Imagine a world in which you can send money, prove ownership, or even store data without any involvement of a government, a bank, or a technology firm. Imagine no more; that is now possible thanks to blockchain technology.
You understand that when you purchase Bitcoin on an exchange, trade tokens, or even purchase NFTs on any of the platforms, you are taking advantage of blockchain technology? However, to be successful and thrive in the crypto space, first, you need to know how blockchain technology works.
Blockchain: In Simple Terms
So, what is blockchain? Essentially, it’s a type of database or ledger. But unlike the ledgers banks or businesses keep, blockchain isn’t controlled by a particular institution. It is decentralized, so it’s on many computers and all of them ensure they are all in sync with the books.
This distributed architecture stores information in blocks, which are linked together sequentially in a chain. A block carries a quantity of settled transactions and some unique cryptographic reference, a “hash,” that connects it to the following block. This setup prevents anyone from altering or deleting information in a blockchain after entry through consensus by the whole network.
What’s so incredible about blockchain is that it establishes trust between people who are not necessarily all that similar to each other, without the need for a middleman like a bank. While it’s the backbone behind cryptocurrencies like Bitcoin and Ethereum, its applications are many more than just financial. It’s used to control identity, supply chain management, and secure data sharing as well.
How Does It Work?
In an attempt to comprehend blockchain technology and its working, we first need to explain how a straightforward transaction is done: sending crypto from one person to another. Here, for example, suppose John wishes to send 1 BTC to Bob.
- Transaction creation: John starts sending the transfer with his crypto wallet. His transaction contains details like his wallet address, Bob’s address, and the size of Bitcoin sent. It also needs to be digitally signed using his private key.
- Send to network: The moment John hits the “send” button, his transaction is sent to a decentralized network of nodes, or computers that verify and store the blockchain. All nodes receive a copy of the transaction and begin verifying it.
- Consensus verification: The network uses a consensus algorithm, which is a set of rules the nodes follow to determine which transactions are valid. For Bitcoin, this is the Proof of Work (PoW) system, where miners solve math problems. If enough nodes check and agree that the transaction is valid, it can move forward.
- Bundling into block: The verified transactions are put into a new “block” by a miner (or validator, in Proof of Stake schemes). The block has a reference back to the previous block’s hash and a timestamp.
- Block added to chain: The new block is attached to the blockchain and becomes a permanent, unchanging part of the ledger. Bob receives his 1 BTC, and each node updates its version of the chain.
- Immutable & transparent record: The transaction is verifiable by anyone on a public blockchain explorer. John and Bob are not able to modify the transaction once it is completed.
Key Features to Know
Decentralization & Immutability
In banks and government, as it traditionally exists, there has to be central control. If the central server is damaged or goes down, the whole system collapses. But no longer with blockchain. It operates on a decentralized system where every node on the network maintains a copy of the ledger. This design makes it virtually impossible to manipulate, censor, or crash.
Once information has been added to the blockchain, it’s there forever. You can’t delete or alter it without impacting all versions of the ledger. It would require a huge amount of processing power and consent from most individuals on the network. That’s why blockchain is utilized for safe financial transactions and agreements; it’s all about immutability.
Transparency & Security
Anyone can see the complete history of transactions on public blockchains like Ethereum or Bitcoin. Such transparency creates accountability and trust, particularly in voting or financial transactions. In addition, real-time analysis of whale activity, patterns in transactions, and even interactions in DeFi smart contracts are provided to traders.
Generally speaking, blockchain secures data using sophisticated cryptographic techniques. A private key, such as a password, and a public key, such as an address, are given to every user. Transactions, being digitally signed, cannot be broken. When coupled with the consensus mechanism, blockchain is secure and irreversible.
Types: Public, Private & Consortium Blockchains
Whenever the word blockchain is said by the majority, cryptocurrencies come to mind. The truth, however, is not all blockchains are the same. They are public, private, and consortium.
Public blockchains are first. Anyone can join. Anybody can join in, look at transactions, become part of the network, and contribute to the consensus process. Examples are Ethereum, Solana, and Bitcoin. They are great at digital currency and DeFi applications, because they are decentralized and open.
Private blockchains are, however, controlled by one company, and therefore can restrict who gets to see the data and validate transactions. While they may lack public blockchains’ decentralization, they offer quicker performance and more privacy. Private blockchains are used by companies for applications like supply chain tracking, compliance, and internal information sharing.
Lastly, consortium blockchains strike a balance between centralization and decentralization. These blockchains are managed by a range of organizations, all running their own nodes and verifying data. The blockchains are particularly useful for industries where numerous organizations need to share access to verified data, such as banking, logistics, or healthcare.
Consensus Mechanisms: The Brains Behind Blockchain
Blockchain decentralization is rooted in consensus algorithms, or more broadly, those that allow nodes to reach consensus on a single version of reality.
Proof of Work (PoW)
The first model, utilized by Bitcoin. Miners race each other to solve a hard puzzle and get rewarded. Slow and power-intensive though it may be, it is very secure.
Proof of Stake (PoS)
Proof of Stake, implemented by Ethereum 2.0 and Solana, makes validators eligible on the basis of how much they stake in cryptocurrency. It is energy-efficient and scalable compared to PoW.
By other Models
- Delegated PoS (DPoS): Used by EOS to select reputable validators.
- Proof of History (PoH): Used by Solana, in addition to PoS, to execute transactions extremely fast.
- Proof of Authority (PoA): Used in private networks where identity overcomes anonymity.
Consensus models used by different blockchain tokens affect the network’s speed, cost, and decentralization, each an important consideration to make when trading.
Why Blockchain Matters to Traders
- Researching the underlying tech of a coin rather than just its price chart to better make decisions.
- Learning how decentralization, scalability, and transaction speed impact real-world utility.
- Identifying budding opportunities early, i.e., blockchains with developer communities working on them or tokens that are using bleeding-edge consensus mechanisms.
Looking for Learn More?
It’s all built upon the blockchain, everything in crypto, from Bitcoin to smart contracts to NFTs to DeFi. But why should you be interested? Simple. You’ll be able to judge projects, trade with confidence, and make sense of markets better if you know what’s under the hood.
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