Unless you’ve been living under a rock for the last decade, chances are, you’ve come across the term “blockchain” in the context of cryptocurrencies, or in some cases, even banking. You might know that blockchain is the technology that is used by Bitcoin, the cryptocurrency that has taken the world by storm since 2008. Have you ever wondered what’s so special about blockchain technology, how it functions, or its different applications?
Look no further, as we’re going to decode everything you need to know in a single space.
What is Blockchain?
The concept as a whole can be overwhelming, but the fundamentals are fairly simple to understand. Before going into what blockchain means, it is crucial to understand what a database is and how it works. According to Oracle, a database can be defined as an organized collection of structured information, or data, typically stored electronically in a computer system.
If you further delve into the linked article, you can find details on the different types of databases, how each type of database works, and how it can be used for various purposes. But in order to understand blockchain, all you need to know is the fact that databases are usually an electronic and organized way of storing data, usually in a tabular format.
Blockchain is a very specific type of database that has a unique way of storing information. The data in a blockchain is structured differently when compared to a typical database. The information is gathered in groups called blocks. Each block has a predefined storage limit, and once filled, it will be chained with the previously filled block. When new data is presented, a fresh block is created, within which the additional data is compiled, which is added to the chain. This creates a virtual chain of blocks and, thus, is called “Blockchain”.
Blockchain can be used for many purposes (we’ll take a look at the applications of blockchain technology in detail later), but the most widely used application has to be in cryptocurrencies.
Over the course of time, since the advent of the Internet, a significant amount of entities – governments, private companies, or even enthusiastic groups of software engineers, have attempted to create a virtual currency as an alternative to fiat currency (legal tender money that we use, like the INR, USD, EUR, etc.). However, there’s an issue of trust that has always prevented these attempts from succeeding.
To explain with an example, consider that a popular tech company has created a currency called JSL. The company promises that JSL is valued equivalent to 200 INR and can be used as an alternative to regular currency. If the company uses a normal database system, say SQL, to keep a record of the money, there is no guarantee to the users that the company won’t illegally alter the records to increase or decrease anyone’s account balances. They may even choose to give themselves a billion JSL and thus ruin the integrity of the coin.
Even in the case of fiat currencies, the government may choose to print more money as and when necessary, something that’s happened quite a lot throughout our history. This causes the value of the currency to decrease, and this decrease in value is what is called inflation in economics.
Blockchain technology, on the other hand, is decentralized. There is no single person in charge of a blockchain database.
“But, how do we resolve disputes?”, “If nobody’s in charge, anybody can alter data to their advantage, right?” Some common questions that everybody has when they hear that cryptocurrencies, and blockchain in extension, are decentralized.
While it is true that no single entity is in charge, this problem is solved by something called the P2P (Peer to Peer) environment.
How is Blockchain Decentralized?
Blockchain, as mentioned earlier, takes advantage of a P2P network. The way it solves the problem of having nobody in charge is by making everybody in charge. Doesn’t make sense? Let us elaborate.
Say there were only 100 people in the world. They decide to take advantage of the blockchain network to create their own cryptocurrency. Let’s call it Pitcoin. All 100 people will be a part of the network, and each of them will be a part of the common blockchain. Once a transaction is verified, it will be entered in the block, sealed shut with an immutable (unchangeable) cryptographic signature called a hash. A copy of this version of events stored in the blockchain would then be distributed to all 100 people in the network.
Let’s say that one person with malicious intent tries to give himself 200 pitcoins, taking them off from innocent bystanders. After a lot of hard work, he manages to hack his version of the blockchain and give himself the 200 pitcoins. However, after he changes his balance, his version of events will be different from everyone else’s version of events and can easily be pinpointed as the malicious chain, and this chain would be cast away as illegitimate. Now extrapolate this to the real world.
Thus, by taking advantage of P2P networks, blockchain has solved the problem of decentralization and can remain trustless (there is no necessity of trust for the system to operate).
Advantages Of Blockchain
- Highly Accurate
Blockchain networks eliminate the necessity of a human being in the verification process, and as a result, eliminates human error. Even if computational errors happen in one part of the network, the error would not be reflected in the blockchain as a whole, for the same reasons as to why the hack mentioned earlier is impossible.
- Eliminates Middlemen
Usually, for any transaction to occur, the cost associated with middlemen are significant. Whether they be banks for international transactions, payment gateways for processing a sale, lawyers in case of contracts, etc., middlemen have played a significant role in the traditional system, and thereby making up for a substantial portion of costs. However, with blockchain, as the transactions occur in a P2P network, direct transfer and verification are possible, eliminating the need for middlemen and the associated costs.
As mentioned earlier in the “how is blockchain decentralized” section, the data entered is extremely secure. Bitcoins can definitely be a practical testament to the security aspect of Blockchain, as Bitcoin cannot be faked, hacked, or double-spent (the same bitcoin can’t be spent twice). By spreading the data across the network as a whole, rather than storing it in a centralized location, it becomes practically impossible for the database to be tampered with. Even if some computers in the network are destroyed, it is practically impossible to physically tamper with more than 51% of the computers in the network, especially for a network the size of Bitcoin.
By eliminating middlemen, along with decreasing the overall cost, blockchain also improves the efficiency of transactions. In the case of currencies, international settlement can take days and often are subject to holidays and other availability related issues. On the other hand, the blockchain enables direct transfer of money, and a transaction that would have otherwise taken days can be completed within minutes.
- Privacy and Transparency
Though every member has access to the blockchain’s data, the data is encrypted and is completely pseudonymous. Though the transactions are available for everyone to see, only the public key is recorded, instead of personal information in the case of Bitcoin, making these transactions extremely private.
On the other hand, most blockchains are entirely open-source. Every person can view the code, regardless of whether they actually take part in the network. Anyone can suggest changes and upgrades, but they will take place only with the consent of a majority of people in the network.
Disadvantages of Blockchain
There’s no such disadvantages for the world’s most innovative technology. But here are a few, which can be easily taken care of.
- Technology cost and resources
Despite saving money on transaction fees and the like, the system that is used to validate transactions is costly. Especially in the case of Bitcoin, the “Proof of Work” system uses significant computational abilities. According to forbes.com, the cost to mine 1 BTC can range between $5000 and $8000. To make this worthwhile, the miners (those who use computational powers to validate transactions using this “proof of work” system) have to be rewarded appropriately.
Being one of the most secure databases comes at the cost of speed. Bitcoin, for instance, can validate only 7 transactions per second. This pales in comparison to legacy databases, such as Visa’s ones, for instance, which can process over 1,700 transactions per second. However, developments are being made on this front even as you read, with Ethereum 2.0 reported to be able to handle over 100,000 transactions per second.
- Abuse of Privacy
While blockchain does offer privacy, and in the case of Bitcoin, pseudonymity, there are cases in the history of blockchain where people have abused this aspect of the technology for illicit purposes. The most infamous example of Bitcoin being the main currency in the silk road has given Bitcoin and blockchain a bad image, temporarily harming adoption rates.
While it is indeed true that the most popular application of blockchain technology is cryptocurrencies, the technology can be used to achieve a number of purposes. In the case of cryptocurrencies, the blockchain database is used as a digital ledger to store transactional data. It can also be theoretically used to store a wide variety of data. This can include real estate data, health records, inventory records, among many, many others. Let’s take a look at some of the potential disruptions that can be caused by blockchain technology.
- Banking and Finance
This has to be the obvious sector on the list, apart from cryptocurrencies. Due to the 24/7 availability of blockchain, compared to the traditional financial institutions, transactions that could take days could be settled in a matter of minutes. DeFi (or Decentralized Finance) has already been causing disruptions in the finance world, enabling cheaper and extremely secure trades possible without requiring a central authority.
Hospitals can optimally use blockchain to store confidential medical data securely, with full confidence that they can’t be tampered with. With medical data present in a blockchain, patients can be extremely confident that their records will not be altered while maintaining privacy.
- Real Estate
One of the most common disputes in the real estate sector surrounds ownership, where, in some cases, it can be nearly impossible to trace ownership. The current system used to register ownership is highly inefficient and involves a lot of middlemen. However, all this would be eliminated if blockchain is utilized in the field.
- Smart Contracts
Smart contracts are already utilized by DeFi exchanges operating on cryptocurrencies such as Ethereum. Smart contracts are essentially contracts built into the blockchain, and when the laid down conditions are met, the transaction is carried out automatically. This eliminates many hassle and middlemen such as notaries, arbitrators, and attorneys, among others.
These are just a few examples of sectors in which blockchain can be used. Other areas of note include automobile, education, and food – where the idea of utilizing blockchain is experimented with.
Blockchain technology has caused a massive disruption in our day-to-day lives and soon would be an integral part of our lives. Hopefully, this guide gave you a thorough understanding of the basics of blockchain.Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.