While blockchain technologies are not all that new this past year has generated a lot of buzz and chatter in the cryptocurrency and the blockchain space. Much of the mainstream interest in blockchain technology has stemmed from the blistering investment market for cryptocurrencies. Bitcoin hit a record price of nearly $20,000 in December 2017 (before declining substantially just days later).
The decline in cryptocurrency markets did not result in a decline in technological development. Fundraising for initial coin offerings (ICOs) reached $6.3 billion in the first quarter of 2018 alone. The technological development has continued despite the decline in public interest.
Whether you are interested in cryptocurrency investment or you just want to understand how blockchains work, this article will discuss four of the core principles behind blockchain technology. In order to be useful to most people, we will provide a general overview without getting too specific in terms of individual cryptocurrencies or technical details.
It is important to distinguish between bitcoin and blockchain, which are related but quite distinct concepts. Bitcoin is merely one of many cryptocurrencies that are built on blockchain technology and it is the cryptocurrency that has received by far the most mainstream attention and investment. Blockchain is a digital ledger in which transactions are made and recorded. We will discuss blockchain independently from any cryptocurrencies that use it.
1. Distributed Databases
At its core, blockchain technology relies on the creation of peer-to-peer distributed networks, which do not require a central authority to facilitate transactions. Network participants, which are known as “peers,” are able to interact and transact directly with one another.
All of the transactions between peers are recorded on a continuous ledger. Each network participant maintains their own separate and identical copy of this ledger. This means that the greater the number of peers participating in the network, the more redundant and more secure the ledger becomes.
Peer-to-peer distributed networks are decentralized by design, with no central server or authority. The records of the blockchain exist nowhere and everywhere at once, which means they have no single point of weakness or vulnerability common in traditional databases.
2. Transaction Speed
Suppose that you want to wire money between your bank accounts at Wells Fargo and Bank of America. While the banks create the illusion, this is far from an instantaneous process. In order for the transaction to occur, both independent systems must settle and verify it before it can go through.
Banks typically place temporary holds on your funds (visible and invisible) while processing a transaction. In addition, because banks are for-profit businesses, the act of processing a transaction carries an inherent cost that may or may not be visibly passed on to the customer in the form of a transaction fee.
On the other hand, the decentralized nature of the blockchain creates an open environment on a singular system in which transactions can be processed without the need for a third-party authority. Peers can directly submit transactions to other peers on the network in real time, dramatically improving processing speeds and reducing the risk for fraud.
3. Security and Immutability
The fact that blockchain ledgers are distributed among many different peers makes security paramount. Fortunately, most blockchain networks have been built from the ground up with security and consensus in mind.
Although different blockchains approach the question of security in different ways, most networks use the same general formula. The most recent transactions are bundled into a “block” that must be verified and accepted by the network in order to be added to the existing chain. Once added they become the basis for all blocks that follow.
The security of blockchain ledgers stems from two key features. First, new blocks cannot violate the stringent specifications and criteria established by the network. Second, previously accepted blocks cannot be changed or modified, as this would violate the network’s consensus algorithms and invalidate all subsequent blocks.
In other words, transactions must be valid in order to be settled on the blockchain and accepted by the network. Once present on the blockchain, transactions are immutable and irreversible.
When you write a bank check and use it at a store, the cashier must have three levels of trust in order to accept it:
- First, the cashier must trust that you are not using a counterfeit check and that you have adequate funds in your checking account.
- Second, the cashier must trust that the financial institution issuing the check will transfer the funds as promised.
- Third, the cashier must trust the government that issues the currency in which the check is written, believing that the funds have value and can be spent.
The blockchain removes the need for peers on the network to trust each other because it has inherent protections against fraud. Transactions cannot be made and reversed later on when the network discovers that there are not adequate funds to complete them. Because the network knows the balance of each peer in advance, unsubstantiated transactions will not be processed or authorized.
As a result, blockchains are “trustless.” Participants need to have trust in the blockchain and its immutability, but trust does not necessarily need to exist between peers themselves in order for the network to function.
These four important principles enable blockchain technology. While these principles make the blockchain extremely well-suited for applications such as cryptocurrencies they also provide a robust platform for a variety of other business use cases.
We believe that blockchain technology is tremendously exciting: it has the potential to not only transform existing processes but also create new opportunities and innovations. As the frenzy around the cryptocurrency market subsides, we expect that businesses will pay more attention to applications and capabilities of the blockchain technology in industries such as real estate, finance, healthcare and manufacturing.