Cryptocurrency is considered one of the most important financial innovations of our times. However, despite everyone having heard about Bitcoin, Ethereum, and Doge, their knowledge about how they operate is limited.
Unfortunately, failing to understand the technical aspect of crypto could prevent you from investing smartly.
The reason for this is that most cryptocurrencies are more than just a digital form of money. Even coins like Bitcoin, Dogecoin, and other transactional cryptocurrencies, rely on a technology that provides them with unique advantages. This technology is known as blockchain.
If you are not familiar with what blockchain technology is, worry not. In this article, we will provide you with an overview to take your understanding of crypto to the next level.
What is Blockchain?
Blockchain is a system of recording information in a way that makes it difficult or impossible to change, hack, or cheat the system.
It is usually defined as a decentralized, digital, and immutable ledger. This ledger allows the tracking of assets and recording of transactions of any type.
Unlike traditional databases, blockchains are decentralized. This means that the information is not stored in a single location like a server or computer. Instead, many copies of all the information in the blockchain are stored on different devices in a network.
These devices that store the network’s data are known as nodes and allow the entirety of the network to operate. If a node goes rogue or becomes unavailable for some reason, the other nodes ensure the network continues operating.
As there are many nodes participating at any given time, the data is highly transparent. However, the use of cryptography and the distributed storage model ensures its immutability and security.
Why is Blockchain Relevant?
While blockchain is the fundamental technology that allows cryptocurrencies to operate, its importance goes beyond that. As one of the safest methods of storing and sharing information, blockchain has become increasingly important in different industries.
Today’s world runs on information, which makes its security, availability, and accuracy more important than ever. Just think about the increasing number of ransomware attacks and other actions performed by malicious actors…
The loss of information can paralyze entire industries and affect millions of people.
Distributed ledgers like blockchain remove what is known as single points of failure because there is no central body in charge. As the technology can be applied to anything from crypto to social media, more organizations are implementing it in their systems.
If you need to store data, ensure it is accessible, secure, and efficient, blockchain can help.
However, not all blockchain networks are made equally. As the technology continues to develop, different types of blockchains started to emerge. This variety ensures that no matter the needs of an organization or project, blockchain can be applied.
What Elements Does a Blockchain Have?
Understanding blockchain can be a daunting task due to its complexity. However, understanding the general idea will be enough for you to grasp the potential of a given network… and therefore its cryptocurrency’s potential.
The elements of a blockchain are:
- Nodes: They are used to describe all the devices connected and interacting with a blockchain network. Different types of nodes exist depending on the network, each with its own functions.
- Blocks: The structure in which data is stored in a blockchain network. It allows the recording of several transactions.
- Chain: Blocks are stored sequentially, with each connecting to the next. A chain is composed of multiple blocks, giving the technology its name.
- Miners/Validators: A specific node essential to every network.These nodes process transactions, ensuring their validity and storing them in the network.
- Smart contract: A piece of software that establishes rules that can be evaluated, executing a specific action automatically depending on the result of said evaluation.
- Consensus algorithm: The method used to validate an account. For example, bitcoin uses what is known as proof-of-work (first to validate earns a reward). Other networks use other methods to select which node will validate, such as proof-of-stake (similar to a lottery system).
- Token: A unit of value used by certain cryptocurrencies to facilitate transactions. These tokens are what cryptocurrencies like Ethereum, Bitcoin, and Dogecoin are.
While there are more elements that make blockchain what it is, these are the basic building blocks (pun intended). All networks will have a different approach, which is why looking at their specific implementation is always a good idea.
You can usually find this information in the form of a “White paper” or “Whitepaper”.
Now that you know the basic terminology, it is time to talk about how blockchain actually works.
How Does Blockchain Work?
Answering “what is blockchain?” requires having a basic understanding of how it works. In essence, the process by which blockchain works is pretty straightforward.
Most blockchains will operate following these steps:
- A transaction takes place: A transaction in a blockchain doesn’t have to be monetary necessarily. If you want to record any data, this would be considered a transaction.
- The data is stored in a block: The information of the transaction is stored in a block. This information can be varied, including elements such as the date at which it took place, amount, type of transaction, parties involved, etc.
- The block is shared with the network. Once the block is created, it will be shared with other nodes in the network.
- Validation occurs: Validator or miner nodes validate the transaction. They ensure the format of the block is correct, the funds are available, the recipient/sender are authorized to operate, etc.
- Validators are rewarded: Once the block is validated, specific nodes will be rewarded for doing so. How the node is determined will depend on the consensus algorithm used by the network. This incentivizes users to participate and keep the network working.
- Block is added to the chain: The block is added to the chain, storing it permanently in the network to facilitate future validations.
- The transaction is complete: The data will be permanently stored and visible to all members of the network with the necessary permissions.
As you can see, the name blockchain is a pretty good description of how the technology works. This methodology is what allows blockchain networks to power cryptocurrencies, as it is a matter of keeping records of all transactions.
When it comes to networks that use tokens, these will usually be used as a form of payment for network services or rewards for validators.
The 4 Types of Blockchain Networks
Not all organizations or projects have the same needs. As such, different types of blockchain networks have emerged over the years, each offering different benefits. The most common type of blockchains are: public, private, permissioned, and consortium blockchain networks.
Public blockchain networks are accessible to anyone who wants to participate. These are the most popular, being the type used by projects like Bitcoin, Ethereum, Litecoin, etc. You don’t need authorization before joining and participating in the network.
Private Blockchain Networks, on the other hand, are decentralized networks only on the technical aspect. The organization behind it has complete control over who can participate and is in charge of maintaining the ledger.
An example of a private network is Hyperledger, as the infrastructure is maintained by an authority.
Permissioned Blockchain Networks have restrictions in place for who is allowed to participate in the network and to what degree. You are required to get an invitation or authorization to join the network and operate.
If you have heard about Quorum or Carda, these are permissioned blockchains.
Finally, Consortium Blockchains are a form of a private blockchain network in which multiple organizations share the responsibility of maintaining the network. An example of this is Hedera Hashgraph, which is run by a group of companies.
It is important to note that a given blockchain network can have more than 1 type.
An example of such a network is Hedera Hashgraph, which we mentioned before. While anyone can join and use the network at any given time, a consortium is in charge of all validations and keeping the network usable.
There is much more to the question “What is crypto?” that can be explained in a single article. As the industry evolves, so does the number of approaches and networks that exist.
For example, Ethereum used to be the undisputed king when it came to smart contracts. Now, other projects like Cardano, Polkadot, and Binance Smart Chain have offered alternatives to developers and investors.
Making sure to understand what makes a blockchain network different from the others, will give you a competitive advantage. Remember that a lot of times you are not betting only on a cryptocurrency… But also on the network in which it runs.
For example, coins like Chainlink, Maker, Wrapped Bitcoin, VeChain, and more, run on the Ethereum network. This means they will be directly impacted by the performance and popularity of Ethereum, unlike coins that run in their own network (such as BTC).
Congratulations on making it to the end. Hopefully, you now have a better understanding of how blockchain allows crypto to operate. If you are still in need of help on how to buy or the benefits of crypto, we suggest you check our crypto section.
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