corporations and governments worldwide continue to test and implement blockchain technology, but this won’t happen overnight. So, if we ever reach a point where government currency is blockchain-based or medical records are converted to a blockchain, it won’t be anytime soon.

Meanwhile, you can speculate on the power of Blockchain by adding a blockchain-based cryptocurrency like Bitcoin to your portfolio. However, that’s not the only way to put your dollars behind the technology. You can also regulate more conventional investments, so they’re blockchain-forward. For example, check out whether your ETFs or mutual funds involve companies developing blockchain technologies or starting to utilize Blockchain technology in their business processes.

Even ETFs are entirely made up of these companies, known as Blockchain ETFs. For example, launched in 2018, the Siren Nasdaq Blockchain Economy Index (BLCN) has outpaced the S&P 500’s total return yearly and three-year average. These funds don’t put any of your money in crypto precisely; instead, they invest in selected company stocks ranging from established businesses like IBM to lesser-known startups like Galaxy Digital.

While it still doesn’t assure a return, it can be a more conservative substitute for directly putting your money into the unpredictable cryptocurrency market.

Chen compares the difference between speculating in cryptocurrencies directly and investing in blockchain companies to the California gold rush two centuries ago. “Many people rushed in there in search for gold, and most of them never earn any money,” he says. “The folks who made money are those who sold the shovels. The companies supporting the development of Blockchain are the shovel sellers.”

Frequently Asked Questions (FAQ)

Q1. How to Invest in Blockchain Technology

Blockchain technology and stocks can be profitable investments, and there are numerous ways to take the next step toward making your first blockchain investment purchase. Bitcoin is typically the first thing that comes to mind when investing in blockchain technology, and it shouldn’t be overlooked.

In addition to Bitcoin, there is also the choice of investing in cryptocurrency penny stocks, such as Litecoin and Altcoin. Some apps and services are in the pre-development stage and are using blockchain technology to raise funding.

Q2. What is Blockchain vs. cryptocurrency?

Blockchain technology enables the existence of cryptocurrency, among other things. Bitcoin is the most popular cryptocurrency for which blockchain technology was developed.

Q3. Is Blockchain the future?

Blockchain technology will fundamentally transform how we live and work in the future. As a result, the Global Blockchain Market is expected to reach USD 34 billion by 2026, with a growth rate of 45%.

Q4. Do all cryptocurrencies run on Blockchain?

Most cryptocurrencies use blockchain technology to record transactions. For example, the bitcoin network and Ethereum network are based on Blockchain.

Q5. How safe is Blockchain?

Blockchain technology is very safe and secure as it is decentralized and distributed. There is no single point of failure, making it more challenging to corrupt. In addition, hacking into one part of the system cannot impact other parts.

The Bottom Line

Regardless of its potential, Blockchain remains something of a niche technology. Gray sees the potential for Blockchain to be used in more situations, but it entirely depends on future government policies. “It remains to be seen when and if regulators like the SEC will take action. However, one thing is evident the goal will be to protect markets and investors,” he says.

Shtylman compares Blockchain to the initial stages of the internet. “It took nearly 15 years of having the internet before we observed the first version of Google and above 20 for Facebook. So it’s hard to predict where blockchain technology will be in another 10 or 15 years. Still, much like the internet, it will considerably renovate how we transact and interact with each other in the future.”

Challenges will remain, especially with the transaction limits and energy costs. Still, for investors who see the potential of the technology, blockchain-based investments may be a bet that is worth taking.