Blockchain, the underpinning technology that maintains the transaction ledger for bitcoin, has revolutionized the way information can be shared on the internet because the data can't be altered or deleted.
Bitcoin is probably the most widely known application of blockchain, however that's just the beginning. Blockchain technology can be used to reduce costs, speed up transactions, and improve data security for financial institutions, health care providers, businesses, and more. That's good news for consumers and investors. Although blockchain technology hasn't yet been widely adopted, it has the potential to dramatically change the way we do business by offering a trusted, cryptographic system for exchanging information.
What Is Blockchain?
Blockchain gets its name from the way in which it stores transaction data—in blocks linked to form a chain. Blockchain and bitcoin were introduced together in 2008 in a white paper titled "Bitcoin: A Peer-to-Peer Electronic Cash System."
Think of a blockchain as a book containing a list of transactions that all members of a group, or network, need to see. Every member or "node" of the network has their own copy of the book. Each page of the book is a "block" of data. Every page of the book is identified by a unique page number called a "hash," and the first entry on each page is the "hash" of the previous page. That first entry is the "chain" that links the pages or "blocks" of transactions together.
Bitcoin and blockchain are not the same thing. Bitcoin is a type of unregulated digital currency whose transactions ledger is maintained by blockchain technology.
How Does Blockchain Work?
- Every copy of the blockchain, or "book," must be identical. All members have the same information.
- New blocks can only be added if the majority of network nodes, or "members," agree that the information contained is valid. The process is called a consensus mechanism.
- When a new copy of the blockchain is distributed, each member compares it with the old copy. If all the historical blocks in a new copy don’t match, the existing copy’s members will not accept the new copy.
All members, or nodes, are continually processing transactions into new blocks of data. When a new block is filled, each node in the network has to independently verify that the block is valid by using a complex mathematical formula. The new block is only added to the chain when members agree that the block is valid via the consensus mechanism.
This comparison process is why blockchain transactions can’t be changed. The hefty computing power required for multiple members to solve complex mathematical puzzles for verification is another way to inhibit fraud and hackers.
A beginner’s guide to blockchain technology explains the distinctive checking process. “Machines with identical copies of the ledger ‘team up’ to solve the puzzle they’ve been given. The first team to solve the puzzle wins, and all other machines update their ledgers to match that of the winning team. The idea is that the majority wins because it has the most computing power to solve its puzzle first.”
After validation, a new copy of the blockchain is then distributed to each member.
Blockchain and consensus are used for bitcoin and other cryptocurrency networks because the technology prevents "double spending." No one can keep a bitcoin once it has been spent; it moves from the sender on to the recipient. The transaction can’t be changed or undone, because the data blocks can't easily be altered by hackers.
The original paper introducing blockchain in 2008 envisioned the process as follows: “We proposed a peer-to-peer network... to record a public history of transactions that quickly becomes computationally impractical for an attacker to change if honest nodes control a majority of [central processing unit] power.”
Blockchain can also work with protocols, or rules, that make the data useful. Smart contracts are protocols used with blockchain to automate a series of transactions based on the terms, like purchase orders, invoices, and payments. Smart contracts are a powerful tool because they reduce transaction errors, processing time, and administrative overhead. That translates to lower cost and higher profits for users.
Types of Blockchain
A public blockchain is public, and members are anonymous. Anyone can join the network, process transactions, and validate blocks, providing they have the substantial computer resources required. All members of a public blockchain can see all of the data.
Members of a public blockchain network, like the one that supports bitcoin, use “miners” for the consensus mechanism. Miners are members who validate data blocks on the public network. Miners compete with other miners to validate data blocks by solving complicated mathematical equations.
Public, or “permissionless,” networks are used for cryptocurrency because transactions are direct between the parties without a financial intermediary, like a bank. The anonymous nature of the transactions, however, does attract criminal activity. One 2019 study estimated that 46% of bitcoin transactions, or $76 billion per year, involve illegal activities.
Blockchain miners are awarded bitcoin or other cryptocurrency for validating transactions.
A private, or “permissioned,” blockchain requires that all members be identified and need credentials, or permissions, to submit transactions and validate data blocks. A private blockchain may give access to all data to some users while restricting others. Private blockchains are more suitable for an individual business.
Can Blockchains Be Hacked?
Blockchains are difficult to hack because every member has a copy of transactions, but they are not completely impenetrable. Hackers need to gain access to multiple individual members in order to create fraudulent transactions and have them accepted. The vast computing power required alone makes hacking blockchains very difficult and expensive.
The real weakness lies in the protocols, such as smart contracts. Hackers can potentially exploit a weakness in the way these operate and “game” the system.
- Blockchain technology hasn’t been widely adopted yet, but it has the potential to dramatically change how we do business in a variety of industries.
- Blockchain transactions can’t be altered.
- Blockchain is the technology that makes bitcoin and other cryptocurrencies possible.
- Blockchain is secure, but not “unhackable.”