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In depth: The blockchain explained


In depth: The blockchain explained
Understanding the Basics

When you hear the term “blockchain,” your mind likely immediately associates it with cryptocurrencies. Additionally, the term “blockchain” may seem complex and daunting, but in reality, its foundation is quite simple. Blockchain is essentially a type of database, so to comprehend the term “blockchain,” it is essential to understand what a database actually is.

Understanding Databases
Most people are familiar with the concept of a database. A database is a collection of various data stored in a computer system. The data in a database is typically structured in a tabular format, with each table consisting of rows and columns. Each column contains the same type of data (specified by the column name), and each row represents a unique set of data (corresponding to the columns).

In a database, data can be easily filtered or searched. However, you might wonder what the difference is between Microsoft Excel and a database.

Differentiating Microsoft Excel and databases
The distinction is straightforward. Microsoft Excel is a tool suitable for managing small amounts of data, often used by individuals or small groups. On the other hand, a database is designed to handle larger quantities of data and is accessible to larger groups of people. Moreover, multiple people can work simultaneously on a database. A prime example is a MySQL database linked to nearly every website. All the website’s data is stored in the MySQL database, and when multiple visitors access the website, they all use the same database. Consequently, databases often allow for specific user permissions, ensuring that visitors cannot modify the data on your website.

Demystifying blockchain begins with understanding its foundation as a database. While blockchain technology extends beyond simple databases, comprehending the basics of databases provides a solid starting point. Databases play a vital role in managing and organizing data, while blockchain introduces the revolutionary concepts of decentralization, immutability, and transparency. By grasping the fundamentals, you can embark on a journey to explore the potential of blockchain technology and its transformative impact on various industries.

To fully understand blockchain, it is helpful to examine it in the context of how it was implemented by Bitcoin. Similar to a database, Bitcoin requires a collection of computers to store its blockchain. For Bitcoin, this blockchain is simply a specific type of database that records every Bitcoin transaction ever made. Unlike most databases, however, these computers are not all located in one place. Instead, each computer or group of computers is managed by a unique individual or group of individuals.

Imagine a company that has a server with 10,000 computers and a database containing all customer account information. This company has a warehouse where all these computers are housed, and they have complete control over each computer and the information it contains. Similarly, Bitcoin consists of thousands of computers, but each computer or group of computers that holds the blockchain is located in a different geographic location and is managed by separate individuals or groups of people. These computers that make up the Bitcoin network are called nodes.

In this model, Bitcoin’s blockchain is used in a decentralized manner. However, there are also private, centralized blockchains where the computers that make up the network are owned and controlled by a single entity.

In a blockchain, each node has a complete record of the data stored on the blockchain since its inception. For Bitcoin, the data is the complete history of all Bitcoin transactions. If a node has an error in its data, it can use the thousands of other nodes as reference points to correct itself. This way, no node within the network can modify the information stored in it. As a result, the transaction history in each block that makes up the Bitcoin blockchain is immutable.

If a user attempts to manipulate the transaction record of Bitcoin, all other nodes cross-reference each other and easily identify the node with incorrect information. This system helps establish an accurate and transparent sequence of events. For Bitcoin, this information is a list of transactions, but a blockchain can also contain a variety of other information, such as legal contracts, state identifications, or a company’s product inventory.

To change the functioning of the system or the information stored within it, a majority of the computational power of the decentralized network must agree on the proposed changes. This ensures that any changes that occur are in the best interest of the majority.

Due to the decentralized nature of Bitcoin’s blockchain, all transactions can be transparently viewed by having a personal node or using blockchain explorers that allow anyone to see transactions in real time. Each node has its own copy of the chain, which is updated as new blocks are confirmed and added. This means that if you wanted to, you could track Bitcoin wherever it goes.

For example, exchanges have been hacked in the past, resulting in the loss of Bitcoin for those who had them on the exchange. Although the hacker may be completely anonymous, the Bitcoins they have extracted are easily traceable. If the Bitcoins stolen in some of these hacks were to be moved or spent, it would be known.

Is blockchain secure?
Blockchain technology is responsible for addressing security and trust issues in various ways. Firstly, new blocks are always stored linearly and chronologically. That is, they are always added to the “end” of the blockchain. If you look at Bitcoin’s blockchain, you will see that each block has a position on the chain, known as its “height.” As of November 2020, the block height had reached 656,197 blocks so far.

Once a block is added to the end of the blockchain, it becomes very difficult to go back and modify the contents of the block unless a majority consensus is reached. That’s because each block contains its own hash along with the hash of the previous block, as well as the aforementioned timestamp. Hash codes are created by a mathematical function that converts digital information into a series of numbers and letters. If that information is altered in any way, the hash code changes as well.

This is why it is important for security. Suppose a hacker wants to alter the blockchain and steal Bitcoin from others. If they were to modify their own copy, it would no longer be in agreement with everyone else’s copy. If everyone cross-references their copies, they would notice this one copy standing out, and the hacker’s version of the chain would be discarded as illegitimate.

To succeed with such a hack, the hacker would need to simultaneously control and modify 51% of the copies of the blockchain, so that their new copy becomes the majority copy and therefore the agreed-upon chain.

Such an attack would also require an enormous amount of money and resources because they would have to recompute all the blocks since they would now have different timestamps and hash codes.

Due to the size of the Bitcoin network and how quickly it grows, the costs to perform such a feat would likely be insurmountable. Not only would this be extremely expensive, but it would probably also be futile. Something like this would not go unnoticed, as network participants would observe such drastic changes to the blockchain. The network participants would then split off to a new version of the chain that has not been affected.

This would cause the attacked version of Bitcoin to plummet in value, rendering the attack ultimately pointless because the villain would have control over a worthless asset. The same would happen if the bad actor were to attack the new fork of Bitcoin. It is designed in such a way that participation in the network is much more economically incentivized than attacking it.

Bitcoin versus Blockchain
The goal of blockchain is to capture and distribute digital information without allowing it to be edited. Blockchain technology was first described in 1991 by Stuart Haber and W. Scott Stornetta, two researchers who wanted to implement a system where document timestamps couldn’t be tampered with. However, it wasn’t until almost two decades later, with the launch of Bitcoin in January 2009, that blockchain had its first real-world application.

The Bitcoin protocol is built on a blockchain. In a research paper introducing the digital currency, the pseudonymous creator of Bitcoin, Satoshi Nakamoto, referred to it as “a new electronic cash system that’s fully peer-to-peer, with no trusted third party.”

The key to understanding this is that Bitcoin uses blockchain solely as a means to transparently record a ledger of payments, but blockchain can theoretically be used to record an unlimited number of data points. As discussed above, this can take the form of transactions, voting in elections, product inventories, state identifications, property deeds, and much more.

Currently, there is a wide variety of blockchain-based projects seeking to implement blockchain in ways other than just recording transactions to benefit society. A good example is using blockchain as a way to vote in democratic elections. The immutability nature of blockchain means that fraudulent voting would become much more difficult.

For example, a voting system could work such that every citizen of a country receives a single cryptocurrency or token. Each candidate would then have a specific wallet address, and voters would send their token or crypto to the address of the candidate they wish to vote for. The transparent and traceable nature of blockchain would make counting human votes unnecessary, as well as prevent bad actors from tampering with physical ballots.

Blockchain and Banks Banks and decentralized blockchains are vastly different. To understand how a bank differs from blockchain, let’s compare the banking system to the implementation of blockchain by Bitcoin.

How blockchain is used As we now know, blocks on the Bitcoin blockchain store data about monetary transactions. But it turns out that blockchain is actually a reliable way to store data about other types of transactions as well.

Some companies that have already adopted blockchain include Walmart, Pfizer, AIG, Siemens, Unilever, and many others. For instance, IBM has created its Food Trust blockchain to track the journey that food products take to reach their destinations.

Why is this done?
In the food industry, numerous outbreaks of E. coli, salmonella, listeria, and hazardous substances accidentally making their way into food products have occurred. In the past, it took weeks to determine the cause of these outbreaks or the source of illness by analyzing what people consumed.

By utilizing blockchain, brands can track the journey of a food product from its origin, through every stop it makes, and ultimately to its delivery. If a food item is found to be contaminated, it can be traced all the way back through each stop to its source. Not only that, but these companies can now also see everything else it has come into contact with, allowing the problem to be identified much earlier, potentially saving lives. This is an example of blockchains in action, but there are many other forms of blockchain implementation.

Banking and Finance
Perhaps no industry stands to benefit more from the integration of blockchain into its operations than banking. Financial institutions operate only during office hours, five days a week. That means if you try to deposit a check at 6:00 PM on a Friday, you’ll likely have to wait until Monday morning for the funds to be deposited into your account. Even if you make your deposit during office hours, it can still take one to three days for the transaction to be verified due to the massive volume of transactions banks need to process. On the other hand, blockchain never sleeps.

By integrating blockchain into banking, consumers can see their transactions processed in as little as 10 minutes, which is actually the time it takes to add a block to the blockchain, regardless of holidays or the time of day or week. With blockchain, banks also have the ability to exchange money between institutions faster and more securely. In the stock market, for example, the settlement and clearing process can take up to three days (or longer for international trades), meaning the money and shares are frozen during that period.

Given the magnitude of the amounts involved, even the few days it takes for the money to be in transit can incur significant costs and risks for banks. The European bank Santander and its research partners estimate potential savings of $15 billion to $20 billion per year. Capgemini, a French consulting firm, estimates that consumers can save up to $16 billion annually in bank and insurance fees through blockchain-based applications.

Blockchain forms the foundation for cryptocurrencies like Bitcoin. The US dollar is controlled by the Federal Reserve. Under this central authority system, a user’s data and currency are technically in the grip of their bank or government. If a user’s bank is hacked, the customer’s private information is at risk. If the customer’s bank collapses or if they live in a country with an unstable government, the value of their currency can be jeopardized. In 2008, some banks that ran out of money were partially rescued with taxpayer funds. These are the concerns with which Bitcoin was first conceived and developed.

By spreading its operations across a network of computers, blockchain ensures that Bitcoin and other cryptocurrencies can function without the need for a central authority. This not only reduces risk but also eliminates many of the processing and transaction costs. It can also provide people in countries with unstable currencies or financial infrastructures with a more stable currency, offering them more opportunities and a broader network of individuals and institutions to engage with, both nationally and internationally.

The use of cryptocurrency wallets for savings accounts or as a means of payment is particularly impactful for those who lack state identification. Some countries may be torn apart by war or have governments that lack a proper infrastructure to provide identification. Citizens of such countries may not have access to savings or securities accounts, and therefore, there is no way to securely store wealth.

Healthcare providers can use blockchain to securely store their patients’ medical records. When a medical record is generated and signed, it can be written into the blockchain, giving patients the evidence and trust that the record cannot be altered. These personal health records can be encrypted and stored on the blockchain with a private key, making them accessible only to specific individuals, ensuring privacy.

Property Registrations
If you have ever spent time at your local Recorder’s Office, you know that the process of recording property rights is both cumbersome and inefficient. Nowadays, a physical deed must be handed over to a government employee at the local registration office, where it is manually entered into the county’s central database and public index. In the case of a property dispute, claims to the real estate must be reconciled with the public index.

This process is not only costly and time-consuming, but it is also riddled with human errors, with each inaccuracy making the tracking of property rights less efficient. Blockchain has the potential to eliminate the need for scanning documents and tracking physical files in a local recording office. If ownership of real estate is stored and verified on the blockchain, owners can trust that their deed is accurately and permanently recorded.

In war-torn countries or areas with little to no government or financial infrastructure, and certainly no “Recorder’s Office,” proving ownership of property can be nearly impossible. If a group of people residing in such an area can utilize blockchain, transparent and clear timelines for property ownership can be established.

Smart contracts
A smart contract is a computer code that can be embedded in the blockchain to facilitate, verify, or negotiate a contract agreement. Smart contracts operate under a set of conditions agreed upon by users. If these conditions are met, the terms of the agreement are automatically executed.

For instance, imagine a prospective tenant wanting to lease an apartment using a smart contract. The landlord agrees to provide the tenant with the door code to the apartment once the tenant has paid the security deposit. Both the tenant and the landlord would send their respective portions of the deal to the smart contract, which would hold onto the door code and automatically exchange it for the deposit on the date the lease agreement begins. If the landlord fails to provide the door code on the rental date, the smart contract would refund the security deposit. This would eliminate the fees and processes typically associated with using a notary, a third-party mediator, or agents.

Supply Chains
Similar to the example of IBM Food Trust, suppliers can use blockchain to record the origin of materials they have purchased. This enables companies to verify the authenticity of their products along with commonly used labels such as “Organic,” “Local,” and “Fair Trade.”

As reported by Forbes, the food industry is increasingly adopting the use of blockchain to track the path and safety of food during the journey from farmer to consumer.

As mentioned, blockchain could be used to enable a modern voting system. Voting with blockchain has the potential to eliminate election fraud and increase voter turnout, as tested during the November 2018 midterm elections in West Virginia. By using blockchain in this manner, tampering with votes would be nearly impossible. The blockchain protocol would also maintain transparency in the election process, reducing the staff required to conduct an election and providing officials with virtually immediate results. This would render recounts unnecessary or any genuine concerns about fraud threatening the elections.

Advantages and disadvantages of blockchain
Despite all its complexity, the potential of blockchain as a decentralized form of archiving is virtually limitless. From enhanced user privacy and increased security to lower processing costs and reduced errors, blockchain technology can very well see applications that go beyond what has been described above. However, there are also some disadvantages.

Accuracy of the chain
Transactions on the blockchain network are approved by a network of thousands of computers. This almost eliminates any human involvement in the verification process, resulting in fewer human errors and accurate record-keeping. Even if a computer on the network were to make a computational mistake, the error would only be made in one copy of the blockchain. For that error to spread to the rest of the blockchain, it would need to be made by at least 51% of the network’s computers—a near-impossibility for a large and growing network the size of Bitcoin’s.

Cost savings
Typically, consumers pay a bank to verify a transaction, a notary to sign a document, or a minister to officiate a marriage. Blockchain eliminates the need for third-party verification and, therefore, the associated costs. Entrepreneurs pay a small fee when accepting credit card payments, for example, because banks and payment processors need to process those transactions. In contrast, Bitcoin has no central authority and has limited transaction fees.

Blockchain does not store any of its information in a central location. Instead, the blockchain is copied and distributed across a network of computers. Each time a new block is added to the blockchain, every computer on the network updates its blockchain to reflect the change. By distributing that information across a network rather than storing it in one central database, blockchain becomes harder to manipulate. If a copy of the blockchain were to fall into the hands of a hacker, only a single copy of the information would be at risk, rather than the entire network.

Efficient transactions
Transactions placed through a central authority can take several days to process. For example, if you try to deposit a check on a Friday evening, you may not see the funds in your account until Monday morning. While financial institutions operate five days a week during office hours, blockchain operates 24 hours a day, seven days a week, and 365 days a year. Transactions can be completed in as little as ten minutes and can be considered secure after just a few hours. This is particularly useful for cross-border transactions, which typically take much longer due to time zone issues and the need for all parties to confirm payment processing.

Private transactions
Many blockchain networks operate as public databases, meaning anyone with an internet connection can view a list of the network’s transaction history. While users have access to transaction details, they do not have access to identifying information about the users performing those transactions. It is a common misconception that blockchain networks like Bitcoin are anonymous when, in fact, they are only confidential.

This means that when a user performs public transactions, their unique code, called a public key, is recorded on the blockchain instead of their personal information. If a person has made a Bitcoin purchase on an exchange that requires identification, then the person’s identity is still linked to their blockchain address, but a transaction, even when associated with a person’s name, does not reveal any personal information.

Secure transactions
Once a transaction is recorded, its authenticity needs to be verified by the blockchain network. Thousands of computers on the blockchain race to confirm that the purchase details are accurate. After a computer validates the transaction, it is added to the blockchain block. Each block on the blockchain contains its own unique hash, along with the unique hash of the block before it. When the information on a block is modified in any way, the hash code of that block changes, but it does not change the hash code on the block after it. This discrepancy makes it extremely difficult to alter information on the blockchain without prior notice.

Most blockchains are fully open-source software, meaning anyone can see the code. This provides auditors the ability to assess cryptocurrencies like Bitcoin for security. It also means that there is no real authority over who manages the code of Bitcoin or how it is edited. This allows anyone to propose changes or upgrades to the system. If a majority of network users agree that the new version of the code with the upgrade is sound and worthwhile, Bitcoin can be updated.

Banking the unbanked
Perhaps the most profound aspect of blockchain and Bitcoin is the ability for anyone, regardless of ethnicity, gender, or cultural background, to use it. According to the World Bank, there are nearly 2 billion adults who do not have bank accounts or the means to store their money or wealth.5 Almost all of these individuals live in developing countries where the economy is still in its infancy and heavily reliant on cash.

These people often earn meager incomes paid in physical currency. They then have to store this physical cash in hidden locations within their homes or localities, making them vulnerable to robberies or unnecessary violence. Keys to a Bitcoin wallet can be stored on a piece of paper, a cheap mobile phone, or even memorized if necessary. For most people, it is likely that these options are easier to conceal than a stack of money under a mattress.

The blockchains of the future are also seeking solutions to not only be a unit of account for wealth storage but also to store medical records, property rights, and a variety of other legal contracts.

Drawbacks of blockchain
While blockchain has significant benefits, there are also substantial challenges to its adoption. The roadblocks to the application of blockchain technology today are not only technical but largely political and regulatory, not to mention the thousands of hours (read: money) of custom software design and back-end programming required to integrate blockchain into existing business networks. Here are some of the challenges hindering broad acceptance of blockchain.

Technology costs
While blockchain can save users money on transaction fees, the technology is far from free. For example, the ‘proof of work’ system that Bitcoin uses to validate transactions consumes enormous amounts of computational power. In the real world, the power of the millions of computers on the Bitcoin network is close to what Denmark consumes annually. Assuming electricity costs of $0.03 to $0.05 per kilowatt-hour, mining costs excluding hardware expenses amount to approximately $5,000 to $7,000 per coin.

Despite the costs of mining Bitcoin, users continue to drive up their electricity bills to validate transactions on the blockchain. That’s because when miners add a block to the Bitcoin blockchain, they are rewarded with enough Bitcoin to make their time and energy worthwhile. However, when it comes to blockchains that don’t use cryptocurrency, miners will need to be paid or otherwise incentivized to validate transactions.

Some solutions to these problems are starting to emerge. For instance, there are Bitcoin mining companies being set up to utilize solar power, excess natural gas from fracking sites, or electricity from wind farms.

Speed inefficiency
Bitcoin is a perfect case study for the potential inefficiencies of blockchain. Bitcoin’s ‘proof of work’ system takes approximately ten minutes to add a new block to the blockchain. At that rate, it is estimated that the blockchain network can handle only about seven transactions per second (TPS). While other cryptocurrencies like Ethereum outperform Bitcoin, they are still limited by blockchain. For context, the legacy brand Visa can process 24,000 TPS.

Solutions to this problem have been in development for years. There are currently blockchains capable of processing over 30,000 transactions per second.

Illegal activity
While confidentiality on the blockchain network protects users from hacks and preserves privacy, it also enables illicit trade and activity on the blockchain network. The most cited example of blockchain being used for illegal transactions is likely the Silk Road, an online dark web drug marketplace that operated from February 2011 to October 2013 when it was shut down by the FBI.6

On the website, users could browse without being traced using the Tor browser and make illegal purchases in Bitcoin or other cryptocurrencies. Current U.S. regulations require financial service providers to obtain customer information when opening an account, verify the identity of each customer, and confirm that customers are not on a list of known or suspected terrorist organizations. This system can be seen as both a benefit and a drawback. It provides access to financial accounts for everyone but also enables criminals to conduct transactions more easily. Many have argued that the positive use of crypto, such as banking the unbanked, outweighs the misuse of cryptocurrency, especially when most illegal activities still occur with untraceable cash.

Many in the crypto space have expressed concerns about government regulation regarding cryptocurrencies. While it is becoming increasingly difficult and nearly impossible to shut down something like Bitcoin as the decentralized network grows, governments could theoretically make it illegal to own cryptocurrencies or participate in their networks.

Over time, this concern has diminished as major companies like PayPal begin to allow ownership and use of cryptocurrencies on their platform.

What Does the Future Hold for Blockchain?
Blockchain is settling comfortably into its late twenties. Like most millennials of its age, blockchain has seen its fair share of public scrutiny over the past two decades, with companies worldwide speculating on what the technology is capable of and where it is headed in the coming years.

With many practical applications of the technology already being implemented and explored, blockchain is finally making a name for itself at the age of twenty-seven, not least thanks to Bitcoin and cryptocurrency. As a buzzword on the lips of every investor in the nation, blockchain is poised to make business and government operations more accurate, efficient, secure, and cost-effective with fewer intermediaries.

As we prepare to enter the third decade of blockchain, it is no longer a matter of ‘if’ legacy companies will adopt the technology, but rather ‘when’.

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