Most people who have invested in or are curious about cryptocurrencies have at least heard of blockchain and Bitcoin and the association with the two, but they don’t understand the connections between them.
Reaching a broader understanding should have positive implications for people interested in cryptocurrency and its future.
What Is the Blockchain, and How Does Transaction Validation Happen?
The blockchain is a digital ledger that exists in a shared and continually reconciled database. Thousands of computers on a blockchain network can see new transactions occuring when Bitcoins or other cryptocurrencies get sent or received. Then, complex algorithms come into play to make a collective decision about the validity of the transaction.
Proof-of-work or proof-of-stake algorithms help reach a consensus. Proof of work shows a substantial amount of effort has taken place. Cryptocurrency miners abide by proof-of-work algorithms by solving computationally tricky math problems. Proof of work is the validation system Bitcoin uses, as well as numerous other well-known cryptocurrencies.
With proof of stake, people have more power to validate transactions as their ownership of cryptocurrency coins grows. And, their motivation to do good work relates to the coins they own. Individuals who fraudulently verify blockchain transactions lose their coins and the right to check future transactions.
With either method, valid transactions get grouped and sealed with hashes, then linked to the previous transactions in that blockchain network. This process adds another block to the overall chain — making it clear how the technology got its name. Once a transaction gets confirmed and added to the blockchain, the information is unchangeable.
The Three Types of Blockchains
Contrary to what some people think, there is more than one kind of blockchain, although they all operate in the way described above.
Firstly, a public blockchain allows anyone to see transactions on it using an interface called a block explorer. Plus, anyone can make transactions on public blockchains. But, there are also private blockchains, and people often argue they defeat the decentralized principle of the blockchain.
A private blockchain typically has one organization or representative overseeing the activities and giving or denying the right to participate. In this case, “consensus” happens based on the preferences of the person or group in charge. Private blockchains also do not allow anyone to see them via blockchain explorers.
Finally, there are federated or consortium blockchains. They aim to remove the concentration of power that’s present in a private blockchain by granting control of those blockchains to several parties. In this arrangement, the applicable entities strive to make blockchain-based decisions for the good of everyone using the blockchain.
There Are Many Blockchain Protocols
Just as there are several types of blockchains, people build them with various purposes in mind. For example, the basis for Bitcoin’s blockchain is the desire for making decentralized payment transactions on a network without using intermediaries.
The blockchain for Ethereum, another cryptocurrency, is for facilitating smart contracts, including those that allow people to pay each other on set schedules. People can also create cryptocurrencies that use the Ethereum blockchain. Those are just two of the many examples.
Why Blockchain Supports Bitcoin
Bitcoin was the first cryptocurrency, and a technology built on the blockchain system. Its arrival helped people see transactions in ways that go beyond their expectations.
One of the things people like most about Bitcoin is that it’s a decentralized form of payment. That means when people use it, they don’t have to do so in accordance with a single establishment — such as a bank — or even a country. As described above, thousands of parties check blockchain entries for validity, making the method of adding entries to the ledger decentralized, too.
The blockchain is the method of verifying transactions of Bitcoins or any other cryptocurrencies. But, advocates for the technology say it’s possible to record any transaction on the blockchain, not just financial ones. Cryptocurrency experts have weighed in to say they believe the blockchain has disruptive potential that could result in the technologies of the future.
The Blockchain Does Not Lead to Untraceable Transactions
Some people mistakenly think Bitcoin transactions on the blockchain are anonymous. Although people don’t have to give their names before initiating transactions, it’s still possible to trace transactions.
Supporters of Bitcoin like how it’s possible to transfer Bitcoin funds to each other without using expensive and time-consuming money-transfer services. Since the Bitcoin blockchain is public, anyone can see the transactions on it, making them potentially traceable.
Some companies even specialize in tracking Bitcoin transactions on the blockchain. They mainly assist with revealing evidence of illegal activity. Notably, though, some cryptocurrencies besides Bitcoin are so-called “privacy coins.” They use technology that hides transaction data.
The Blockchain Is Very Secure
All the computers involved in verifying blockchain transactions keep records of such activities. That means if an entity wanted to hack into the blockchain or change the records on it, it would have to compromise all the applicable machines at once. Doing that is much more difficult than carrying out a traditional attack on a network.
However, known incidences of blockchain hacks exist. In one instance, cybercriminals infiltrated the Ethereum blockchain with a distributed denial of service attack that slowed down the network. There are also cases where cybercriminals steal Bitcoin or other currencies, often by obtaining the private keys associated with wallets.
The inherent transparency of the blockchain has nonetheless made banks and other large-scale entities curious and hopeful about potentially using blockchain technology to verify transactions, reduce fraud and increase supply chain visibility.
Blockchain Technology Is in the Early Stages
Indeed, blockchain technology is what makes Bitcoin transactions possible. However, there is a widespread belief that its potential is much broader.
Only time will tell how blockchain evolves in the future.
Kayla writes about cryptocurrency, blockchain and technology in general. Her work has been featured on The Week, The Daily Dot, Cointelegraph and Bitcoin Magazine. To read more posts by Kayla, please visit her blog: https://productivitybytes.com.