What is blockchain technology and how does it work?

What is a blockchain?

It acts as a kind of database and is most widely known for its application as a key part of most cryptocurrencies.

Before we go further, let’s clarify something. People often talk about “the blockchain,” but it’s not a single entity. There are many blockchains, and while some are more popular than others — the Ethereum and Bitcoin blockchains, for example — new ones can be created at any time.

When we refer to “the blockchain,” we usually mean this technology as a whole rather than specific examples of blockchains.

How does blockchain technology work?

As the name suggests, it’s composed of a series of “blocks.” The term “block” refers to a unit of data storage within the code of the blockchain. Each block contains the unique number of the block that preceded it, and this creates a “chain” of blocks.

Think of the first block as the first line of a database. It is called the genesis block, and on its own, it’s just a small collection of data, not a chain of data blocks. However, it contains a unique numerical signifier, for example, 0001. If a second block is added, it will identify itself as block 0002 and contain the information that it follows block 0001. That’s how a chain is formed.

So far, so good. But the next thing we need to tackle is the bit that makes a blockchain special.

Decentralization

Unlike a normal database stored on a single server, a blockchain is decentralized and distributed across a peer-to-peer network.

Each node in the network (usually a device or a server of some kind) has a copy of the blockchain. Before a new block is added, most node operators on the network must check and validate it. This helps to limit the threat of people tampering with the chain’s integrity (for example, by adding a block that doesn’t link to the correct preceding block).

Bitcoin’s blockchain, for example, reportedly had more than 13,000 nodes last year. That’s what people mean when they describe cryptocurrencies and their blockchains as decentralized.

Thanks to this system and to the way in which the blocks are coded, it’s very hard to remove information from the chain once it’s been added.

Benefits of blockchain technology

Data integrity

Because of the peer-to-peer network system, it’s difficult for people to tamper with the data stored on the blockchain. Once a piece of information is embedded in the chain, you can be relatively confident in the integrity and accuracy of that data, even if you’re reviewing it years after it was added.

Greater transparency

Most blockchains are very transparent, allowing outside observers to view data stored on the chain. This is particularly important for cryptocurrencies. Tracking the flow of money through blockchain wallets is much easier than following it through private bank accounts. That transparency can make it easier to identify and track scammers.

Decentralized control

Blockchain technology is built on the idea of decentralization. It doesn’t rely on large organizations like banks or credit card companies to handle your data and money. Instead, the peer-to-peer ledger system avoids any single person or entity gaining too much control over a blockchain.

Disadvantages of blockchain

Lack of regulation

Because blockchain technology is less regulated, it’s much harder to recoup losses if data you have stored on a blockchain is stolen. If you have currency in a blockchain wallet, and someone manages to access your wallet, there’s no bank or central agency to help you get that money back. This is a major factor in why a large percentage of the public struggles to trust cryptocurrency and the technology it’s built on.

Too much transparency

There’s a downside to transparency, too. Because most data on a blockchain is accessible to most people, it’s not a good place to store sensitive information. Hashing hides the fact that you’re the owner of the data, but the data itself is still visible to prying eyes. That’s why suggestions to use blockchain for government record-keeping or medical data should be treated with some skepticism.

Blockchain examples and use cases

If you’ve heard of blockchains before, it’s likely because of two other technological innovations: cryptocurrency and NFTs.

Cryptocurrency

Cryptocurrencies like Bitcoin, Ethereum, and Dogecoin (yes, there’s a currency named after the Doge meme) use blockchain to record transactions. Every time these digital coins change hands, the interaction is recorded in a block on a blockchain.

This means that, if you can find someone’s crypto wallet stored on the blockchain, you can view the history of their crypto transactions. You might not know who owns the wallet, but you can still view their activity because the blockchain is highly transparent. When people talk about untraceable cryptocurrency, they’re usually referring to the fact that the owner of the wallet is often untraceable, rather than the transactions themselves.

While transactions are publicly available, however, details of who is making the transactions are private, thanks to a cryptography process called hashing.

NFTs

Over the last year, NFTs have become a huge online craze. NFT stands for “non-fungible token,” and these “tokens” are essentially just positions on a blockchain. They’re often associated with pieces of digital artwork or other non-physical media.

Each token represents a unique block on a blockchain. People have been buying and selling these tokens in a manner similar to speculative stocks. They do this by linking a piece of media they own, like an image they created, to a position on a blockchain. They can then sell ownership of that position, and the associated media, to someone else.

The buyer can resell it to try and make a profit, and tens of millions of dollars have changed hands in this way. However, before you rush out to buy an NFT art piece, you should know that many buyers have already made huge losses on their investments.

Internal company blockchains

Some businesses are open to using blockchain technology for internal record-keeping, provided all the nodes of the network are under their control. This is a good way of getting around some of the issues with transparency while still keeping the benefits of data integrity and accuracy.

With systems like permissioned and consortium blockchains, several businesses or government agencies can maintain a single node network. This allows logging information and sharing it on a blockchain without it being publicly available.

Types of blockchain

Public blockchain networks

These are the most common kind of blockchains, which are accessible to everyone. Cryptocurrencies run on these chains, and they provide the least privacy in terms of transaction and activity logs.

Private blockchain networks

A private blockchain suits a company or organization that wants to use the technology without the extreme decentralization of a public blockchain. These blockchains could be maintained across several devices within a workplace rather than being spread over nodes all around the world. Cybersecurity is important, and this approach to blockchain can allow for a greater level of safety and privacy.

Permissioned blockchain networks

Also a good option for businesses, permissioned blockchains are exactly what they sound like. They require access granted either through a central administrator or use of automated verification processes. A private blockchain could also be a permissioned blockchain and vice versa.

Consortium blockchains

Consortium blockchains are like private and permissioned blockchains, only shared across multiple organizations. For example, several businesses or government agencies could be responsible for maintaining nodes on a blockchain network. It could still be kept relatively private, but members of all involved organizations could access the data it stores.

The future of blockchain

Blockchain has a lot of potential uses, and it’s already revolutionizing currency and data ownership. However, despite some enthusiastic predictions about its transformative power in wider society, we’re unlikely to see mass adoption any time soon.

The biggest benefits of blockchains — decentralization and transparency — also make them inappropriate for many use-cases outside the cryptocurrency space. While the technology will continue to gain popularity and may evolve to fit the needs of companies and governments, its full potential is yet to be realized.