What is blockchain technology and how does it work?

Blockchain / 20 Min Read
Axi Team / 25 Aug 2021

Blockchain technology is an innovative way to store data but it is also so much more than that. Blockchain is the technology that makes cryptocurrency possible.

It's a system of storing and sharing information that can be verified by everyone who has access to the network. Blockchain technology was first developed for Bitcoin, but now there are many different kinds of blockchain networks in use all over the world. Many people see blockchain as being revolutionary because it solves some problems with how we interact on the internet today - like ensuring privacy or providing transparency into transactions.

In this guide to blockchain technology you will learn:

What is blockchain technology?

At its heart, blockchain is simply a way of digitally recording financial transactions. It’s a relatively new technology, but it’s become increasingly popular thanks to some unique advantages.

Blockchain is built on what’s known as a distributed network. This simply means there is no single point of authority – like a bank or government – that controls it. Instead, the trust in the system comes from its transparency. Anyone within an individual blockchain network can view and verify transactions, creating a level of accountability that is difficult for anyone with bad intentions to get around (at least without anyone else noticing).

How blockchain works can be a confusing concept, so perhaps the easiest way to get a practical understanding of what blockchain is and how it works is with a very simplified example.

Let’s say John owes $30 to Tim, but he only had $10 at the time. John writes a note confirming that he’s going to pay another $20 at a later date and gives the note to Tim as a record of the amount owed.

Now, the only thing stopping that note from being manipulated is good faith on behalf of John and trusting Tim. But if Tim chose to try and change the amount he was owed – let’s say from the original $20 to $120 – John would have no way to prove it.

But what would happen if John had made copies of the original note? In that case, there’s increased visibility over the transaction, so it’s easy to see if one party had attempted to manipulate the original document. This transparency and fraud prevention is effectively what blockchain allows, only on a more sophisticated and much larger scale.

In blockchain, each individual transaction is time-stamped and stored in what’s known as a ‘block’. These blocks are digitally chained together in chronological order, forming the blockchain. Each block can be identified by a hash code – which is similar in nature to an ID card – and there’s no limit to the number of new blocks that can be recorded.

So does that mean all transactions are eligible to be recorded on a blockchain? Well, no. For that we need to understand the role of miners whose job it is to validate transactions. But let’s hold off on that for now and dive into the history of blockchain.

History of blockchain

The first work on blockchain technology came nearly 18 years before the introduction of Bitcoin when, in 1991, research scientists Stuart Haber and W Scott Stornetta brought the concept into existence. With their understanding of how easily digital media was being modified, they proposed blockchain as a solution by digitally time-stamping documents.

Within a year, they incorporated something called ‘Merkle Tree’ into the blockchain, which added to its security and efficiency. Merkle Tree is a data structure, used in computer science, that makes it possible to record many transactions in a single block, making it faster and easier to verify.

Then came the pivotal moment: the introduction of Bitcoin. In 2008, an online document titled ‘Bitcoin: A Peer-to-Peer Electronic Cash System’ was published under the pseudonym of Satoshi Nakamoto, proposing how digital transactions could take place between two parties, with no centralised authority. The following year, the original white paper on Bitcoin was released and it comprehensively detailed how the Bitcoin blockchain structure worked. Today, it serves as a digital ledger for all Bitcoin transactions across the globe.

Bitcoin got the world talking and ignited the imagination of developers around the world. One such spark led a Canadian developer, Vitalik Buterin, to propose a platform for decentralised value transfers and decentralised software applications. In 2014, along with seven other co-founders, Ethereum was launched on the back of a crowdfunding initiative.

Ethereum brought the concept of ‘smart contracts’ into the blockchain space. These are programs that self-execute once the terms set and agreed upon by both parties are met. This space quickly became a developer’s haven as it provided a platform for them to develop decentralised apps (dApps) and other smart contract-based applications.

So that’s a basic outline of how we got to this point with blockchain and the more well known cryptocurrencies, but let’s start delving into the specifics of how blockchain technology works.

How does blockchain work and record transactions?

Primarily, there are three parts to recording a blockchain transaction:

1. Hash encryption

When a transaction is initiated on a blockchain, it creates a new block which contains three important pieces of information:

  • Data: the details of the transaction
  • Previous hash: this helps connect the current block to the preceding block, building the blockchain
  • Nonce (number only used once): this is a random number used to prevent replay attacks i.e. duplicating the same transaction

Note: Nonce is the only component of a block that a miner can change. All other data is predetermined.

Now, the network itself establishes the digital identity, or signature, for the transaction. Moving on, we’ll see how authentication and recording work.

2. Mining

Mining is the way transactions are authenticated and recorded on the blockchain ledger.

To validate a signature, miners need to generate the ‘hash’ output. The hash is like a human fingerprint in that it is unique, therefore it’s difficult to compute. To find the right hash value, miners need to solve complex mathematical puzzles and find the exact nonce number that generates an accepted hash. And given there’s no template to solve these puzzles, miners must use trial-and-error.

After finding the right nonce value, they add the block to the chain. Once this has been done, the miner gets a financial reward – for example, native coins (i.e. Bitcoin) and/or transaction fees of that block.

3. Validation and nodes

After mining, the block needs to be communicated to all the nodes in the network, which validates it. In other words, you have to confirm the transaction is complete by telling everyone about it.

Nodes play a crucial role in validating a new block, and any electronic device that can hold and distribute copies of the blockchain ledger is considered a node. The use of a consensus algorithm – an agreed set of criteria that legitimises a block – achieves the validation.

After validation, the newest ledger has to be made accessible to everyone in the blockchain’s infrastructure. Nodes allow this while also contributing to the upkeep of the decentralised nature of the technology.

So, after the block has been mined and added to the blockchain, all the nodes in the network exchange the latest version of the digital ledger. By doing this, the nodes have maintained the consistency of the ledger throughout the network, making it impossible for any party to alter the ledger without triggering all the validators in the network about it.

Without nodes or miners, the hallmark principle of blockchain – decentralisation – is not possible. With nodes being a critical piece of the infrastructure, it’s worth understanding them in more detail.

Diagram of how blockchain technology works

What are blockchain nodes?

Nodes are to blockchain what nerves are to the human body.

Imagine your hand touching a hot stove. Your reflex action is to take the hand away. This reflex is possible because your nerves sensed the heat, conveyed it to the brain and led to a response. But what if your nerves can’t carry the information to your brain? You are the proud owner of a burnt hand.

In a blockchain, if the full set of nodes are not there, it’s impossible to conduct transactions. How would miners know if there’s enough balance for the transaction to go through? Miners depend on full nodes to gain access to the full blockchain history, then use that information to conduct transactions.

Since no single authority controls or manages the blockchain, there is no centralised database or intermediary to store data. Hence, blockchain is reliant on nodes, as they are the primary elements of its structure. All the nodes on a network connect to each other and this helps them efficiently relay the information back and forth.

Just as we divide our nerves into sensory and motor types, nodes also have different types.

Types of blockchain nodes

Mining nodes

Also known as ‘miners’, these nodes create blocks that are added to the blockchain. These blocks are produced through solving complex cryptographic puzzles to find the right nonce. Once the right hash value has been generated, mining nodes create blocks and send them to full nodes for validation. Depending on the blockchain, mining nodes receive native tokens or other currencies as rewards.

Full nodes

Full nodes are a comprehensive store for all information held on a blockchain. They’re an integral part of decentralised communication as they hold and distribute copies of the entire blockchain ledger and help in validating the history of the blockchain. The more full nodes in a network, the more decentralised it is and the harder it is to hack the network.

Super nodes

These nodes are the bridges that connect full nodes to each other. Super nodes relay information across the network and ensure that all full nodes have an accurate copy of the blockchain.

Light nodes

These are a scaled-down version of full nodes. Rather than holding the entire blockchain ledger, light nodes hold only a specific portion i.e. the block header of the previous transaction. This means light nodes store the timestamp and the nonce of the block. Likewise, they confirm the blocks using the block headers and relay the information to other nodes.

You can consider light nodes as a team of support staff for the full nodes: if a full node holds an inaccurate copy of the blockchain, the light nodes mark it as ‘incorrect’. Furthermore, they help the full node to conform to the correct version of the blockchain.

Note: Not all blockchains are equipped with each type of node outlined above. The purpose and the functionality of the blockchain helps in deciding which category of nodes to use.

How does blockchain mining work?

Mining is an essential part of maintaining and building a blockchain. People also view it as an avenue of earning crypto tokens as reward for successful mining. So, let’s dig into how blockchain mining works.

First off, mining is like forgetting the key combination of a number lock. You start with something like 0-0-0 and try different combinations to try and crack the code. Here, you’re using mental energy to find the right code. If you fail, you can also use physical energy to smash the lock into bits and pieces…

However, mining doesn’t work like that. The network encrypts the block into a cryptographic puzzle where validation is possible only after finding the right hash value. So, how do you find the hash? This is where mining is more than just solving mathematical problems. As there is no set template to finding the right hash, miners need to adopt a trial-and-error method to discover the exact hash.

To accomplish this, miners combine the nonce value with the previous block’s header. Here, the header contains information and is not changeable. However, miners can change the nonce value. Changing the nonce value quickly to generate the right hash is hashing.

Confused? Put it this way: to keep changing the nonce number and crack the code, miners need a huge amount of computational power, which requires a huge amount of electricity. This is a key reason why small-scale mining is no longer feasible.

To understand how complex it is to confirm a correct hash value, here’s an example of what one looks like:

682c18061d0e703c6c6ede973d41ff3e82ccc63a3362e9652889f9efd39e27ae

Once the miner eventually generates the right hash value, they transmit the block to all the nodes (participants) within the network. They verify and confirm the block, then add it to the chain of blocks.

Types of blockchain networks

There are four different types of blockchain networks:

Public

Public blockchains are decentralised networks with no barriers to entry. They are commonly used in cryptocurrencies (such as Bitcoin) to conduct peer-to-peer transactions. In this network type, participants and their transactions are semi-anonymous, though the transparent ledger does store all transactions.

Private

Despite running contrary to the ethos of blockchain, this is a closed network maintained by a central authority. The upside is that it allows monitoring and restriction of access, making the network more secure. Enterprises like DHL, JP Morgan, and Walmart employ private blockchains to help streamline their operations.

Hybrid

As the name suggests, this is a hybrid version that incorporates certain elements of both public and private blockchains. Controlled by a single authority, hybrid blockchains allow flexibility in managing access to information and records. Real estate and healthcare are two sectors that have extensively adopted hybrid blockchains.

Sidechain

This is a blockchain subset connected to a parent blockchain via a two-way peg. Just think of sidechains as a secondary blockchain whose job it is to make things easier for the two blockchains to talk with each other.

Types of blockchain consensus algorithms

Blockchain consensus algorithms are essentially a process where everyone on a network agrees on the real-time state of the blockchain – and it’s really important. Achieving consensus is necessary to maintain trust, security and reliability in a decentralised setting.

Different blockchains follow different consensus algorithms, and these are the most popular:

Proof of Work (PoW)

Introduced by Satoshi Nakamoto, the inventor of Bitcoin, Proof of Work is the oldest consensus algorithm. It’s built on the concept of mining, which involves nodes or miners solving complex mathematical problems to validate a block, which is then added to the blockchain. Mining requires enormous amounts of computational power to solve the problems. Once it is solved, the network rewards the successful miner before they move onto mining the next block. Cryptocurrencies like Bitcoin, Monero and Litecoin all use this algorithm.

Proof of Stake (PoS)

Proof of Stake appeared in 2011 but really only gained popularity when it was championed by the developers of Ethereum. In PoS, validators replace miners. They can stake digital assets to validate blocks and add them to the blockchain. For every confirmed transaction, the validator receives a reward. By limiting mining power in proportion to the volume of assets staked, PoS is a more resource-friendly algorithm. Polygon (MATIC), Binance and Solana are some of the more recognised crypto projects using PoS algorithms.

Proof of work vs proof of stake

Delegated Proof of Stake (DPoS)

This is a variant of the traditional PoS algorithm, built to add more democracy and efficiency in achieving consensus. Here, participants vote to select a set of nodes or delegates who can validate the blocks on their behalf. The volume of coins held by each participant helps in determining their voting power. In a DPoS system, 21 to 100 delegates are elected to validate the blocks and publish them onto the blockchain. Cardano, Tron and EOS are projects that leverage DPoS algorithms.

Proof of Authority (PoA)

A more recently developed consensus algorithm, PoA relies on awarding authority to qualified nodes to validate blocks. Nodes or participants can gain the right to validate nodes after passing a certain set of criteria. This involves voluntarily disclosing identity and evaluation of the node’s reputation. To qualify, nodes have to prove that they adhere to the defined procedures of validating blocks. PoA is popular in enterprise and private institutional setups as the algorithm attaches the nodes’ right to participate to their reputation. VeChain and Decred are two popular projects that employ the PoA algorithm.

Other notable algorithms include:

  • Practical Byzantine Fault Tolerance (PBFT)
  • Proof of Burn (PoB)
  • Leased Pool of Stake (LPoS)
  • Proof of Capacity (PoC)
  • Proof of Importance (PoI)

How is blockchain used?

Blockchain technology with its inherent qualities of safety, security, and enhanced accessibility make it a tool potent enough to disrupt industries. From transacting currencies without extra permission through to documenting land titles, the potential applications for blockchain are enormous. Here are some major industries where blockchain is currently being used at scale.

Financial Services

Blockchain technology has brought transparency and efficiency to the banking sector. Using decentralised exchanges (DEXs), anyone can conduct transactions at lightning speeds without the need for a centralised authority, like a bank. Blockchain is also beginning to revamp the age-old credit system with decentralised lending and borrowing facilities, while initiatives like yield farming and staking are creating more avenues for investment. With smart contracts, blockchain and decentralised finance (DeFi) is disrupting the financial sector and some believe its true potential within this industry is far greater.

Supply Chain

From the factory to the receiver, consignments are being tracked continuously. Since blockchain allows traceability of data and goods, firms can easily engage in real-time verification. This is helping the global market to transact goods of value across borders without worrying about counterfeiting and other common concerns.

Healthcare

Blockchain is replacing the need for paper in documenting a person’s health history. An open-source database, accessible only by registered healthcare centres, is now becoming a reality. Examples of how this might be used include enabling a simple assessment of medical history and helping avoid things like the consumption of falsified drugs.

Real Estate

From tokenisation of properties to efficient verification of tenant identity, blockchain is revamping the way real estate operates. It’s also removing the middleman in the transaction process by automating the transfer of ownership using smart contracts.

How to invest in blockchain?

The blockchain industry is maturing quickly, with more users and institutions adopting the technology and a growing number of services, products and applications being built on blockchain technology. As it becomes more mainstream, investing in blockchain will become more enticing. The diversity of blockchain has given rise to multiple avenues to invest in and leverage the potential of this disruptive industry.

Cryptocurrencies

By far the most popular application of blockchain tech is cryptocurrency. To date, over 10,000 cryptocurrencies are being traded publicly and each of them has its own use, ranging from buying digital art to funding movies. With more industries and sectors adopting blockchain technology, an increase in demand for digital currencies is likely.

Since most cryptocurrencies are dependent on a blockchain, they are a straightforward avenue to invest in. Given the speed to market and the well-known volatility of these currencies, potential investors should do plenty of research and due diligence. Reading the white paper or official documents of the associated project is a good way to begin understanding its credibility.

Cryptocurrency CFD Trading

Short for “Contract For Difference”, a CFD is a contract between a trader and a broker, where you speculate on the change in a coin’s price. 

In cryptocurrency CFD trading, the level of investment is often low when compared with directly investing in coins. This is due to you only having to invest a percentage of the whole value of the trade to gain full exposure to it. So, if your prediction is correct, you gain profits for 100% of the trade value. However, if your prediction fails, you have to bear the entire loss.

Example

You are trading bitcoin CFDs with a trade value of $10,000. If you think bitcoin will rise in value you would place a buy order (go long), if you think it will fall then you would place a sell order (go short).

You only have to pay a small deposit from your initial $10,000 up front – let’s say $100. Despite that, you ‘ll still enjoy the profit based on the entire $10,000 – if your prediction is correct. But if your prediction is incorrect, you ‘ll have to pay the losses accrued on the total $10,000.

Example of bitcoin cfd trade

Firms providing blockchain services

Many established companies (think IBM, Microsoft and Amazon) provide blockchain services on their platforms, and many more multinational corporations are investing in this technology to diversify their services. With decentralised solutions popping up across the world, these services are likely to be in high demand for streamlining processes and reducing human error. So, investing in these firms is like dipping your toes in the blockchain market without staking your livelihood. And because these firms are not entirely reliant on blockchain, the risk is comparatively low.

Pure blockchain firms

Unlike the firms mentioned above, several companies have incorporated blockchain technology as their core competency; Microstrategy, Coinbase and Silvergate Capital are pure blockchain and crypto-related firms. They facilitate trading, decentralised applications, and other ventures that solve real-life problems using blockchain.

Further reading: How to trade cryptocurrency?

How does blockchain compare to banks?

Ever since blockchains gained steam, there have been a growing number of comments on how they can disrupt the banking sector. As things stand, banking institutions remain the main point around which the financial system revolves, but the potential for a decentralised financial system gets a lot of people excited. Before that happens, evaluating how blockchain-enabled decentralised finance (DeFi) weighs up against banks will be necessary to understand how the future might look.

Sense of control

Let’s say Jake receives a dreaded, “The server is down” text when he tries to pay for something at a shop. This doesn’t sound drastic, right? But, for Jake, he can’t use his money – he’s entirely reliant on his bank to access his own funds. So, the basic sense of ownership is no longer in Jake’s hands but at the disposal of his bank. But with blockchain, a smartphone and the internet is all Jake needs to transfer his funds and establish a greater sense of control of his money.

Enhanced security

Banks store all information about their users in a centralised database. Likewise, they use a single centralised server to facilitate their transactions. That means two points of weakness for banks, potentially making it simpler for hackers.

On the flip side, blockchain is more secure as there are no central points of infrastructure to fail. Since the database is immutable, breaking through the blockchain is virtually impossible.

Speed and efficiency

A day for cheque clearance; 3-7 business days for international transfers; closed on weekends. These are just some of the reasons blockchain users believe the traditional banking system is becoming redundant. And that’s not to mention transaction fees.

In contrast, the transaction time for Bitcoin is about 3 to 10 minutes. The same on the Ethereum network is between 15 seconds to five minutes, on average. If we look at newer blockchains, the payments are near-instant with a negligible fee. This is a clear demonstration of how efficient blockchains are as an effective payment method.

Despite this, changing a centuries-old financial system is not quick or easy. With the lack of consistency in regulations, blockchain is far from being mainstream in today’s financial world.

However, there is a possibility of integrating certain blockchain-based functionalities into the current financial system to enhance their efficacy.

How is blockchain different from traditional database models?

There are four areas that set blockchain apart from traditional database models:

  • Authority

The basic difference between blockchain and traditional database models is the type of authority. The decentralised nature of blockchain ensures there is no single authority that manages the ledger. Traditionally, a centralised administrator maintains the databases.

  • Immutability

Recording of data on the blockchain allows for two operations: view and write. There is no space for altering or deleting any transaction on the blockchain. On the flip side, databases support CRUD – Create, Read, Update and Delete. So, a malicious actor can more easily infringe a database and commit fraudulent activities.

  • Transparency

Everyone on the blockchain network can view transactions happening on the blockchain. But, in the traditional model, only the administrator can determine who can access the data in the database.

  • Corruption

It’s virtually impossible to hack or alter a decentralised chain, making them secure from malicious activities. However, any individual with sufficient leverage in a traditional database can corrupt the entire system.

How are blockchains and distributed ledgers different?

Discover the four key areas that determine the difference between a blockchain and a distributed ledger.

Structure

Blockchain is a structure built on chains, whereas there is no specific structure for a distributed ledger. It is simply a database that’s accessible and shared across several nodes.

Use cases

Several governments and institutions are adopting blockchain technology for varied applications. With smart contracts and dApps, there’s no limit to the use cases and growth of the technology. However, there is currently a negligible real-life implementation of other forms of distributed ledger technology.

Sequence

Blockchain follows a chronological sequence to record data and transactions, whereas distributed ledgers do not have a particular sequence to conform to. The sequence a ledger follows depends on its underlying technology.

Consensus algorithms

Adding blocks to the blockchain needs collective acceptance from all nodes in the blockchain. There are several consensus algorithms (such as previously mentioned Proof of Work or Proof of Stake) that we can incorporate into blockchain networks. However, distributed ledgers don’t need this consensus for their maintenance.

Cryptocurrency

How is blockchain decentralised?

‘Decentralisation’ is a buzzword commonly associated with blockchain technology, but how does it actually work?

Let’s take the example of banks. They store data like users’ personal details, transaction history, and credit history in a single database. Likewise, they facilitate transactions in their individual server or network. Here, the bank is in complete control of the database and the server.

In a decentralised system, data is shared across several computers with no geographical consistency. Since all the computers maintaining the blockchain ledger are not under one roof, no single authority or group can collude and perpetrate fraud. If a particular computer attempts to tamper the records, all the other computers in the blockchain can cross-reference with each other to hold an accurate set of records. This system firmly establishes decentralisation and disallows fraudulent activities.

Let's learn about some of the key benefits of a decentralised system.

Trustless network

With banks, users trust the management (i.e. a group of people) to safeguard their funds and facilitate transactions. However, in a decentralised blockchain, there’s no need for trust as every participant has equal access to the immutable record. By removing the trust factor, blockchains avoid any collusion within the system.

Resource utilisation

All the participants in the network collectively maintain the blockchain. This means everyone shares the resources without relying on a single source. And since the need for resources is shared, there’s minimal barrier to entry when adding people to the network. And as more members join a blockchain, the ledger is further decentralised, further increasing the network’s security.

Reduce bottlenecks

Traditional systems rely heavily on a specific set of people for decision-making. This hierarchy means every action in an organisation consumes a lot of unnecessary time and causes inefficiency in the system. With decentralisation, the entire network uses consensus to achieve changes. This reduces congestion in the blockchain and allows never-ending operation.

How is blockchain secure?

Many people tout blockchain as the future of industry and data storage, so its security is of paramount importance. Here are some critical factors required to maintain the integrity of the blockchain:

  • Distributed ledger

Blockchain uses a distributed network to record and store data. This means there is no single point of weakness that can be used as a loophole by a potential hacker.

  • Immutable

The blockchain allows its participants, or nodes, to perform only two functions: read and write. That leaves zero chance for a node to conduct fraudulent activities by altering the transaction records.

  • Cryptography

Mining nodes encrypt every block on the blockchain with unique digital signatures. The proof of ownership sits only with the true owner, hence theft is highly unlikely.

  • Consensus

Transactions recorded in the blockchain require approval by a series of nodes in the network. Only after achieving consensus and verifying the block can it be added to the chain. This prevents the manipulation of transactions and the ability to leverage them to commit fraud.

  • Perpetual recording

Blockchain is a dynamic ledger that keeps recording transactions endlessly. Since it’s also immutable, rolling back the ledger to edit blocks is difficult.

What is a blockchain wallet?

A blockchain wallet is a digital wallet that allows users to transact on a blockchain, manage transactions and track the value of digital currencies. It works in a similar way to a bank account, with each wallet having a unique cryptographic address (similar to an account number) which is used to send, receive, and exchange cryptocurrencies.

Blockchain wallets are secured by a private key (a 256-bit number). Knowing this number will allow direct access to any funds held in the wallet, so it should not be shared. Make sure you don’t forget it because, thanks to the decentralised nature of blockchain, there’s no ‘forgot my password’ service – if you forget your private key, you’ll be locked out of your digital wallet forever!

There are two major types of blockchain wallets:

Hot wallet

In general, any wallet connected to the internet is a hot wallet. All crypto exchanges, apps and websites that facilitate trading come under this category.

Cold wallet

Any wallet that stores your crypto without connecting to the internet is a cold wallet. It uses the internet only when you are conducting a transaction. USB drives, bits of paper and hardware not connected to the internet can act as cold wallets.

A combination of hot and cold wallets can be a great way to secure your coins while still being able to conduct transactions. For more on wallets, read our guide 'What is a cryptocurrency wallet and how does it work?'.

Cryptocurrency wallet

Advantages of blockchain

Explore the five key advantages of blockchain below:

Decentralised structure

Using blockchain, people, organisations, machines, and even bots can transact and interact with each other with negligible friction. There’s no need for an intermediary to conduct a transaction. Similar to the way e-mail enables people to message with no geographical barrier, blockchain enables peer-to-peer interaction with no centralised authority.

Increased transparency

The immutable nature of blockchain makes it a shining example of transparency. Being a distributed ledger, data is recorded and time-and-date stamped before making it accessible to everyone. By decentralising the data storage, the chances of manipulation and fraud are minimised. This is why many people believe blockchain to be crucial for governments around the world enabling online voting.

Speed and efficiency

Blockchain can streamline and automate processes, which leads to increased speed and efficiency.

For example, how efficient would it be if patients could walk into any hospital, anywhere and get diagnosed? That’s what is envisioned if doctors have the patient’s medical history, sourced from a public health database. By attaching all the medical history to the individual’s public key, both time and effort are saved.

Enhanced security

Data on any blockchain is encrypted and immutable. Any effort to alter or steal data sets off the alarm to the entire blockchain as the records will no longer match. And since traceability of the record is possible, fraud detection is easy. All these contribute to making blockchain a secure technology.

Accessibility

The internet is making the world smaller with ease of communication across geographical barriers, yet achieving this inclusiveness in the financial sector has a long way to go. Using decentralisation, blockchain enables financial inclusivity as anyone with a basic internet connection can access its services.

Disadvantages of blockchain

We've explored the advantages now let us cover the disadvantages of blockchain:

Scalability

Bitcoin, on average, conducts 5-7 transactions per second (TPS). Comparing it with a centralised system like PayPal, which boasts of an average TPS of 1700, shows the problem of blockchain scalability. However, today’s third-generation blockchains can conduct transactions almost instantaneously. To put this into perspective, Solana, a new-age blockchain, can conduct 65,000 TPS.

As each transaction needs to be transmitted to all the nodes in the blockchain, a lot of time goes to waste. The growing volume of transactions has also adversely affected the fees, ease of mining, and block size. All of this contributes to blockchain potentially being slow, expensive and unsustainable.

Storage

From the first to the latest transaction, a mountain of data needs to be stored by all nodes. For example, the entire transaction history on the Ethereum blockchain has recently crossed 300GB; every node on the network storing 300+ GB worth of data is not feasible. With the blockchain touted to grow more in the coming years, the life span of the blockchain is questionable.

Security

The concept of security in the blockchain is like democracy. If the majority accept a lie as truth, then that lie is now a truth for the entire population. In cryptocurrency circles, it is referred to as a ‘51% Attack’. The need for computing power for mining is increasing by the day, and this is reflected in small-scale miners leaving the network. This provides a window for large-scale miners or mining institutions to collude and compromise the entire network.

But the probability of a 51% attack on large-scale blockchains such as Ethereum or Bitcoin is generally perceived to be minuscule. Coordinating an attack of this volume is extremely difficult, given the breadth of the networks and their diversity.

Pseudo anonymity

We know the ledger records every transaction and is accessible by anyone on the network. Imagine you transfer 1 Ethereum to your child. In reality, you’re letting them know all of your previous transactions that are linked to your wallet address. So, alongside 1 Ethereum, you’re also transferring your financial history to them.

This contradicts the argument that blockchain helps upkeep the privacy of individuals. Seeing this at an institutional level, the collateral damage could be catastrophic.

However, exceptions remain, as projects such as Monera and ZCash are working towards a completely anonymous ecosystem with no chance of traceability.

What is cryptocurrency?

Cryptocurrencies, also known as coins or tokens, are digital currencies that are encrypted. Since no government regulates them, cryptocurrency is the basis of a decentralised financial system. Most of these coins use blockchain technology to record their transactions.

With a smartphone and internet access, anyone can buy, sell, and exchange cryptocurrencies with no input from a bank. This peer-to-peer transaction method is a core advantage of cryptocurrencies as they are time-efficient and more secure than traditional banking systems.

There are over 10,000 coins available to trade in the crypto market, with each of them having a variety of uses. Bitcoin and Ethereum are two of the most famous cryptocurrencies in the current market. As Bitcoin continues solidifying its place as a credible store of value, Ethereum is fueling the use of smart contracts in the space.

The general view of cryptocurrency as a speculative asset is reducing as coins are becoming more widely used as a store of value. While cryptocurrencies are known to be volatile, as awareness and understanding of the market grows, the market is likely to become more stable.

Further reading: What is cryptocurrency trading?

Diagram of cryptocurrencies

What is the difference between blockchain and cryptocurrency?

Simply put, blockchain is the technology that makes cryptocurrencies possible. But, the exponential growth of cryptocurrencies has made them synonymous with the technology itself.

A classic example to show the difference is gambling chips used in a casino. Here, the casino acts like the blockchain technology, where the chips are the token of value used to take part in transactions. When you’re outside the casino – i.e. outside the blockchain network – the chips or coins have no value.

Nature

Blockchain is a technology developed to record transactions in a global ledger. Cryptocurrencies are digital currencies used to facilitate peer-to-peer transactions. Several blockchains do not have tokens embedded in them, but most cryptocurrencies need blockchain technology to exist.

Utility

Blockchain creates transparency by recording transactions and storing data in an immutable ledger. We can then use cryptocurrencies for virtual purchases, payments, investments, etc. Networks also use cryptocurrencies as incentives for mining nodes and for developers working on blockchain-related applications.

Monetary value

Blockchain, as a technology, has zero monetary value. But cryptocurrencies do, and we can use them in exchange for other stores of value. In theory, a coin’s value is based on demand and supply, but in a practical sense that argument is speculative.

Transferability

The possibility of transferring a blockchain is zero, as it is decentralised and not under the control of any single entity. The ethos of blockchain enables the distribution of all the recorded data and transactions across the network. Conversely, we can transfer cryptocurrencies from one wallet to another, in a peer-to-peer transaction with substantial anonymity.

What is Bitcoin?

Bitcoin is the first-ever cryptocurrency, created to help transact digital currencies without a centralised intermediary. It was created in 2008 by a person (or a group of people) under the pseudonym Satoshi Nakamoto.

Bitcoin is cash, but in virtual form, and it can be used to buy anything from pizza to a Lamborghini. Every single bitcoin transaction needs to be validated by the blockchain network before being added into the digital ledger.

Uses

Bitcoin can be used to buy goods and services anonymously, with no bank needed to authorise the transaction. Since no nation or government regulates Bitcoin, it’s a quick and effective method of making international payments. Some firms use Bitcoin to pay salaries and wages to their employees, and El Salvador became the first nation to recognise Bitcoin as a legal tender.

Tokenomics - Study of the currency’s supply and demand

Contrary to popular belief, the supply of Bitcoin has an upper limit. Capped at 21 million coins, the current value of the entire bitcoin market is over $600 Billion. But most of the coins (nearly 18 million of them) have already been mined. Meanwhile, the mining of Bitcoin – i.e. the remaining 3 million – is a race that ends in 2140, with mining difficulty increasing gradually over time.

What is the difference between blockchain and bitcoin?

Find out the difference between blockchain and bitcoin below, just remember, you can’t have one (bitcoin) without the other (blockchain).

Identity

Blockchain is a technology built on the values of decentralisation. Bitcoin is a cryptocurrency used to facilitate peer-to-peer, secure, and anonymous transactions. Bitcoin uses blockchain technology to record its transactions.

The relationship is like that of Google and the internet. Google operates on the internet and cannot exist without it. Yet, the internet would still exist without Google. Likewise, Bitcoin wouldn’t exist without blockchain technology.

Purpose

Blockchain can record transactions and related data, and store it in an immutable ledger. Its technology is used in industries like healthcare, logistics, real estate and plenty more. With the use of smart contracts, blockchain’s functionality is being incorporated into more and more solutions to real-life problems.

Scope

The growth and adoption of blockchain technology is on the rise. With governments and institutions increasingly adopting the technology for key applications, the growth potential is considerable.

Bitcoin is the most well known cryptocurrency and has become a credible store of value, with its growing acceptance globally helping fuel demand. And with limited supply, that demand is likely to soar. With El Salvador the first country to recognise Bitcoin as legal tender and more countries in line to do the same, Bitcoin is touted as being the first globally recognised cryptocurrency legal tender.

A final word

Given the trends, there’s a very good case to say that blockchain and cryptocurrencies like Bitcoin are here to stay. This resource has been written simply to help you understand the intricacies behind blockchain technology before getting involved.

As individual firms and entire industries start to embrace blockchain and its applications, there will be many opportunities on the table. We hope you read, digest, and grasp the resource well enough to leverage any opportunity you’re willing to take a shot at.

 

 

 

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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