No matter if it’s on YouTube, in newspaper articles, podcasts or in a conference room – everybody is talking about the blockchain revolution.
But what is blockchain exactly? The blockchain technology first established its reputation as a decentralized, virtually tamper-proof database technology used as a booking system for the cryptocurrency Bitcoin.
But the times when blockchains were only used for Bitcoin transactions are long gone. Now that the initial hype about the new technology has slightly subsided, different economic sectors are investing in research and further development of a variety of blockchain applications.
Blockchain has developed into a cross-industry information technology, which can be used for a wide variety of purposes.
Blockchains have become a subject of interest for many big companies including McDonalds, Nestlé and IBM. Platforms such as “Food Trust” by IBM are already based on blockchain technology. They are used to trace food supply chains in order to create more transparency.
But what is blockchain technology in detail? How exactly does it work? What is blockchain used for at the moment, and what is its future potential?
In this article we tell you everything you need to know about blockchains, with explanations that are simple and easy to understand.
Why blockchains are revolutionary
As a decentralized, virtually tamper-proof database technology, blockchains play a revolutionary role when it comes to security and trust whenever critical and sensitive information is exchanged between two or more parties.
Especially after the financial crisis in 2008, there has been increased public focus on the security of transactions. Financial institutions such as banks, insurance companies or other central agencies are repeatedly accused of abusing their customers’ trust when it comes to handling their money.
That leaves us with the question: how would it change the world if these central agencies were to become redundant? If transactions were guaranteed to be safe, because they no longer needed to go through potentially corrupt entities that can be bribed or hacked?
In 2008 this idea was embraced and published under the Pseudonym Satoshi Nakamoto.
This was the moment the most famous cryptocurrency was born: Bitcoin.
Bitcoin enables us to pay securely online, without being dependent on central agencies such as banks.
The words blockchain and Bitcoin are often used in one breath, probably because blockchains started as booking system for Bitcoins. But today the application possibilities of blockchains go far beyond cryptocurrencies like Bitcoin.
In theory, blockchains can be used in any context where critical information is exchanged between several parties such as banks, public authorities, food production or logistics.
This results in a shift of control, away from central authorities.
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How blockchain works – Blockchain technology explained in detail
What is blockchain? The most basic blockchain definition is almost self-explanatory: it is a sequence (chain) of linked data records (blocks). To be more precise, a blockchain is a decentralized database technology. At the moment, the Bitcoin blockchain is the longest data record chain in the world.
- The database is stored on many different computers all over the world, all connected via the Internet.
- Every database contains the same information.
- The integrity of the database is secured through cryptographic concatenation. This means that subsequent manipulation is nearly impossible, because the hash value of the current data record (block) is stored in the following data record. How that actually works is explained in detail in the following.
Blockchains and Bitcoin – explained simply
Let’s take an in-depth look at the Bitcoin blockchain. To thoroughly understand why it is so difficult to manipulate a blockchain database, it is important to understand the following concepts:
- Consensus method
- Hash value
Blockchain mining – verification of a transaction
There is a reason why the terms ‘miner’ and ‘mining’ are used in this context. Because just as a gold miner mines for gold, in the blockchain universe, the miner mines for bitcoins.
The miners provide computing power to the blockchain network, and you could say that as a reward for this, the miner receives Bitcoins. During this process, new Bitcoins are introduced into the system.
The computing power, provided by the miners, is used to solve complicated cryptographic tasks in order to verify a block (representing the transaction). Once the task is successfully solved, a new data record (block) is generated. This process is used to control and verify the transactions made within the network.
In the early days, those cryptographic tasks could easily be solved by your computer at home. Those times are long gone. Today it takes a computer farm to mine Bitcoins.
It is also important to know that the total number of Bitcoins that can be mined is limited. This is achieved by cutting the reward for the miner in half after every 210,000 blocks. While at the start of Bitcoin a miner received 50 Bitcoins for mining one block, at the moment miners receive 6.25 Bitcoins (halving last took place on 11 May, 2020). Once there are 21 million coins, no more can me mined.
Consensus method: Proof of work
How exactly is a block verified? An easy question, with a complicated answer. We have summed up the basics for you:
To verify a block, a consensus method is used. One of the most popular ones is the proof-of-work method, but it is just one of many.
The proof-of-work method is used for Bitcoins and works with the SHA-256 algorithm. SHA stands for secure hash algorithm. With this method a hash value is calculated for each block, and saved in this particular block as well as in the following block.
But how does this make a blockchain virtually tamper-proof?
Hash Value – a digital fingerprint for data
A hash value always has the same length and is a sequence of numbers and letters. You can think of it as a digital fingerprint for data that is basically unique.
Roughly simplified, the consensus method works as follows:
- Arbitrary rule: every hash value has to start with a predetermined number of zeros, let’s say 7.
- Now the miner, or to be more precise the miner’s computer farm, tries to calculate the right hash value for the data records in one block. This hash value has to start with seven zeros. Once this value is found, the transaction is validated and a new block is added to the blockchain.
- Every block has a nonce, which consists of a sequence of numbers. The miner finds the right hash value by changing the nonce until he gets a hash value that starts with seven zeros.
- This hash value is saved in the current block as well as in the following block – the procedure continues with every new block added.
Let’s illustrate this with an example:
Imagine a blockchain with 5000 blocks. Someone, let’s call him James, wants to manipulate the data in Block 3000 in his favor to make a profit.
The second he changes the data the hash value changes as well, because the hash value is like a fingerprint, it is different for every data record.
Because the hash value in block 3000 has changed, all the following 2000 blocks are now invalid. This is because Block 3001 has saved the original hash value of block 3000, and has now detected that this hash value has changed.
To make all those blocks valid again, James would have to mine every single block from 3000 to 5000 again. The longer the blockchain, the more complex and time-consuming the process.
But even if James were to successfully mine all those blocks, it would still be easy to for other network users or the computer to uncover the fraud. Why? Because a blockchain is a decentralized database, which means every user has a copy of the blockchain on his or her computer. This way, the other users can see that James’ hash values differ from theirs. The fraud is exposed.
The majority principle is used to decide which is the officially valid Blockchain. Like in our example with James, if 2000 people have the same blockchain, and only James has a different one, his blockchain is invalid. The more users a blockchain network has, the safer it is.
That said, theoretically a fraudster could use this majority principle to manipulate a blockchain. Then we speak of a 51% attack.
This would happen if one person managed to provide more than 50% of the miners. This way, he would be in control of more than 50% of the computing power and the hash rate, so that his blockchain would be the official one. In this case, the blockchain security would be compromised.
51% attack is very unlikely and smaller blockchains are more at risk. The bigger the blockchain, the more difficult it is to perform a 51% attack.
Blockchains: Transparency and Pseudonymity
All transactions are stored in the database, publicly accessible for all users without a time limit.
It is as if you had access to all transactions made at a certain bank. For obvious reasons information like this could easily be abused, which is why accounts are pseudonymized.
This means that personal data is altered in a way that can’t be traced back to one person, or at least only with a huge amount of effort. This is why when other users take a look at the transactions, they don’t see a name attached to it, but something comparable to a bank account number. Every user gets a unique address consisting of numbers and letters. This number doesn’t reveal a person’s identity, unless they themselves reveal this information in some way.
In general, it is recommended to use each assigned address only once, to make sure that no one can make a connection between a person and an address.
Which industries are already using blockchain technology?
Data that is stored in a blockchain is:
- Transparent (public for users of the network)
- Updates/changes to the blockchain can only be made if everyone agrees
Tasks that are usually fulfilled by a central agency are now transferred to all the participants of a blockchain.
All of the above makes the blockchain technology relevant for many industries. But, apart from cryptocurrencies, what is blockchain used for?
As mentioned already, important areas of application that are on the rise are logistics and food production, although blockchain technology could also be used for ownership rights, such property rights, or intellectual property, such as the rights of an artist to his music. The fields of application are numerous.
Blockchain technology is also becoming more and more interesting for advertising and marketing. Because it could eliminate the need for costly intermediaries. It could also maximize the visibility of ads and reduce online fraud.
The future of blockchain
Blockchain technology could be an opportunity for countries that struggle with corruption, money laundering or bribery of authorities. The transparency of the blockchain makes such activities extremely difficult.
Transactions with small amounts of money
If you pay for something with your credit card, your money has to pass through a couple of different entities before it’s finally transferred to the designated bank account. But your money can reach the recipient much faster thanks to blockchain and cryptocurrency.
Not only is it faster, it also offers an opportunity for the world’s poorer population. Because many intermediaries find transactions below 20 cents unprofitable because of the transaction costs, and therefore set a minimum transaction value which excludes the poor.
But thanks to blockchains, which can replace many bank services for free, transactions of small amounts of money are now possible. This would enable even people with no bank account to access the global economy.
In this way, the blockchain technology opens up possibilities many people never dared to dream of.
If you are interested to read more about this, there are books, such as “Blockchain Revolution”, which cover this topic in-depth.
Pros and cons of blockchains
- Security: blockchains are virtually tamper-proof
- Central agencies become superfluous
- Decentralized database: fail-safe due to redundant storage of the blockchain on the computers of every user + no central agency = equality between the users
- Cross-industry, multi-purpose information technology
- Optimizes business processes
- Increased energy consumption due to the computing power needed for mining
- Risk of a 51% attack
- Challenge: integrating the blockchain technology into the current IT infrastructure
- Scalability and storage requirements: every block added to the blockchain requires more storage space
Transparency of blockchains
Depending on your point of view, transparency can be an advantage as well as a disadvantage.
On the one hand, transparency makes it more difficult to manipulate a blockchain. On the other hand, even though the users are anonymous, they have an insight into all transactions that are made. This could be used, for example, to take a look at your competitors’ prices.
Conclusion – as a cross-industry, multi-purpose information technology, blockchains hold great potential
There is no doubt about it – the blockchain industry is growing. Global blockchain technologies are on the rise as blockchain technology opens up new possibilities, because it is almost impossible to manipulate a blockchain.
Another important aspect is that blockchains can replace many tasks done by a central agency like a bank, allowing control to be shifted away from central agencies, and instead distributing the responsibility among all users of the blockchain.
Cryptocurrency is far from being the only interesting application for blockchain – basically, blockchain technology could be of use in any situation where critical and sensitive information is exchanged between two or more parties.
Whether you’re talking about blockchain in banking, blockchain insurance or the use of blockchains in logistics, there are many fields of application for blockchains.
So even if blockchains are not relevant for your industry right now, they might be in the future. And as the world becomes more and more connected every day, technologies and content also become relevant not only for one country, but for an audience in many countries.
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