Crypto Basics Crypto Knowledge

How Does Blockchain Work?

While the designs for a truly decentralized network have been the holy grail for many IT specialists since as early as the ‘70s, it was blockchain technology that recently made a breakthrough by facilitating all cryptocurrencies, NFTs and DeFi smart contracts. Blockchain’s decentralized distributed digital ledger database is stored in multiple computers across a network of interconnected nodes. The ledger is often described as a “chain” made up of individual “blocks” of data which are periodically verified from the previous block, confirmed and added to the network, updating every other node on the network. Such decentralized system makes it very difficult for anyone to hack or cheat the blockchain network.

So, in essence, a blockchain consists of three essential ingredients: blocks, nodes and miners.

What are Blocks?

Each chain consists of multiple blocks and each block has three basic elements:

  • The data in the block.
  • A nonce, which is a 32-bit whole number randomly generated when a block is created.
  • A hash 256-bit number wedded to the nonce

Upon creation of the first block of a chain, a nonce generates the cryptographic hash.

What are Miners?

Miners create new blocks on the chain through an intense computational process called mining. With the use of a special software, miners solve complex mathematical problems of finding a nonce. This is a very challenging process as there are a couple billion possible combinations which have to be mined before the right one is found, called the “golden nonce”. When a block is successfully mined, the change is accepted by all of the nodes on the network and the miner gets financially rewarded.

What are Nodes?

The main reason why blockchain has received such a warm welcome into many communities around the world is its underlying concept of decentralization. Each action in the blockchain has to be algorithmic ally verified by the previous trusted node, maintaining data integrity across the network and creating trust among users.

Types of Blockchains

Every blockchain algorithm consists of a cluster of nodes functioning on a peer-to-peer (P2P) blockchain system run by a network of computer. Each node can verify, initiate and receive transactions and create blocks for the entire network. There are four types of blockchains which are currently possible.

Public Blockchain

A public blockchain is an open-source permissioned blockchain, accessible by anyone with an internet connection. The most common use of public blockchains is for mining and exchanging crypto. Thus, the most popular blockchain networks are the Bitcoin blockchain and the Ethereum blockchain.

Private Blockchain

Private blockchains are restrictive and require permission from the controlling organization. Only selected members can participate and real-world use cases include voting, supply chain management, digital identity and asset ownership.

Consortium Blockchain

A Consortium Blockchain is a semi-decentralized type of blockchain network where more than one organization can act as a node and exchange information or perform mining. Such blockchains are usually used by financial institutions, government organizations, healthcare institutions, etc.

Hybrid Blockchain

A hybrid blockchain is a combination of private and public blockchains which users can access both via a private permission-based system, as well as a public permissionless system.

How is Blockchain Used?

Blockchain technology can be used for a vast range of purposes, including:

Cryptocurrencies 

Cryptocurrencies are virtual or digital currencies secured by cryptography. Probably the most common use of blockchain technology today is fast and cheap cross-continent transfer of money. Bitcoin is the first and most used crypto to this day. Cryptocurrencies use either proof-of-stake or proof-of-work consensus mechanisms to mine coins and validate transactions.

Asset Transfers 

Currently, digital assets represent ownership of digital art and video. Some of the most popular asset transfers are happening in the NFT space. However, blockchain can also process real-world assets, such as real estate and vehicles. The ledger acts as a verification and record-keeping tool that confirms each party’s ownership.

Smart Contracts  

Smart contracts are self-executing blockchain applications that run when predetermined conditions are met, eliminating the need for third-party verification. Their implementation can be seen across a myriad of use cases such as lending, insurance, artist royalties, to name a few. Smart contract technology allows for processes to be faster and less expensive, providing greater transparency and anti-tamper guarantees usually ran on the Ethereum blockchain.

Government  

Central authorities and regulators across the world are faced with the challenges of bureaucracy. Blockchain offers sound solutions which could support voting, governmental benefits, medical and tax collection data storage, among others. The distributed ledger’s accuracy reduces fraud to a minimum and creates a more efficient record transaction tracking system where all records are stored in the database and where certified personnel can easily access and verify them.

Advantages and Disadvantages of Blockchain 

Blockchain technology is still in its early stages of mass adoption. Here are some of the advantages and disadvantages of blockchain which we have identified. 

Advantages

  • The accuracy of transactions is verified by multiple nodes, so if there is any error in one node’s database, the others would always spot it.
  • Intermediaries could be eliminated by blockchain as it acts as a more efficient, trustworthy and cost-friendly third-party verification system.
  • Nowadays, platform tampering through hacking and network breaches is becoming more and more commonplace. When it comes to blockchain security, the network is extra secure and in order for a hacker to forge a transaction, they has to hack at least 51% of the nodes, which is almost impossible when in the case of large blockchains such as Bitcoin and Ethereum. 
  • Waiting for days for international bank transfers to go through is in the past. Blockchain technology allows you to operate your financials and assets seamlessly 24/7.

Disadvantages

  • As blockchain technology and its ecosystem are still fresh and new in regards to mass adoption, the networks are not yet fully developed. This has a negative effect on the transaction speed and there are serious challenges on the scalability front.
  • As multiple nodes work together to verify a transaction, higher energy usage is required, which affects global warming. In response to this issue, cryptocurrency mining operations are turning towards geothermal, solar or wind power. One of the most notable projects are the “Volcano Bonds” in El Salvador. 

Like this article and want to read more? Check out our HUB

Was this post helpful?

Related posts

glasses with arrows
What is a XPUB and How Does It Work
Every crypto user needs a cryptocurrency wallet with an XPUB to conduct any crypto transactions....
glasses
How Does Staking Work?
Staking, in simple terms, involves locking cryptocurrencies to your wallet to receive rewards. Read more
What is CeFi? Centralized Finance on the Blockchain
Through the advent and growth of cryptocurrencies in the financial and technological world, new innovative...