What is blockchain technology and how does it work?
The emergence and rise of cryptocurrencies and blockchains has gone hand in hand with the digitalization of our society.
In 2009, a person (or group) known as Satoshi Nakamoto has devised the blockchain. A blockchain is a software that stores information across a network of personal computers.
As its name suggests, it represents a chain of information-containing blocks. Each block includes three components. The data, the hash and the previous block’s hash. This last feature is what gives the system its security and stability. Namely, if someone would tamper with one of the blocks, this would automatically invalidate all subsequent blocks. That is, except for the first one, the so-called genesis block. In such a concept, the hash serves as the data’s fingerprint or signature.
Applied to cryptocurrency, for example, the bitcoin blockchain stores the data of sender, receiver and the amount of coins.
A major feature of the technology – and the cryptocurrencies which derive from it – is its decentralized nature. There is no central entity that manages this chronological chain, but rather a peer-to-peer network. Upon joining it, one gets a full copy of the chain. The record of every transaction ever made is called the ledger. Thus, each link verifies the validity of the entire chain.
The full potential of the blockchain technology was utilized in 2009 for the creation of the first cryptocurrency in the world – the bitcoin.
What is a cryptocurrency?
The original idea of a cryptocurrency was to exclude the middleman. With all the commodities we have with today’s financial transactions, each of them still goes through a bank.
People frequently describe cryptocurrency as “virtual money”. Hence, cryptocurrency is a digital currency with no government issuing it. Also, there is no bank managing and administering it. What does that mean in practice? Well, most importantly, that there is no central organization deciding on adding more currency to the market. This is in stark contrast with traditional currency.
We could describe a bitcoin as a digital file containing information on transactions. Or an addition to a blockchain, monitored by each member of the network. When making a transaction, a cryptocurrency user will announce doing so to everyone else. They will provide several pieces of information to the entire network. Their account number, the account number of the person they’re sending currency to, and the amount of currency. So, everyone else will then record this data.
But how are bitcoins, or any other digital currency, generated? And how does monetary value come into this equation? You have probably heard of bitcoin mining. Mining entails using special software to solve complex mathematical problems, with a certain amount of bitcoins received as a reward. That is how more currency is issued. Also, it is how all members of the network are motivated to take part and control the validity of transactions.
One bitcoin is divisible in 100,000,000 units. Thereby, each unit is identifiable and programmable. Features assigned to each unit do not only imply monetary value. They can represent shares in a company or digital ownership certificates, among others.
In late 2016, the total size of bitcoin’s blockchain ledger has surpassed 100 GB of data. The overall value of the bitcoin in mid-December 2017 was estimated at almost 250 billion dollars. However, there are thousands of other cryptocurrency platforms – Ripple, Ethereum and Litecoin, to name just a few.
What does the future hold for cryptocurrencies?
The future is difficult to predict, as expert opinions vary on this subject. They range from those who describe it as an economic bubble destined to crumble. Many are also voicing concern that cryptocurrencies could irreparably damage global economy. On the other hand, there are those who believe cryptocurrencies will steadily be incorporated into traditional ways of handling our finances.