Understanding Blockchain: The Expert Guide

Digital currencies have gained significant attention in recent years, and understanding how to navigate this landscape is becoming increasingly important.

You may have come across the term blockchain frequently, as it serves as the foundation for digital currencies. Therefore, grasping what blockchain is and how it operates is essential.

If you're new to cryptocurrency and investment and are eager to learn more about digital currencies, we invite you to read through this article.

We will clarify what blockchain is, break down its components and functionality, discuss its pros and cons, and compare it to Bitcoin and traditional banking systems.

 

So, what exactly is blockchain? 

Blockchain is a decentralized network that employs cryptographic techniques to publicly document the history of all transactions involving digital assets in a digital ledger.

Once information is recorded in the blockchain, it cannot be altered, and all data is transparently accessible to users.

This network facilitates transactions without the need for banks or financial institutions, enhancing the security of digital currencies—a factor that has attracted many enthusiasts.

While blockchains are crucial for maintaining a secure and decentralized transaction record in digital currency systems, their applications extend beyond just cryptocurrencies.

They can ensure data integrity across various sectors, enabling the development of decentralized applications (DApps), supply chain management solutions, voting systems, and much more.

The potential of blockchain technology to transform multiple industries lies in its ability to foster trust, security, and efficiency.

Since Bitcoin's launch in 2009, the adoption of blockchain has surged, leading to the creation of numerous digital currencies, the rise of decentralized finance (DeFi), non-fungible tokens (NFTs), and smart contracts.

Blockchain technology is essentially a system that keeps track of transaction records, known as blocks, organized in a database referred to as a "Chain."

This structure operates within a network of interconnected computers, or "Nodes," that communicate directly with one another.

Collectively, this setup is known as a "Digital Ledger." While these concepts might sound a bit complex, let's break it down into simpler terms.

 

Understanding Blockchain Simply  

To put it simply, blockchain can be thought of as a lengthy chain of data. This data is made up of transactions that occur within the network.

These transaction records are grouped into units called blocks. Once the information in a block is complete and verified, it gets added to the end of the chain.

This entire sequence of blocks is what we refer to as the blockchain, and it is stored across the network's nodes.

These nodes are computers responsible for maintaining the complete information of the network, with each one holding a copy of all the data.

 

What is a digital ledger?  

A digital ledger can be described as a comprehensive record-keeping system, with blockchain serving as a prominent example. It securely stores details of network transactions in a clear and organized manner.

For any data to be added to the network, it must undergo verification through a digital signature and receive approval from other participants in the network.

No single entity owns a blockchain network, allowing everyone to view the recorded information; however, they cannot alter it.

This is because all data is replicated across each node, and altering any information would require changes to every copy in all nodes. Additionally, the design of blockchain ensures that modifying the data in one block renders it invalid.

Next, we will delve deeper into blockchain technology and illustrate this crucial topic with examples.

 

To better understand blockchain, consider this scenario:

 When you want to send money through a bank, the bank verifies your account and the recipient's account, processes the transfer, takes its fee, and updates both account balances.

This entire process is managed by the bank's system. If a hacker gains access to this system, they could reroute the funds to their own account instead of your friend's. It's fascinating to note that such incidents occur thousands of times globally each year!

In contrast, the blockchain operates on a different principle. Here, your information and your friend's details are verified not just by a single institution like a bank, but by everyone in the network.

The use of algorithms, hashes, and miners (which will be explained further below) guarantees that your digital assets are transferred accurately.

Once a transaction is completed, no one can alter the details, and the entire network can view the transaction information.

Additionally, transaction fees on the blockchain are typically much lower than those charged by banks, which becomes particularly significant when dealing with large sums of money.

 

History of Blockchain  

Blockchain technology was first introduced in 1991 and has evolved significantly since then. Here’s a brief overview of the key milestones in the development of blockchain technology.

 

1991: The inception of blockchain technology came from two scientists, Stuart Haber and W. Scott Stornetta.

2000: Stephen Kent shared his theories on cryptographically secure chains, along with ideas for their practical application.

2004: Hal Finney, a computer scientist and crypto activist, unveiled a digital cash system known as Reusable Proof of Work.

2008: An anonymous individual or group under the name Satoshi Nakamoto introduced the concept of a Distributed Blockchain in the Bitcoin White Paper, originally titled Peer-to-Peer Distributed Timestamp Server.

2009: Satoshi Nakamoto launched the first blockchain, serving as a public ledger for Bitcoin transactions.

2014: The concept of blockchain 2.0 emerged, aiming to leverage this technology for purposes beyond just transferring value. This version focused on enabling decentralized businesses and organizations through smart contracts, paving the way for the future development of DeFi.

2015: The Ethereum Frontier network was launched, marking the first public iteration of the Ethereum blockchain, which allowed developers to create smart contracts and decentralized applications.

2017: Japan officially recognized Bitcoin as legal tender, while Block.one developed the EOS blockchain operating system to facilitate decentralized business applications.

2018: Bitcoin celebrated its 10th anniversary, with its price fluctuating between $4,000 and $16,000 throughout the year.

2019: The Ethereum network saw a surge in activity, with daily transactions exceeding 1 million.

2020: The popularity of stablecoins grew, and Ethereum launched the Beacon Chain in preparation for Ethereum 2.0, transitioning to a proof-of-stake model.

2022: in the Ethereum network transitioned from the traditional Proof of Work (PoW) consensus mechanism to the more modern Proof of Stake (PoS) model. This significant shift involved merging the Ethereum mainnet with the China Beacon.

This section highlights just a few of the key annual changes in the blockchain realm. It's important to recognize that blockchain technology continues to advance, and numerous developments have occurred in recent years, making it impossible to cover them all in a brief overview.

 

Blockchain is made up of three essential components:

1. Blocks
2. Miners
3. Nodes

Let’s take a closer look at each of these elements.

 

What is a block?

In the blockchain network, the individual units of information are referred to as blocks. A blockchain is composed of numerous blocks, and each block contains three key components:

Data: This includes the transaction details recorded within the block.

Nonce: The nonce, or "number used once," is a 32-bit number that can generate around 4 billion unique combinations. It is randomly created when a block is formed and serves as a hash header for that block.

Hash: Hashes are 256-bit numbers that accompany the nonce. Miners are tasked with discovering the correct nonce that will produce a valid hash for the block.

 

What exactly is a miner, and what function do they serve in the blockchain? 

Miners play a crucial role in generating network blocks through a process known as mining. Each block in the blockchain contains its own unique nonce and hash, along with the hash of the preceding block.

This makes the task of creating or mining a block quite challenging, particularly in extensive networks that hold millions of blocks.

To tackle this, miners utilize advanced software and hardware to solve intricate mathematical problems, ultimately generating a nonce that can produce a valid hash.

 

Why does the mining process consume so much energy? 

As we noted, NANCE operates on a 32-bit system. However, since hashes are produced in a 256-bit format, merging a 32-bit nonce with a 256-bit hash is quite intricate, requiring the calculation of billions of different states before miners can discover the right combination.

Once a valid nonce is identified, the block is prepared to be added to the network. After a block is successfully integrated, all nodes within the network verify it, and the miner is rewarded with a network incentive (like Bitcoin) for their work.

This entire process is known as Proof of Work, ensuring that everyone in the network can trust the accuracy of the block's information.

This system allows miners to generate a substantial income and accumulate bitcoins. The distribution of Bitcoin as a reward serves as a crucial motivation for conducting these calculations within blockchain networks.

 

What is a node in the blockchain?

A node refers to any electronic device that can keep a complete copy of the entire blockchain network and facilitate its operations.

Nodes play a crucial role in decentralizing processes and distributing information within the blockchain.

Whenever a new block is added to the network, it is verified by these nodes. The blockchain's transparency allows for easy verification and access to all its data, thanks to the presence of nodes.

They are interconnected in a Peer-to-Peer manner, ensuring that each node holds the same information. This robust information storage system helps maintain the integrity of the network and fosters trust among its users.

 

Understanding the difference between nodes and miners

In the Bitcoin network, all miners function as nodes and possess a full copy of the transaction history.

However, not all nodes are miners; some may not participate in creating new blocks, meaning they do not dedicate their computer's processing power to mining or verifying user transactions.

 

How does blockchain function?

 In the earlier section, you learned about the various components of blockchain, making it easier to understand how transactions occur within it. Each blockchain has its own specific process for handling transactions.

For instance, in the Bitcoin blockchain, your transaction is first sent to a memory pool known as the Mempool, where it is stored and waits until a miner or validator picks it up.

After that, a Bitcoin miner chooses your transaction and incorporates it into a block, which serves as a container for all the transactions that need processing.

The miner's role involves demonstrating their work within the network by executing a series of intricate mathematical calculations to determine the hash number using their processing systems.

Once this is done, the block that includes your transaction is verified by the network and added to the existing chain of verified blocks.

Furthermore, every new block created after the one containing your transaction acts as an additional confirmation of that transaction.

It's important to note that this process specifically pertains to the Bitcoin network; other blockchain networks like Ethereum or Solana may have different methods for processing transactions.

 

What measures are in place to ensure the security of blockchain?

Blockchain is secured through multiple layers of protection, including various algorithms, Proof of Work, hashing, and a Peer-to-Peer system.

These elements work together to form a robust and stable network. New blocks are consistently added to the end of the blockchain, ensuring that previous blocks remain unaltered.

The hash function plays a crucial role in maintaining the integrity of the entire chain; each block contains the hash of the preceding block, meaning that any alteration in the data will result in a different hash for that block. Additionally, security is enhanced by the use of private and public keys, which we will explore further later on.

 

What is a private key?  

A private key is a unique combination of letters and numbers that is generated randomly and securely given to an individual when they create a new wallet or address on the Bitcoin network.

This key allows the wallet owner to manage their address, enabling them to sign transactions or transfer assets to other addresses.

Additionally, the recovery phrase, often a 12-word passphrase for digital wallets, is derived from the private key, offering users a more user-friendly way to access their funds.

It's crucial to keep both the private key and the recovery phrase safe and confidential to ensure the security of blockchain wallets.

 

What is a public key?  

A public key is a unique code made up of letters and numbers that is derived from the private key through a cryptographic algorithm. Following this, a wallet address is generated from the public key using a similar algorithm.

As you can see, the private key, public key, and wallet address are interconnected, but the sophisticated encryption methods used in blockchain networks make it nearly impossible to deduce the private key from either the address or the public key. This design is what helps secure wallets within blockchain networks.

 

The distinction between blockchain and bitcoin  

While blockchain and bitcoin are closely related concepts, it's important to recognize that they are not identical and have their own unique characteristics.

Blockchain is a technology that creates a decentralized and distributed ledger, allowing for secure and transparent transactions and data storage.

On the other hand, bitcoin is a specific digital currency that operates on its own blockchain network.

There are also other blockchains besides Bitcoin, such as Ethereum, which may have different structures and functionalities compared to the Bitcoin network.  

In summary, blockchain serves as the foundational technology that supports Bitcoin and various other digital currencies, whereas Bitcoin is a distinct digital currency that exists within its own blockchain framework.

When we look at the traditional banking system, several key issues arise. For instance, when you transfer money, a hefty fee is often deducted from your account. Banks have access to all your account details and can modify them as needed.

This centralization poses a risk; if the bank loses its data, all account information is lost as well.

 

On the other hand, blockchain technology offers numerous benefits compared to traditional banking, including:

- The ability to conduct transactions anonymously

- Lower transaction fees

- A decentralized and highly secure system

- Enhanced transparency

- Elimination of intermediaries

- Robust network security

- Permanent record of information

- Environmental sustainability

- No central authority overseeing transactions

- Capability to transfer assets regardless of location

- Faster transaction speeds

 

Applications of blockchain technology  

Blockchain technology offers a wide range of capabilities, with asset transfer being just one of them.

Over the past few years, numerous innovative ideas have emerged in the blockchain space, significantly expanding its potential applications. Let’s explore some of the key uses of blockchain.

 

Value transfer  

As previously mentioned, one of the primary uses of blockchain is value transfer.

Through blockchain networks like Bitcoin, individuals can transfer value, specifically BTC, between various addresses without any geographical limitations and irrespective of the transaction amount.

This process is not only quick and cost-effective but also maintains a high level of anonymity for both the sender and receiver.

 

Smart contracts  

Smart contracts are automated software programs that execute specific tasks when predetermined conditions are met.

Blockchain networks serve as the foundation for creating and implementing these smart contracts.

Many popular platforms in the cryptocurrency realm, including decentralized exchanges (DEX), NFT marketplaces, and decentralized social networks with millions of users, rely on smart contracts for their operations.

 

DeFi, or decentralized finance

refers to platforms that offer services akin to traditional financial systems but operate in a decentralized manner for users of digital currencies.

Common services in the DeFi landscape include lending, asset trading, digital currency insurance, and staking, all of which have attracted a significant number of participants.

The Internet of Things (IoT) encompasses a network of interconnected electronic devices that communicate over the Internet.

By linking these devices online, they can be managed and controlled through specialized software.

For instance, you can use an app on your smartphone to adjust your home's air conditioning system, ensuring the temperature is just right by the time you arrive home.

Blockchain technology presents a promising solution for creating the necessary infrastructure to oversee IoT systems.

When it comes to transactions or recording payment details for IoT applications, blockchain can effectively support these processes.

A digital identity management system built on blockchain can provide a secure framework for storing individuals' identity information without the need to disclose personal identities. In this setup, individuals retain significant control over their data, ensuring that user privacy is upheld to the highest standards.

 

Data Storage  

Centralized storage systems and cloud services like Google Drive often have various security flaws and vulnerabilities. One innovative application of blockchain technology is decentralized storage solutions. In these systems, users can utilize storage space from computers located worldwide and can compensate for its upkeep using digital currency.

 

Digital Art Supply  

The rise of virtual tokens or NFTs has become one of the most prominent uses of blockchain, experiencing significant growth in recent years.

By leveraging the standards available in blockchain networks, individuals can transform their digital art into tokens and assign a value for sale.

It's important to highlight that blockchain technology has numerous established and experimental applications that are continually expanding.

This section only touches on a few of the more daring applications of blockchain.

Blockchain technology consists of multiple layers that work together to manage and secure transactions through a distributed ledger (DLT).

This distributed ledger plays a crucial role in recording and validating every transaction within the network. To facilitate this authentication process, blockchain employs a layered architecture.

 

The five key layers of blockchain include:

 

1. Hardware infrastructure layer (Infrastructure layer)
2. Data layer
3. Network layer
4. Consensus layer
5. Application layer

Each layer serves a specific role and function, which we will outline briefly below.

The infrastructure layer serves as the foundational component of the blockchain, responsible for processing and storing transactions through its nodes.

Its primary goal is to maintain the integrity of the blockchain's distributed ledger by validating and securely storing transactions in a decentralized way.

This layer creates a distributed database where all information is transparently recorded. Transactions and data within the infrastructure layer are confirmed through consensus mechanisms.

The data layer follows as the second tier of the blockchain, ensuring that all transactions are transparent, immutable, and cannot be deleted once recorded.

This is where transactions are kept within the distributed ledger.

Next is the network layer, often referred to as the P2P layer, which connects all nodes within the blockchain network.

It facilitates the communication necessary for validating transactions and blocks before they are incorporated into the blockchain.

The consensus layer, the fourth component, is tasked with verifying the legitimacy of blockchain transactions.

It enables nodes to reach an agreement on the sequence of transactions using various algorithms, such as Proof of Work (PoW), Proof of Stake (PoS), Delegated Proof of Stake (DPoS), and Practical Byzantine Fault Tolerance (PBFT).

Finally, the application layer is where users engage with blockchain technology. This layer houses smart contracts and decentralized applications. Without it, the blockchain would merely function as a distributed database.

 

Benefits of Blockchain  

We've already touched on many of the advantages that blockchain networks offer. Now, let's dive deeper into these benefits so you can better understand this innovative technology.

 

Precision of the Chain  

Transactions on a blockchain network are validated by numerous computers and devices, ensuring that the information recorded is precise.

If a single computer makes a mistake in its calculations, that error will only appear in one instance of the blockchain and won't be recognized by the rest of the network.

 

There are various types of blockchain technology, each with unique features. Here are four main types:

 

Public Blockchains  

Public blockchains are open to everyone, allowing anyone to join the network, validate transactions, and create smart contracts. Bitcoin and Ethereum are two well-known examples of public blockchains.

 

Private Blockchains  

Private blockchains are created by organizations or companies for specific uses. These networks are typically not decentralized and are managed by a central authority.

 

Hybrid Blockchains  

Hybrid blockchains merge the characteristics of both public and private blockchains. They enable organizations to regulate who can access the information on the blockchain and determine which data is available to the public.

 

Consortium Blockchains  

A consortium blockchain, often referred to as a federated blockchain, is a type of private blockchain that restricts access to a select group of participants.

This setup helps mitigate the risks associated with a single entity having control over the network. In this model, the consensus mechanisms are managed by specific, pre-selected nodes.  

The four types mentioned are just a few examples of the primary categories of blockchain. With the continuous evolution of blockchain technology, there is always potential for the emergence of new types and modifications.

 

Blockchain algorithms and mechanisms

Blockchain algorithms play a crucial role in this technology, facilitating the recording and verification of transactions across various nodes. Below, we provide a brief overview of some significant blockchain algorithms.

 

Hashing Algorithms  

Hash functions are predominantly utilized in blockchain algorithms to generate digital signatures. Notable examples of widely used hashing algorithms include SHA-256 and Keccak-256.

 

Proof of Work Algorithm  

Proof of Work (PoW) is a consensus mechanism employed by numerous blockchain networks, including Bitcoin. In essence, this method allows the first miner to successfully complete the necessary calculations for block extraction to add a new block to the blockchain.

The proof-of-work consensus mechanism enhances network security, although it demands substantial energy resources.

 

Proof of Stake  

Proof of Stake (PoS) is a consensus algorithm that designates validators for the creation of new blocks based on the quantity of cryptocurrency they are prepared to lock as a stake. Following the Merge update, Ethereum has emerged as a prominent example of a proof-of-stake blockchain.

 

Algorithm for Verifying Assigned Shares  

Delegated Proof of Stake (DPoS) is a consensus mechanism utilized by the Tron and EOS blockchains, designed to achieve greater throughput compared to traditional proof-of-work and proof-of-stake systems.

 

Practical Byzantine Fault Tolerance (PBFT) Algorithm  

Practical Byzantine Fault Tolerance, or PBFT, is a consensus algorithm specifically tailored for private blockchain networks. This algorithm ensures the network's continued operation even in the event of certain nodes becoming inoperative.

 

Directed Acyclic Graph (DAG) Algorithm  

Directed Acyclic Graphs (DAG) represent a technology for distributed ledger development that differs fundamentally from blockchain architecture. In a DAG structure, nodes are employed to illustrate the relationships between transactions, with each transaction validating the two preceding transactions.

The algorithms mentioned above are merely a selection of the various consensus mechanisms available in the blockchain ecosystem.

Different blockchains may implement distinct algorithms and consensus strategies based on their unique objectives.

 

The Future of Blockchain

In his book "The Fourth Industrial Revolution," Professor Klaus Schwab identifies blockchain as a pivotal engineering technology for humanity's future.

Current trends suggest that blockchain will instigate significant transformations across various industries in the upcoming decades.

 

Several key sectors poised for substantial change through the implementation of blockchain technology include:

 

Cybersecurity

 Due to its distributed nature, blockchain technology can effectively prevent data tampering, enhance data security, and enable users to authenticate files.

 

Government  

Blockchain technology has the potential to replace conventional paper-based systems within government operations. Furthermore, its application in voting processes can diminish the risk of fraud and safeguard voter identities.

 

Finance and Banking

With the rise of global inflation and the growing costs associated with money transfers among financial intermediaries, it's anticipated that developing nations will increasingly adopt digital currencies.

A key area for blockchain innovation lies in the establishment of national digital currencies aimed at addressing the shortcomings of traditional currencies.

 

Medicine  

Blockchain technology has the potential to enhance applications related to patient data management, drug supply chain oversight, automation of medical examinations, and medical transactions.

Additionally, it can serve as a powerful tool for verifying the authenticity of vaccine shipments and monitoring their distribution, thereby alleviating concerns regarding counterfeit vaccines.

 

Marketing  

In the future, blockchain is set to become an invaluable asset in the marketing sector.

By leveraging blockchain, businesses can improve the tracking and assessment of advertising campaign effectiveness while significantly reducing instances of advertising fraud.Furthermore, it can aid in gathering insights into customer behavior and psychology.

 

In this article, we explored the idea of blockchain, including its key elements, functionality, benefits, and drawbacks.

We also examined the various types of blockchain technologies and compared Bitcoin with traditional banking systems.

Blockchain operates as a decentralized network that facilitates secure transactions, promotes data transparency, and ensures user privacy, which contributes to its growing popularity.

While blockchain is often associated with digital currencies like Bitcoin, its applications extend far beyond the realm of cryptocurrency, and as we move into the third decade of blockchain, its potential uses continue to broaden.

 

Common inquiries  

What distinguishes blockchain from bitcoin?  

Blockchain serves as a technology for creating a distributed ledger, whereas Bitcoin is a specific blockchain network and a digital currency that operates on that network.  

Which blockchain is considered the best?  

Some of the most well-known blockchain networks include Bitcoin, Ethereum, Solana, Binance Smart Chain, Cardano, Avalanche, and Tron, each offering unique functionalities.  

How can one create a blockchain?

 To effectively and reliably build a blockchain, one must have a strong understanding of programming languages and the principles that govern blockchain networks.  

Which blockchain boasts the fastest speed?

 Blockchains like Solana, The Open Network, Fantom, and Algorand are recognized for their rapid transaction processing capabilities.  

What is the largest blockchain?  

The Ethereum network holds the title of the largest blockchain, with assets worth tens of billions locked in and a vast array of protocols, tokens, and NFTs hosted on it.