Blockchain

As the name suggests, a blockchain is a chain of blocks that contains certain information. This technique war originally described in 1991 by a group of researchers and was originally intended to timestamp documents so that it´s not possible to backdate them or to tamper with them. It therefore had the function of a digital time stamp.

What is Blockchain?

However, it went by mostly unused until it was adapted by Satoshi Nakamoto in 2009 to create the digital cryptocurrency Bitcoin.

Blockchain is a complete and unchanging history of all transactions of the decentralized community, a database with which everyone who is part of this community, i.e., all users on the network, agrees and is accessible to everyone. Simply put, it is a way of keeping records of value and transactions.

This transaction history is updated regularly and is accepted as a fact by every community participant. Blockchain arises from cryptographic, chain-linked blocks composed of transactions that contain value and therefore have some importance.

Blockchain technology has one interesting feature. If certain data has been recorded within Blockchain, it is very difficult to change it.

What characterizes a block?

If we take a closer look at a block, each block contains some data, the hash of the block and the hash of the previous block. The data that is stored inside a block depends on the type of blockchain. For example, in case of the Bitcoin blockchain, the block contains details about a transaction, such as the receiver, the sender, the amount of coins, or the time of sending.

The block also has a so-called hash or digital signature. We can think of it as a fingerprint. It is a combination of characters that identifies the block itself and its content and is always unique. Once a block is created, its hash is being calculated. Changing something inside the block will cause the hash to change.

The third element of the block is the hash of the previous block. This effectively creates a chain of blocks and it´s this technique that makes a blockchain so secure and reliable and difficult to tamper or alter.

Each new block irreversibly follows the previous one. If we removed one block, we would also have to remove all the blocks above it, which would lead to the disintegration of the entire chain.

Changing a blockchain is much more expensive than the profit we would make with the change. It is thus not economically advantageous for potential counterfeiters and is almost impossible.

What is proof-of-work?

Proof-of-work is an important security mechanism within blockchain technology and the creation of individual blocks. It is the oldest and most used algorithm for consensus. Consensus means agreeing on what happened and what didn't.

In a centralized system, it is provided by a central institution, while in a decentralized system, it is decided by the community.

This process involves people around the world, so-called miners, trying to solve mathematical equations, cryptographic algorithms, and vying to find the solution first and add the block to the chain.

They invest in computing power, electricity, and hardware, and for this process, the so-called mining, and subsequent validation they get the miner reward.

The problem of this mechanism is, that it is causing miners to use massive amounts of electricity and it encourages the use of mining pools which makes the blockchain more centralized as opposed to decentralized.

What is proof-of-stake?

Proof-of-stake is a new consensus algorithm that is as effective or better than proof-of-work. It uses an election process in which one node is randomly chosen to validate the next block.

Proof-of-stake has no miners but instead has “validators” and it doesn´t let people mine new blocks but instead “mint” or “forge” new blocks.

Validators aren´t chosen completely randomly. To become a validator, a node has to deposit a certain amount of coins into the network as a stake. You can think of this as a security deposit.

The size of the stake determines the chances of a validator to be chosen to forge the next block. It´s linear correlation.

If a node is chosen to validate the next block, he´ll check if all the transactions within it are indeed valid. If everything´s checked out, the node signs off on the block and adds it to the blockchain.

As a reward the node receives the fees that are associated with each transaction inside this block.

Validators will lose a part of their stake if they approve fraudulent transactions. As long as the stake is higher than what the validator gets from the transaction fees, we can trust him to correctly do his job. Because if not, he´ll lose more money than he´ll gain.

So the differences between proof-of-work and proof-of-stake are quite significant.

Proof-of-stake doesn´t let everyone mine new blocks and therefore uses considerably less energy. It´s also more decentralized.

What are the benefits of blockchain?

Most transactions currently require intermediaries who provide trust and security for transactions, such as banks and financial institutions. Blockchain technology, on the other hand, eliminates the need for such intermediaries and allows people to make transactions directly with each other without third party involvement and without limits.

Blockchain-based systems also offer a high level of transparency, as any changes to the database are accessible to all users on the network and transactions cannot be deleted, manipulated or altered once entered onto the blockchain. This is associated with trust in technology and its security.

At the same time, such systems run on a decentralized network of computers, reducing the risk of hacking, server downtime or loss of data.

Blockchain technology offers a wide range of uses, as almost anything of value and importance can be recorded on the blockchain. There are many companies and industries already developing and integrating blockchain-based systems.

Last but not least, blockchain technology makes it possible to reduce the costs of verifying, confirming and auditing transactions in connection with the mentioned benefits and, thanks to the absence of a third party, to significantly increase the transaction speed.

What are the potential disadvantages of blockchain?

The main disadvantages or risks include, for example, a lack of privacy, as in many decentralized blockchains account balances and transactions are accessible to anyone on the network.

Another factor is the issue of security. Although blockchain-based systems use advanced cryptographic and encryption mechanisms that are more secure than passwords or numeric access codes, there are many cases with cryptocurrencies, where a user has forgotten or lost his private key and can´t accesses his resources. Eventually, these funds were stolen from him. There is no intermediary in the system you can contact if a theft has occurred, or you have sent funds to the wrong digital wallet address. In the case of decentralized applications, you don´t have the opportunity to contact a specific person if you are dissatisfied with the service or would like to make complaint.

Finally, we can mention high costs of computer equipment, resources or energy, the problem of scaling, i.e., the low number of transactions processed over time, understanding the technology and its use by regular users or the lengthy process of setting up and integrating technology into existing systems of companies and organizations.

What can blockchain technology be used for?

Blockchain technology is a prerequisite for the existence of a decentralized digital currency, whereby cryptocurrencies are only one of the possibilities of using blockchain.

Blockchain has a strong association especially with payments and financial transactions. The use of blockchain-based technology in the world of finance has many positives. The ability of the blockchain to process information faster by eliminating intermediaries has the potential to reduce costs and increase speed and efficiency. This can be applied to currency transfers, stock trading, payments and many activities that are the core operations of financial institutions.

It is not just financial service companies implementing blockchain-based systems. Blockchain technology has a wide range of uses across different industries as blockchain-based technology can be used to transfer and record almost anything of value.

We can mention for example: identity management and digital identities, digital voting, healthcare and medical records, academic certificates, music industry, cloud storage, car leasing and rentals, property and real estate, apartment rentals, travel industry, food industry, loyalty and rewards programs, predictions and gambling or smart contracts.