The words blockchain, cryptocurrency, and bitcoin are heard everywhere these days. Investors with an aggressive risk appetite have gained and lost large sums of money in cryptocurrency. Being a highly volatile security, it has raised a lot of controversy in the Indian investment space.
In this post, we will unravel the technology behind the digital currency- blockchain. How it works, its benefits, shortcomings, and also its future scope.
Let’s get into it.
What is Blockchain?
Blockchain is a chain of blocks containing data. Once a piece of data is recorded in a block, it becomes very difficult to tamper with it, making blockchain a highly secure currency network.
Different cryptocurrencies like Bitcoin, litcoin, etherium, etc revolve in different blockchains creating specific databases.
Blockchain is nothing but a large database that keeps on adding new blocks on every new transaction. It is stored electronically and is not owned by an individual, group, or association. This means that it is free to be accessed by many people at once.
Let’s take a very simple analogy to understand blockchain. Imagine you’re in a casino, playing with the chips provided inside. Those tokens don’t hold any value outside the casino, but in it, they are eligible to make large sums of profit or losses. So, here the casino is the blockchain giving you a network to play(trade) with the coins(cryptocurrency) provided inside.
Everyone has access to the casino but few can make profits out of it!
However, it is simply an analogy and not the entire concept. Blockchains are more complex than that.
How does blockchain work?
Blockchain is not a new concept. It was originally thought of in 1991 as a notary stamp, to preserve the authenticity of documents by timestamping them, almost like a notary. However, that didn’t pan out well.
In 2009, Santoshi Nakamoto adapted the concept and created a digital cryptocurrency famously known as Bitcoin today.
The blockchain is a distributive ledger of such cryptocurrencies. Every time a new transaction occurs, a new block is added to this chain of blocks. The anatomy of a block has 3 elements.
- Data- the sender, receiver, and amount traded
- Hash- it is the unique code of every block, like a fingerprint
- Hash of the previous block- every block is attached to one another, making a chain.
This means a small change to one block can severely affect the entire blockchain. To prevent hackers from misusing the blockchains, an additional step of security is established.
Read to find out.
What is Decentralization in Blockchain?
Whenever a new transaction takes place in a certain blockchain, say bitcoin’s chain, it does not directly become a block that can be added to the blockchain. It first, needs to be verified.
Who does this verification? It is government? The RBI? Or a whole other governing body?
It is a decentralized network of computers. This ensures that the control and decision-making are not in one individual or group’s hand but is evenly distributed in a network to eliminate the chance of bias or misjudgment.
This network is connected via scattered ‘nodes’ that verify the authenticity of a new block, before adding it to the chain. It makes blockchain one step more secure for users. In order for a person to tamper with the blockchain, they would have to tamper with all the blocks of the chain and hack every node, which is next to impossible.
The transactions in blockchain are highly encrypted, thanks to decentralization. Lets take a look at some other benefits this technology brings.
Benefits of decentralized blockchain
1. Distributed authority to erase the possibility of error and bias
Decentralization ensures that the blockchain is not governed by an individual, group, or even the government. It is distributed in a systematic digital network so that nobody can meddle with the transactions.
Other securities are managed by specific individuals that lead to a possibility of human error and bias. It also prevents any kind of insider trading to take place in the blockchain.
2. Real-time data reconciliation
All the data in a blockchain is accessed in real-time by the miners and investors, thus leaving no space for data loss or incorrect data. It works much like google docs, wherein you can share the work with multiple people and it can be edited at the same time.
3. Optimum distribution of resources
Any business can face shortcomings if the resources are exhausted, are not incentivized properly, or driven by greed giving way to corruption. Decentralization ensures that the entire blockchain network is evenly spread among various nodes for optimum utilization of resources.
4. Fast transactions
Blockchain transactions are much faster than bank transactions. This is because a whole lot of intermediaries are cut off from the process.
Limitations of decentralized blockchain
1. History of crime
Since this entire currency operates in a digital mode, hackers and dark web users often preferred blockchain as a medium of transactions, giving way to criminal activities. This is why in 2018, RBI banned all banks and NBFCs to trade cryptocurrencies.
However, the ban was lifted in March 2020 by the supreme court owing to the high potential of digital currency.
2. High volatility
Cryptocurrencies in a blockchain face levels of volatility. The prices shoot up one month and significantly fall the other. This may be due to the lack of a governing authority or a specific system that decides the rates of cryptocurrency.
However, industry leaders emphasize buying and hold in the blockchain since its real returns are yet to reap. They believe that digital currency will become the currency of the future and people who have invested in them in these early stages will enjoy high returns.
3. Obstacle for non-tech investors
Decentralized blockchains completely work digitally. Thier transactions are online coded web. This creates an obstacle for investors who are not very tech-savvy.
To invest in the blockchain or not, highly depends on your understanding of this security. Thus, before putting your money in, make sure you understand the mechanisms of blockchain.
Q1. How is blockchain different from bitcoin?
Blockchain is the network on which different cryptocurrencies operate. And Bitcoin is one of those currencies. Every Cryptocurrency has a different blockchain network.
Q2. Is blockchain secure?
No investment avenue is secure. They all come with a share of risk. However, equity and mutual funds, etc are regulated by government authorities. Blockchain, on the other hand, is decentralized and thus faces high volatility.
Q3. What is the difference between blockchains and banks?
Banks are a tangible entity that is regulated by the government. And hence, they are accountable to the user. Blockchains on the other hand are intangible digital networks decentralized among nodes and do not carry accountability.
Q4. Is blockchain legal in India?
There is no law guiding against the use of blockchains. Take for example gold, there is no law to trade in it or not but it still is a viable investment avenue.
Q5. Who regulates the blockchain?
It is not regulated or governed by a single entity. Blockchains are decentralized coded networks.
Disclaimer: Angel One Limited does not endorse investment and trade in cryptocurrencies. This article is only for education and information purposes. Discuss with your investment advisor before making such risky calls.