A blockchain is a database. (If you want to get more technical, a blockchain is a form of distributed ledger technology. Distributed ledgers are databases that are maintained by multiple parties.)
Like other databases, the job of a blockchain is to store data. (Data is just information.) Data stored by blockchains are organised into ‘blocks’. These blocks are designed to link together, making a ‘chain’ of blocks. Because blocks are ordered in a certain way, data stored in blockchains is extremely hard to change.
Before we further, note that blockchains and cryptocurrencies are different things. Cryptocurrencies are the units that are native to blockchains and occasionally other forms of distributed ledger technology. For example, the bitcoin (BTC) cryptocurrency is native to the Bitcoin blockchain.
READ: What Is Cryptocurrency?
The Big Deal With Blockchain
Some are excited about blockchain technology because blockchains can be decentralised. That is, they can function without having a single party—like a person, company or government—in control of everything.
While centralised databases do a lot well, they have many issues—a big one being security. If a central database gets hacked, the data it stores becomes vulnerable. Another issue with centralised databases is data ownership. Today, basically all your data is owned by someone else. Worse still, the companies you give your data to often use it to make money.
This brings us to another issue with centralised databases: transparency. It’s virtually impossible to check how the owners of centralised database use your data.
Blockchains & Consensus
Each node in a blockchain network has its own version of the truth. (A node is simply a participant in a blockchain network. Nodes communicate with other nodes to ensure the blockchain’s security and integrity.)
“But if decentralised blockchains like Bitcoin and Ethereum have no single owner, how does everyone agree on the truth?”
Thanks to something called a blockchain consensus protocol. This is just a set of rules. Each node follows these rules so that all nodes can achieve consensus over the state of the blockchain. (‘Achieving consensus’ just means ‘reaching an agreement’.)
There are many components to blockchain consensus protocols. Take Bitcoin for example. It uses the Nakamoto consensus protocol, which features a block proposing scheme called proof of work (PoW).
To understand blockchain, you don’t need to understand the nitty gritty of how blockchains reach consensus. If you do, watch the below video from Nugget’s News’ YouTube channel. In it, Alex goes over the similarities and differences between PoW and proof of stake (PoS).
Basic Example of Using Blockchains
You and your brother are disputing who the rightful owner of the family house is. You claim that you own the house. Your brother disagrees.
You both visit a property clerk at the local records office to get an answer. This process can be slow and you must trust that the clerk is giving you the right information.
If the town’s property records were stored on a blockchain, you wouldn’t need to trust the clerk. Instead, you and your brother could simply refer to the blockchain your town stores its property records on.
You both could easily view the details of the family house’s most recent transfer of ownership. These details would include the owner’s name and the date of transfer.
You can trust the information because blockchains are very difficult to change. This is a powerful concept, as it challenges the need to use and trust intermediaries. (In this example, the property clerk was the intermediary.)
How Are Blockchains Used?
The databases we use today let us do things that were unimaginable only a few decades ago. So if these databases are so good, what’s the point of blockchains? Let’s go over some examples of how they’re being used today.
The financial world is using blockchain technology in many ways. Financial and payments infrastructure built on blockchain technology may enable more secure ways of transferring value. This is especially true in the context of international payments. Today, sending money abroad is very expensive in many countries.
Basically all the world’s top financial companies are researching ways to use blockchain technology. Take the Future of Commerce team at Visa for example:
Our Future of Commerce team is currently focused on understanding the fundamentals of cryptocurrencies and blockchain technology. We explore ways to advance the science of blockchain technology and enable the discovery of real-world payment use cases. We collaborate with top universities and the world’s leading blockchain researchers to develop technologies that promise to transform the financial industry in the decade ahead.
Mastercard, PayPal, Goldman Sachs and JPMorgan are some other big names exploring blockchain technology. Another is Fidelity, one of the world’s largest investment management firms. Fidelity’s blockchain unit has over 100 staff.
Gaming is another area where blockchain technology is being applied. For example, Ubisoft—one of the world’s biggest gaming companies—is launching a collectibles game on Ethereum blockchain.
You can see many ways blockchain technology is being used by looking into something like Microsoft’s Azure Blockchain Service. For example, Microsoft uses blockchain to compute royalty statements for Xbox game publishers in hours instead of months.
Because blockchains are useful for verifying that things are what they claim to be, many companies are exploring blockchain technology to help tackle problems like counterfeiting. In Australia, the National Rugby League (NRL) is using blockchain to help consumers identify authentic brands.
Limitations of Blockchain Technology
Blockchains aren’t a fix-all solution. It’s important you know about their limitations.
Blockchains can get congested
When lots of people use a blockchain at once, it can take a long time for your transaction to process.
This is similar to when you’re at a large festival or sporting event and your phone will take ages to load anything. Your phone may show that your reception is good. However, because so many people are on their phones, the network will have trouble handling so much activity.
It’s the same with blockchains like Bitcoin and Ethereum. Despite how busy the network is, you can always send a transaction. Though if the network is busy, it can take a long time for your transaction to get added to the blockchain. (Before transactions get added to a blockchain, they go to a place called a mempool.)
If lots of people want to send transactions at the same time, transaction fees will increase. That’s because the more fees you pay, the quicker your transaction will process. There have been times in the past when sending a transaction on Bitcoin and Ethereum would cost $50!
Blockchains face some security challenges
Blockchains can get attacked. The most common attack is known as a 51% attack. Basically, it’s when a miner or group of miners try to get control of more than 50% of a blockchain’s hash rate. They are not dissimilar to hostile takeovers in the corporate world.
It’s nearly impossible to carry out a 51% attack on Bitcoin and Ethereum. That’s because they have so much computing power being put into them by nodes all over the world, making them ultra secure. Less secure blockchains get attacked quite often. In mid-2020, the Ethereum Classic blockchain suffered a string of 51% attacks.