What is blockchain, where to use it, and what the future holds?
Blockchain is a technology for encrypting and storing data (registry) that is distributed across multiple computers connected to a common network.
Blockchain is a digital database of information that reflects all transactions made. All records in a blockchain are presented in the form of blocks that are linked together by special keys. Each new block contains data about the previous block.
Blockchain is used to store and transfer digital data. It can be either financial or non-financial assets (e.g., images or objects from the video game industry). Blockchain technology allows an asset to be assigned unique information about its ownership by a specific person. This information cannot be tampered with, deleted, or changed unnoticed.
How and when blockchain appeared?
The basic principles of blockchain (distribution and the aggregation of document authenticity data into blocks) were developed back in the early 1990s based on even earlier mathematical concepts. In 1991-1992, American scientists Wakefield Scott Stornetta, Stuart Haber and Dave Bayer described a technology for the sequential creation of blocks of data in which a certificate of authenticity and information about the date of generation are recorded using cryptographic algorithms and a hash tree. But there was no technical possibility to implement this idea in practice at that time.
In 2004, the American programmer Harold Thomas Finney II developed the RPoW system, which is considered a prototype of a cryptocurrency. In October 2008, Satoshi Nakamoto (this is the pseudonym of a person or group of people) in a scientific article about the first cryptocurrency, bitcoin, suggested using blockchain technology to create a decentralized and independent payment system with a limited supply of assets. The development of bitcoin began in 2007 and was completed in 2009.
Blockchain technology became relevant when the need for fast and reliable transmission of digital data emerged.
How does blockchain work?
Blockchain allows everyone in the network to have access to a distributed database. Blockchain does not store the data itself, but records of events (transactions) in their chronological sequence. All new records are authenticated - they must be validated by the majority of the network members before they can be entered into the blockchain. Records are grouped into blocks, which are combined into chains. Once data is on the blockchain, it cannot be altered or deleted without breaking the blockchain's integrity.
Types of blockchain
Blockchain can operate both in a public (open) network to which any user has access and in a private (closed) network, such as a corporate network in the case of sensitive data. Private versions of blockchain can have different levels of access for users and different levels of complexity for encrypting information. The best-known example of a public blockchain is bitcoin and other cryptocurrencies. Corporations use blockchain not only in the financial sector but also in other sectors, such as the entertainment industry (for issuing tickets) and healthcare (to protect patient data).
There are also hybrid networks that combine features of both open and closed networks.
The CB classifies blockchain in various ways:
- By transaction object:
- virtual value (a value whose counterpart does not exist in the "real world" - for example, bitcoin);
by the type of access to the network:
- Unrestricted (networks in which participants are allowed to perform any activity);
- Limited (networks, which restrict the type of activity of the participants);
by identification requirements:
- full identification;
by the network's consensus protocol used:
- PoW (Proof-of-work) - the right to certify a block is given to a participant based on his performance of some sufficiently complex work that meets predetermined criteria.
- PoS (Proof-of-stake) - the right to certify a block is given to an account holder when the amount of his funds and the term of his possession meet the specified criteria. The formulas for calculating the criteria may vary slightly.
- PoS + PoW - a hybrid of PoW and PoS, where blocks can be certified both via calculated PoS criteria and PoW overshoot. The purpose of this approach is to make it harder to recalculate the entire chain (from the very first block), possible when using PoS in its pure form.
- PBFT (Practical Byzantine Fault Tolerance), Paxos, RAFT are algorithms of multistage network consensus establishment. Algorithms of this group allow blockchain to function with small expenses and have significant bandwidth, but are weakly stable to increase the number of participants.
- Non-BFT (Non Byzantine Fault Tolerance) - consensus algorithms, unstable to the behavior in which some participants start to work against the network. Such algorithms are applicable to closed networks with full identification.
By the presence of a central administrator:
- There is a central administrator;
- There is no central administrator.
Where blockchain is used?
Blockchain is used in all areas where rapid transfer of information with a high degree of protection is needed. The technology is used to launch and operate cryptocurrencies and digital currencies, in smart contracts for goods, in the generation of non-fungible tokens (NFT), in banking and legal industries, in network administration and in the gaming industry. Blockchain technologies are used by government agencies (e.g., for conducting and processing referendums and votes), public and nonpublic corporations, public organizations, and private individuals.
Any cryptocurrency functions based on blockchain technology. The technology is used when issuing new cryptocurrencies, generating new tokens (coins), and settling existing ones. There are more than 300 cryptocurrency projects in the world now. The most popular, in addition to bitcoin, are Ethereum, Ripple, Tether, Litecoin and Dogecoin.
Payments in cryptocurrencies are used by PayPal and Square payment systems and one of the largest international banks, JP Morgan. Cryptocurrencies tend to be highly volatile. There are specialized cryptocurrency exchanges for investing in cryptocurrencies.
Some countries around the world are launching pilot projects to create national digital currencies based on blockchain technology. China has achieved high results in this regard, with the digital yuan becoming the first digital currency to be adopted in a major global economy.
Central bank digital currencies (CBDC) were also launched by the Central Bank of the Bahamas (sand dollar), the Eastern Caribbean Central Bank (DCash) and the Central Bank of Nigeria (e-naira). Plans to issue their own national digital currencies have been announced by the governments (or central banks) of the Netherlands, Japan, Russia, Kazakhstan and Ecuador.
Blockchain technology enables smart contracts. Smart contracts are fully digital contacts whose information is protected by encryption. Their key difference is the automatic control and fulfilment of contract clauses. When the conditions are met, the contract is completed automatically, without any additional actions or legal involvement. Smart contracts allow you to track the entire supply chain, which reduces or completely eliminates the possibility of product counterfeiting or illegal actions with it.
NFT is a type of token where each instance is unique and cannot be replaced or exchanged for another token. NFT indicates ownership of an asset on the blockchain and allows the sale and purchase of virtual objects: music, photos, paintings, drawings. According to the statistics of the analytical portal NFTgo, the capitalization of the NFT-market is almost $22 billion.
Another application of blockchain is the gaming industry. Based on cryptocurrency technology, GameFi-projects (from "game" and "finance"), which combine game mechanics and NFT, are implemented. These online games record everything that happens in transactions on a blockchain and allow players to earn real money. Virtual characters and artifacts can be purchased and sold using the blockchain.
DeFi and more
Blockchain technology is being used in the emerging decentralized finance (DeFi) market. Investors are also beginning to invest in new types of digital assets, such as security tokens.
Who are the miners
Blocks are added to a blockchain network, such as when cryptocurrencies are issued, by means of mining - the collection and processing of information about the transactions that take place.
Large blockchain networks require significant computing power to do this, so block creation is done by special people - miners.
What is a blockchain wallet?
A blockchain wallet is a special program that allows you to account for, store and perform other actions with digital assets, in particular with cryptocurrency. When registering a wallet, a person gets access to it in the form of an open (public) and a closed (private) key - a cryptographic code. The wallet keeps records of its owner's account status and all transaction history. At the same time, cryptocurrency is not stored directly in the wallet, it only contains information about the public and private keys, and the coins themselves are stored in the blockchain. More often than not, blockchain wallets are anonymous.
Decentralization and distribution?
Decentralization and decentralization are both advantages and disadvantages of blockchain technology. Information is stored simultaneously on all devices in the network; there is no single centre for data management and storage. Data changes on each individual device occur independently but are captured by the rest of the system.
All transactions are almost instantaneous but may take some time to confirm, depending on the algorithm of the blockchain network. All asset transactions are confidential, only the wallet number is specified, and commissions are minimal because instead of centralized intermediaries, transactions are recorded by miners.
The disadvantages of decentralization are the need for multiple participants in the network to maintain its integrity and stability, as well as the cost in terms of computing power.
Is blockchain technology reliable?
Blockchain technology is relatively reliable, but it's not without its vulnerabilities. Despite its decentralization and distributed nature, hacker attacks are risky. There is also the possibility of users with high computing power colluding to make changes to the blockchain. In addition, there is the risk of loss of assets due to Internet fraud. And the loss of a private hash key to access a blockchain wallet actually results in the loss of assets, i.e., a direct loss of funds.
Advantages and disadvantages of blockchain
The main advantages of blockchain are its decentralized and distributed transparency and the impossibility of changing or destroying information within blocks.
The disadvantages of blockchain include the poorly developed regulatory and legal framework in the vast majority of countries in the world. This leads to attempts by regulators to control blockchain transactions, even to the point of banning cryptocurrency circulation (for example, the Chinese authorities did this). Regulators usually explain their actions by the risk of fraudulent schemes when exchanging digital assets for real money due to the anonymity of transactions. Another disadvantage of blockchain is the irreversibility of transactions.
Digital assets, especially cryptocurrencies, are also highly volatile, which can lead to a total loss of funds.