What is Blockchain, and How is it Used in Cryptocurrency?

6 mins read
by Angel One

Blockchain or blockchain technology is a much-heard word in recent years while investing in the crypto spectrum. However, not many people are as aware of the nuances of this term and its origin and usage. This reading focuses on the blockchain and how it powers a cryptocurrency.

Defining Blockchain 

Blockchain technology is basically a system of recording information in such a way that makes it extremely difficult or next to impossible to change, hack, or cheat the system. It is a chaining technology, which means every step is closest related and dependent on the previous one.

A blockchain is an essential digital ledger of transactions. It is duplicated and distributed across the entire network of computer systems on the blockchain, which keeps the record of every transaction.

Each block in the chain contains several transactions. Every time there is a new transaction on the blockchain, a record of that transaction is added to every participant’s ledger at the same time to avoid cheating.

This decentralized database managed by multiple participants is known as Distributed Ledger Technology (DLT). Blockchain is a type of DLT, where transactions are recorded with an immutable cryptographic signature called ‘hash’.

In other words, if one block is changed anywhere in the world, it would be immediately apparent that there is tampering within the system. If hackers want to corrupt the blockchain system, they will need to change every block in the chain at the same time.

This task is apparently impossible, thanks to the anonymity in the network, across all of the distributed versions of the chain, which is spread across the globe.

Powerful and oldest blockchains such as Bitcoin and Ethereum, constantly and continually growing as blocks globally, are being added to the chain, which significantly adds to the security of the ledger.

Properties of DLT

* Programmable: A blockchain is programmable, which means smart contacts. * Secure: A block is secure as all the records are individually encrypted.

* Anonymous: The identity of participants is either anonymous or pseudo-anonymous. It is one of the biggest and debated features of blockchain.

* Unanimous: All network participants agree to the validity of each record at a particular time. * Time-bound: The transactions in the blockchain are time stamped.

* Immune: Any validated record on the blockchain can not be reversed or changed.

* Distribution: All network participants have a copy of this ledger to make it completely transparent.

Buzz of Blockchain Technology

History shows that there have been multiple attempts to create decentralized digital money, which never yielded success thus far, until late 2008, when the first-ever encrypted currency or cryptocurrency came into existence, which is known as ‘Bitcoin’.

Every legal tender or modern-day currency works on the trust factor. Users of a particular currency know that the central bank or the government of the particular territory is backing the currency, which gives value to it. If the government withdraws its support, a currency bill is as good as another piece of paper.

The prevailing issue in digital currency is trust. If anyone creates a new currency named ‘ABCD’, then the question arises that how can anyone trust? They would not give themselves ample of a particular currency or steal the user’s currency for themselves, or share of the user will remain the same throughout?

The design of Bitcoin tries to solve these problems by using a specific type of database called a blockchain. Also, only 21 million bitcoins can be mined, which means if a user holds one bitcoin, his share will remain 1/21,000,000 as long as he retains the bitcoin.

In most normal databases, someone in charge can easily change the entries. Blockchain is different as it has no central authority, and everyone is treated equally. Thus the given shares remain constant forever as the initial details or backdate information can not be changed.

Let us understand it another way if a government wishes, it can print as much as the domestic currency in the economy as much as they want. These practices might appear alluring, but the excess of supply will add to inflation in the economy.

It means if one has $1,000 out of $100,000 in the economy. The share of currency holders in the economy is 1%. However, if the authority doubles the currency to $200,000, then the shares of $1,000 will reduce to 0.5%, decreasing the power of the currency.

Blockchain addresses the problem as no mining can be done, once the maximum supply is reached and the shares remain constant. What’s more, bitcoins or blockchain-backed coins cannot be faked, hacked, or double-spent. So people that own this money can trust that it has some value.

Disadvantages of Blockchain

Not everything is hunky-dory in blockchain technology as it has its challenges, which need to be addressed significantly. The roadblocks to the application of this new-age technology are not just technical. They are real-life challenges, which may pose a severe threat to the economy.

Some of these challenges are political and regulatory, to say nothing of the thousands of hours of custom software design and back-end programming required to integrate blockchain into current business networks.

* Cost: Blockchain may save the transaction cost, but the technology is not free yet. The ‘proof of work’ system used to validate transactions, consumes a lot of energy and computational power.

In the real world, the power from the millions of networked mega computers on the bitcoin blockchain is equivalent to the annual power consumption of several European nations. If the electricity costs of up $0.05 per kilowatt-hour, mining costs exclusive of hardware expenses can shoot up to $7,000 per coin.

Despite the higher cost, users continue to validate the transactions on the blockchain as they get rewarded for it. The blockchains that do not use cryptocurrency, still need to pay the miners or be incentivized to validate transactions.

However, various solutions have popped up to solve this problem. There are multiple blockchains, which are boasting as many as 50,000 transactions every second.

* Legality and misuse: Blockchain might be ‘hack proof’ and ‘duplicacy proof’ technology, but it also allows illegal activities on the network. Many activities on the dark web are done, whose legitimacy is always suspected.

It gives anyone access to financial accounts but also allows easier transactions to criminals. The users are kept anonymous, which makes their tracing impossible. Such mediums of exchange can also be used in terrorism.

* Regulatory issue: Many global governments have raised their concern about the crypto space and cryptocurrencies. However, they could not stop the bitcoin or ethereum network from growing.

Governments can theoretically make it illegal to own cryptocurrencies or participate in their networks. But their decision is being challenged on various legal platforms.

Another concern is that by shifting to such decentralized or anonymous currency, the government will make its central bank weaker, which thus far has a monopoly on the currency used in a particular currency. Hence this is a grave threat to the economic stability and survival of the country.

The road ahead

The history or the roots of blockchain technology is dated back to the early 1990s. It has been a three-decade-old concept, and the people born in that age have accepted it fast. However, the technology, its use, and accessibility are still under public scrutiny over the years, particularly in recent years.

This new-age technology has immense potential, and businesses worldwide are speculating about its capability and where it’s heading in the years to come. Blockchain, as a technology, is gaining acceptance.

Not just bitcoin or Ethereum, with many practical applications for the blockchain technology already being implemented and explored, it stands to make operations more accurate, efficient, secure, and cheap, only if the given challenges and legitimate issues are solved.

Blockchain is possibly the future of the currency or medium of exchange. However, the question has not shifted from ‘if’ to ‘when’.


Disclaimer: Angel One does not endorse investment and trade in cryptocurrencies. This article is only for education and information purpose. Discuss with your investment advisor before making such risky calls.