What Is Blockchain: The Backbone of Cryptocurrency

What are blockchains? And why are they so important to cryptocurrency?

Girl standing on a rock presenting a glitchy blockchain system.
Created by Gabor Kovacs from DailyCoin

If it werenโ€™t for blockchains, the crypto landscape would be a lawless wild wasteland.

Whenever we buy, sell, or trade crypto, we can do so in a safe and orderly manner thanks to the blockchain. As a result, theyโ€™ve allowed cryptocurrency to be seen as a legitimate form of digital currency rather than a quick internet fad.

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The truth is, though, that blockchains are evolving at a rapid pace and becoming ever more complex, so letโ€™s go back to basics to understand what they are and how important they are for crypto investors.

What Is a Blockchain?

A pile of blue blocks of transactions all stacked on top of one another with a golden Bitcoin at the very top.
Source: Pinterest.com

A blockchain is a database that keeps a register of all data, including digital transactions, that enter the network in real-time. 

By network, I mean a designated space where hundreds, thousands, or millions of crypto users can perform crypto transactions however they want.

Think of them as digital ledgers that keep a permanent record of all financial transactions on the blockchain platform. 

There isnโ€™t just one blockchain system that rules them all, though. While they may have first appeared with Bitcoin (BTC) in 2009, there are now over 1,000 distinct blockchains, all of which have rules to follow and support tokens.

The Importance of Blockchains

Creating cryptocurrency is useless without a safe transaction method. Now that this safety method has been tested, itโ€™s brought more recognition to crypto as a digital currency. 

Cryptocurrency has been swirling around for many years, but it could never have become a reality if there werenโ€™t blockchains to rely on.

As proof of this, the idea of cryptocurrency emerged back in the 1990s, but it wasnโ€™t until Satoshi Nakamoto figured out the blockchain in 2009 that crypto was able to take off.

A few other benefits of blockchains include the fact that they allow for crypto transactions, which are processed much faster and often cheaper than fiat currency, such as sending money abroad. It also makes things easy for investors since all they need to do is send a transaction, and it will automate a chain of events that takes care of the rest, helping to streamline the process. 

How Does a Blockchain Register Transactions?

A visual representation of the Proof of Work transaction process. Small green transactions are entering in from the sides, and after being approved, they turn into pink blocks which hover above.
Source: Limechain.com

So, how exactly does a blockchain register and process such a staggering number of transactions simultaneously?

Though it might seem quick and straightforward on the user’s side, some key players and steps must be performed for a transaction to occur. 

  1. Network participants on the blockchain execute a transaction using the private key in their crypto wallet.
  2. This transaction is broadcast to a collection of nodes, a network of computers spread out across the network. Nodes agree that the order is legitimate and approve it for the next stage: validation.
  3. Miners or validators will work to validate the transaction data. The method for achieving this depends on whether the blockchain follows the Proof of Work (PoW) or Proof of Stake (PoS) algorithm.
  4. Validated transactions are stored in a block, which is then connected to the blockchain. The block will be linked to the previous block and the one after, creating a lengthy chain of blocks that acts as a ledger of transactions.
  5. The transaction is finalized and cannot be changed.

So once a collection approves a transaction of nodes, itโ€™s then up to miners or validators to start verifying the data so that it can be packed into a block and connected to the blockchain. 

However, how these individuals are chosen will depend on whether the blockchain follows a proof-of-work or proof-of-stake consensus mechanism. 

Proof of Work and Proof of Stake

If, like Bitcoin, they use proof-of-work, several miners on the network will need to compete with one another to solve a complex mathematical problem to prove their โ€˜work.โ€™ The winner will then verify and add a new block to the blockchain in exchange for Bitcoin tokens as a reward for their hard work. 

Proof-of-stake, on the other hand, means that validators will be chosen based on how much they stake. In other words, the more tokens they โ€˜lock upโ€™ on the network, the better their chances are of being chosen as a validator, who is the proof-of-stake equivalent of miners.

Blockchain Security 

Considering blockchains are specifically designed to act as safe and transparent spaces for crypto users to share their assets, it makes sense that they would feature top-notch cybersecurity measures.

The most obvious example is how blockchains record transactions and make them part of a permanent record on the blockchain network. Whatโ€™s more, everyone on the network is free to view the supply chain at any time. 

Not only that, but most blockchains are also immutable, meaning there is no tampering that can be done to transactions on the ledger once theyโ€™ve been made. 

This safeguards against people acting deviously, such as trying to scam others or hide their payments.

In addition, thereโ€™s also a lot of caution taken when establishing new blocks after transactions are made, which helps to add another layer of security. For example, every block must have a unique address, and each new block must be agreed upon by several modes, ensuring nothing suspicious is passing through the system.

It does need to be made clear that blockchains are not completely unhackable. Itโ€™s just extremely difficult for hackers to penetrate them and seek out any glaring vulnerabilities. Even attempting this requires an enormous amount of computing power.

Are Blockchains Decentralised?

Decentralization is one of the most important terms in crypto. It refers to the idea of buying, selling, and owning currency without needing to rely on a central authority or intermediaries.

Blockchains can be either centralized or decentralized. Centralized blockchains have a central system that makes all the decisions that affect the network. This system also keeps one singular copy of the blockchain transactions rather than each user having one themselves, which is usually the case. 

However, decentralized blockchains, which donโ€™t rely on any third parties to help in running their networks, are the much more popular option for several reasons:

  • Bitcoin Template: In 2008, Bitcoin laid out the blueprint for decentralized blockchains and proved that it could work in practice.
  • No Central Point of Failure: Decentralized blockchains donโ€™t need to store their data onto a single computer or system, negating any risk of a hack shutting the entire network down.
  • Community Control: In a centralized blockchain, only a handful of individuals have the power to make changes on the network. Decentralized blockchains hand over the control of data and transactions to the users, making them more involved.
  • Trust: Both participants will have a copy of the transaction, so thereโ€™s no need to have trust between them since everything is recorded and clear to see.
  • Development Speed: Unlike centralized blockchains, decentralized blockchains have unlimited potential for development and evolution. Most of them also have open support systems where users can contribute to the network by suggesting new ideas to make it more comfortable and efficient for everyone involved.

Is It Possible to Connect Blockchains? 

A man in a spaceship moving from one planet (blockchain) to another. There are waypoints on each plant showing his movements from one to the other.
Source: Polkadot.wiki

The short answer is yes. Blockchain technology has advanced far enough for individual blockchains, which are usually isolated and remote, to communicate with one another. 

This is known as interoperability, and though it’s still an early concept, itโ€™s already proven to be quite effective and useful in practice. 

There are several platforms that are designed to allow blockchains to interact, with Polkadot (DOT) and Cosmos (ATOM) being the most popular examples. This is made possible through cross-chain messaging protocols which allow for the creation of defi apps (dApps) that function across multiple chains.

dApps are essentially small blockchain-based projects that can be made for their own unique purposes. 

For example, some allow for token swaps between blockchains, allowing someone to send a token and receive something different on the blockchain they send it to. There are also native payments, which enable users to trigger a payment on a separate chain through the native asset, and contract calls, where smart contracts can communicate with one another. 

These are just a few use cases that can be accessed through blockchain interoperability, but this area is still growing, so itโ€™s only the tip of the iceberg regarding what it can offer.

Private, Permissioned, and Consortium Blockchains

So far, weโ€™ve been focusing on public blockchains, which everyone can gain access to. 

However, some types arenโ€™t as accessible and are more secretive in their operations. These types of blockchains tend to be favored by those outside of crypto, such as businesses and corporations using them within a specific field, though they can still be used for handling digital assets.

  • Private Blockchain: Only invited users can join the blockchain. To be considered, a personโ€™s identity needs to be verified and considered authentic. Transactions are still visible, but only to those allowed access to the blockchain. The blockchain is secured using the same cryptography as regular decentralized blockchains. 
  • Permissioned Blockchains: Users must first have permission to enter the blockchain. Ledger administrators then assign them jobs or roles, creating an online workspace ideal for big businesses. 
  • Consortium Blockchains: Blockchains managed and monitored by multiple organizations at once.

On the Flipside

  • Blockchains will never stop evolving, but it can be argued that theyโ€™re moving a little too quickly. There are now blockchains, such as the Hedera network, which donโ€™t accept โ€˜traditionalโ€™ cryptocurrencies and are changing the blockchain formula completely.
  • However, Popular blockchains have problems, especially scalability, as in the case of Bitcoin and Ethereum.

Why This Matters

Ultimately, if youโ€™re a crypto investor, you will be spending a lot of time within a specific blockchain. Therefore, it helps to understand where your payments are going and how they are being processed so that you can feel more comfortable when making transactions.

Once you understand the inner workings of a blockchain, you can also start diving deeper into multi-chain platforms, which open up many new ways to use your precious tokens. 

FAQs

What Is Hyperledger?

Hyperledger is an open-source enterprise project designed to help developers create their own blockchains. It is hosted by the Linux Foundation and is ideal for beginner developers who want to expand their knowledge before diving head-first into the blockchain ecosystem.

How Popular are Blockchains Outside of Crypto?

Blockchains have become extremely popular in several real-world fields, especially financial services. Blockchain uses in this department include asset management, banking and lending, cross-border payments, and more. Blockchains are also used in healthcare, where they can keep a transparent record of medical data. Blockchains can also be used to support non-crypto digital assets like NFTs.

When Were Blockchains Created?

Technically, the idea of a type of distributed ledger technology was first introduced by David Chaum in the 1980s. It was then included in the Bitcoin white paper and was made fully functional by the founder of Bitcoin, Satoshi Nakamoto.

This article is for information purposes only and should not be considered trading or investment advice. Nothing herein shall be construed as financial, legal, or tax advice. Trading forex, cryptocurrencies, and CFDs pose a considerable risk of loss.

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Ewan Lewis

Ewan Lewis is a Blockchain Writer at DailyCoin who produces profile & educational articles. Ewan has minor holdings in Bitcoin and Ethereum.

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