Understanding blockchain technology

Blockchains can allow people to exchange value and verify information online. But instead of using a central third party to process everything behind the scenes, blockchains run on “distributed” global networks of computers, known as nodes, that collectively maintain the integrity of the system.

Think of a blockchain as a digital ledger – one that’s updated in real time after each transaction. This opens the door to some technological improvements – like faster and cheaper transactions, more efficient cross-border payments, increased transparency and security, and clearer asset ownership rights.

Blockchain technology was officially introduced to the public with the publication of the Bitcoin Whitepaper¹ on October 31, 2008 but many of the technologies that form its basis such as cryptography, date back several decades.

The paper solved a complex problem that engineers had been grappling with for a while: how to create trust in a digital world to securely transfer electronic money peer to peer, without relying on intermediaries.

On January 12, 2009, the first transaction was completed – a transfer of 10 bitcoins (the digital currency, with a lowercase “b”) – across the Bitcoin blockchain. From that point on, blockchain has evolved beyond cryptocurrencies with innovators exploring its potential for applications across other sectors. 

The easiest way to understand blockchain technology is by comparing a bitcoin transaction with a regular digital payment between two bank accounts. 

If participant A sends $10 to participant B’s bank account, their banks will talk to one another and each will update their records to show that A’s account has $10 less and B’s has $10 more. 

Both banks will use various checks and balances to make sure they are processing the payment safely and securely. 

Bitcoin takes a different approach: a vast network of bitcoin “miners” take care of it. When someone sends bitcoin from their wallet to another person’s wallet, that transaction is bundled with other ones into a “block”. 

That block gets encoded into an extremely complex cryptographic puzzle, which can only be solved by powerful computers running bitcoin mining software. 

Miners compete to solve the puzzle as quickly as possible, and the fastest one attaches the block of transactions to the blockchain. 

For their efforts “confirming” the block, the miner earns freshly minted bitcoins – along with all the transaction fees of the block. 

As more blocks are added, the transaction is embedded deeper into the blockchain. And after six blocks, it’s trapped on the blockchain forever: it becomes increasingly difficult to reverse the transaction. Even with just one block, they’d need more than half the computing power of the entire Bitcoin network to reverse the above transaction – and that’s no easy feat.

Bitcoin’s confirmation process, or consensus mechanism, is called proof-of-work (PoW). This is the method used by most earlier blockchains to secure and process transactions, but it’s been criticized for its enormous energy cost as it can take a lot of computing power to solve all those complex puzzles. Because of this Bitcoin miners often times will use more sustainable and off-grid energy sources. 

There are many other blockchain validation processes and some don’t use mining at all. A popular example is that of proof-of-stake (PoS).

With PoS, “validators” secure transaction blocks by “staking” crypto as collateral – they front their own coins for set periods of time to verify transaction blocks and if a validator attempts to confirm a fraudulent transaction, they risk losing their staked tokens. 

Ethereum was a PoW blockchain up until September 2022, when it switched to PoS in an event dubbed “the merge”. It’s now suspected to utilize about 99.9% less electricity than it did before.

Blockchain has evolved over the years from performing simple bitcoin transfers to more complex exchanges of value and information. That’s all thanks to smart contracts: programmable rules that developers can tag to blockchains like Ethereum. 

Those blockchains serve as base layers that developers can use as a foundation to build a range of decentralized applications (dapps). This has led to more advanced use cases, which run autonomously on the blockchain. Some of the highlights include:

• DeFi (decentralized finance): where you may exchange, lend, or borrow tokens. 

• NFTs (non-fungible tokens): unique digital assets that represent ownership or proof of authenticity.

• Blockchain games: online games where you may use and earn digital assets and NFTs.

• Blockchain data storage: where data is stored across a secured blockchain rather than a single data warehouse.

Just like with the internet when it first began, we don’t know what’ll turn up in blockchain’s future. But one of the most anticipated potential uses is security tokens: where the ownership of traditional assets like stocks, bonds, real estate or art might all be stored, settled, and tracked on the blockchain. We are also starting to see financial institutions leveraging blockchain technology for more efficient cross-border payments.

While there are numerous benefits unlocked by blockchain technology there are also some inherent risks worth acknowledging. This is an emergent technology and as such it can be subject to security breaches.

While blockchain is touted for its immutability and decentralization, vulnerabilities in smart contracts, coding errors or malicious attacks can still compromise the integrity of the network.

In addition, the inherent transparency of blockchains could raise privacy concerns and the inability to reverse transactions and lack of standardization may impose challenges for broader user and institutional adoption of public blockchains in particular.