A blockchain consists of a ledger, that’s responsible for the storage and display of data, and a consensus mechanism. The latter allows new data to be added in a fair way, without the need for a central authority to approve this. Two very popular consensus mechanisms are proof of work (PoW) and proof of stake (PoS). These are used by Bitcoin and Ethereum, respectively. Do you want to learn more about the consensus mechanisms above and how blockchain works? Or perhaps you want to learn all about the advantages, disadvantages, and applications of blockchain. Either way, the complete article below tells you all you need to know. But what is the blockchain? You may have read about different types of blockchains too, with specific applications outside of cryptocurrency. Understanding how the blockchain works is important, especially if you’re interested in learning more about one of the most significant new technologies of the recent era. In this article, we’re going to talk about what the blockchain is, how it works, explain its uses, and go into deeper detail about this revolutionary technology.
What is Blockchain?
A blockchain is a decentralized database that records information in a chain of digital blocks. Blockchains are often used to record transactions, like a ledger, but they can be used for storing data of any type. The most important differentiating aspect of a blockchain database, as opposed to a “traditional database,” is its decentralized nature. Blockchain networks rely on different nodes (servers), which are usually run by volunteers and/or stakeholders around the world. For instance, the Bitcoin blockchain works the way it does thanks to over 10,000 volunteers who run a node. Every single one of those nodes hosts the entire blockchain. Below you’ll find an easy-to-understand visual representation of a blockchain. The lack of a central authority ensures that no single party can unilaterally manipulate the blockchain in any way. In fact, once a block of data has been verified, it’s very difficult to alter it. This can only happen if a majority of the blockchain network participants agree, or if a so-called fork (a split) occurs. The above has to do with blockchain’s second-most distinguishing feature: its structure. Often, we structure our data in a table, such as a spreadsheet. The blockchain doesn’t work like this; it’s just a series of blocks. These blocks are strung together chronologically. The most recently executed transactions will end up in a block, and only new ones can be added over time.
How Does Blockchain Work?
Blockchains essentially follow the same technical concept. They consist of, at the very least, two important mechanisms: a digital ledger and a consensus mechanism. Below we’ll explain both of these in more detail.
The ledger
For the explanation of distributed ledger technology, we’ll focus on a crypto ledger. In other words, we’ll discuss the ledger as it pertains to blockchains that are used for crypto transactions, since it’s the most common use of blockchains today. Just like a real-life ledger, a ledger in blockchain terms is a (digital) collection of financial accounts. It contains information about every single wallet address that has interacted with the blockchain, including their crypto balances. It also stores every transaction that has ever been executed on the blockchain. The ledger can be consulted by anyone but changed by no one (unless network participants agree). This is what makes the blockchain so transparent and trustworthy.
The consensus mechanism
The consensus mechanism is what determines whether a certain action or transaction has been executed. In other words, it’s what verifies that both parties have held up their end of the bargain. The efficiency of a blockchain’s consensus mechanism is the main factor that determines how scalable it is. If a blockchain’s consensus mechanism can verify transactions quickly, it can process more transactions per second, thus making it more scalable. There are different types of consensus mechanisms. The two most popular ones are “proof of work” and “proof of stake.” The proof of work mechanism employs so-called “miners.” Miners can “win” the right to verify transactions and update the blockchain by proving they have expended enough computational power. They do so by deploying said computing power to solve a series of complex equations to find a hash, which is a long string of alphanumeric characters. The proof of stake system relies on so-called “stakers” instead. These are network members who earn the right to update the blockchain by staking (a part of) their assets. We will now discuss both of these consensus mechanisms in more detail.
Proof of Work (PoW) vs. Proof of Stake (PoS)
Different blockchain platforms use different consensus mechanisms. For instance, Bitcoin uses the proof of work system, while Ethereum opts for proof of stake. Below, you’ll find a brief diagram explaining both, followed by a detailed description of each, how they work, and their shortcomings.
Understanding proof of work (PoW)
The concept of PoW was first discussed by an Israeli and an American computer scientist in 1993. They proposed this method as a solution against spam attacks. Later, in 1999, the term was coined and described in a paper by two other computer scientists. In 2008, the protocol saw its first practical use with the release of Bitcoin.
The proof of work mechanism explained
The proof of work (PoW) protocol is a cryptographic verification method that requires others on the blockchain to confirm whether a transaction was carried out or not. This protocol is what allows Bitcoin miners to not only verify Bitcoin transactions but also add more Bitcoin to the blockchain. The protocol proposes an arbitrary mathematical puzzle that miners need to solve. The aim of solving this puzzle is to find a target hash by expending computing power, which is later confirmed by other verifiers. The first miner who solves the PoW puzzle essentially wins the right to update the blockchain and add a new block of verified transactions. They’ll also get some (currently 6.25 BTC) Bitcoin as a reward. Once the miner finds the solution, they’ll present it to the rest of the Bitcoin network. The other nodes in the entire network will quickly verify that the solution is correct. The reason the others in the network are able to quickly verify whether the solution is correct is because of PoW’s asymmetrical nature. A good analogy would be a keylock: finding the correct combination is time-consuming. However, it’s easy to verify the solution once you have the right combination: the lock simply opens. The proof of work system ensures that it’s not easy to tamper with or corrupt the system. That’s because finding the solution to these complex proof-of-work problems requires significant energy expenditure.
PoW disadvantages and criticism
Bitcoin mining started out very differently from what it is now. When Bitcoin first got on the scene, miners could solve its PoW challenges using a desktop PC. They also needed a reasonably adequate GPU, but this was hardly an obstacle for most miners. These days, competitive miners have entire facilities at their disposal. These often look a lot like huge data centers, filled with thousands of high-end GPUs and computers. That’s because Bitcoin mining has become considerably more difficult. As you’d expect, these mining facilities consume huge amounts of energy. In fact, according to a Cambridge study, Bitcoin uses 0.46% of the world’s electrical supply and 0.16% of all global energy produced. PoW opponents argue that the huge amounts of energy that miners use to verify crypto transactions are a waste, especially in a time where energy conservation is becoming increasingly important.
Mining frequency
Another disadvantage of the proof of work protocol is that transactions aren’t always very fast. This has to do with the frequency of block creation on the blockchain. In the case of Bitcoin, for instance, updating the blockchain with a new block takes 10 minutes on average. The above means that it takes 10 minutes on average for your transactions to be confirmed. However, large transactions can take a lot longer, as these might require up to six confirmations before the transaction is final.
51% attacks
Another disadvantage of the proof of work protocol is that it exposes the blockchain to a 51% attack. This can happen when one entity gains control of more than 50 percent of the mining hash rate, i.e. all of the computational power used for mining. The above means that the majority party has full control over the verification process since they would be able to find the hashes first, thus reducing the need to form a “consensus” and corrupting the entire blockchain. These attacks can have far-reaching consequences: the attacker can prevent the recording of new transactions, allowing them to spend their crypto multiple times, for instance. Moreover, the attackers can even change blocks that were created after the start of their attack. To a lesser extent, a 51% attack can also result in the alteration of blocks that were created before the attack. However, this is extremely difficult and sometimes downright impossible: the longer ago the block was created, the more difficult it is to alter and blocks before a certain checkpoint cannot be changed anymore. Attacking very large crypto networks using this method, such as Bitcoin, is extremely difficult and expensive. That’s simply because these networks involve incredible amounts of computational power as part of their verification process. This is why 51% attacks often tend to target smaller networks.
Understanding proof of stake (PoS)
Proof of stake (PoS) is the protocol Ethereum uses to validate transactions. It’s essentially a voting mechanism. Ether (ETH) users who own sufficient Ether (32 coins) can apply to vote on whether a transaction is legitimate. These “voters” are called validators or minters.
Proof of stake’s origin
Proof of stake doesn’t nearly date back as far as the proof of work protocol. In fact, it was more of a reaction to the PoW protocol. Many believe the first mention of the idea, at least for crypto, came from a BitcoinTalk user called QuantumMechanic. QuantumMechanic believed PoS would offer some important advantages over PoW, such as:
Lower transaction fees Faster transaction times Taking away the potential danger of damaged or confiscated mining equipment Giving stakeholders a stronger voice
PoS saw its first practical use in 2012 when Peercoin, another cryptocurrency, implemented it. From that moment on, more and more theoretical and practical advancements have been made. PoS reached one of its most important milestones quite recently, in 2022, when Ethereum adopted it as its consensus mechanism.
Staking mechanism
In order to become an Ethereum validator, you have to “stake” the required amount of Ether. This is where the name “proof of stake” comes from. If a specific number of validators find a transaction valid, it’s verified and executed. It will then be added to the blockchain. The voters who deemed the transaction to be valid receive some Ether as a reward. Ethereum chooses validators at random. However, the more Ether you stake, the higher your chances are of being chosen as a minter. Note that Ethereum also offers options for people who are unable to or uncomfortable with the idea of staking 32 Ether. These users can rely on “pooled staking” or so-called centralized exchanges. However, these are third-party solutions, and users must weigh the pros and cons first, as Ethereum isn’t responsible for any issues that may arise from using them.
Slashing
“Stakers” cannot only gain but also lose Ether. This is called “slashing.” Fortunately, slashing isn’t that common and will only result from, Ethereum assures, “actions that are very difficult to do accidentally and signify some malicious intent.” In the worst-case scenario, malicious actors can lose all of the Ether that they stake. The malicious actions mentioned above include, among others, “proposing multiple blocks for the same slot or attesting to multiple blocks for the same slot.”
Disadvantages
Although the PoS protocol doesn’t raise environmental issues (yet), it still has some disadvantages, at least when it comes to how it’s implemented by Ethereum:
Voters with a lot of Ether who make a wrong decision could compromise the verification process. “Yes-voters” are rewarded, increasing the risk that they might be more inclined to validate even dubious transactions. The proof of stake process has a tendency to lead to “forks.” These are new blockchains that are derived from the original, resulting in low-end alternatives on the market.
Forks happen when a blockchain splits into two parts because of differing opinions between parties. As for the proof of stake protocol, this split could happen because two groups of validators disagree on the validity of a transaction.
The Origins of Blockchain
The first time that the idea of a blockchain was discussed, was in 1982. Cryptographer David Chaum pitched the idea of a blockchain-like protocol in a dissertation. Over the next decades, various experts in computer science and related fields elaborated on the concept significantly. It wasn’t, however, until 2009 that the blockchain saw its first real-world application. This is when Satoshi Nakamoto, the presumed anonymous creator(s) of Bitcoin, implemented blockchain as the most important feature of Bitcoin.
Are Blockchains Only Used for Crypto?
As we mentioned before, the blockchain isn’t only useful for (crypto) transactions. It has a wide range of applications. Some of the biggest and most important ones are the following:
Smart contracts NFTs or non-fungible tokens Industry and supply chain management
We’ll discuss these Blockchain applications below.
Smart contracts
Smart contracts are becoming increasingly important as a blockchain application. It’s a bit of an umbrella term, as smart contact technology is used in many other applications and industries. Simply put, a smart contract is nothing more than a contract that can execute itself. In this case, it’s a program stored on the blockchain (but different architectures can be used), written with a simple if-then structure. A really simple example of a smart contract, although not on the blockchain, is a vending machine. A vending machine registers, all by itself, if you inserted the required value of money. It then registers what snack you choose, often using a simple letter and number format (A1, for instance). Once the conditions of paying the required amount and snack selection are fulfilled, the machine gives you the snack you chose, all of which happens automatically. Similarly, the creator of a smart contract can store some code on the blockchain. This code will, just like the vending machine, specify certain conditions and consequences that will result from those conditions. Smart contacts have many different uses. For instance, friends that are wagering on a sports game could use this technology to get paid their earnings. Alternatively, big companies can use it to automize certain processes. In theory, even insurance companies could use it to automize payouts. One of the most important blockchain applications that use smart contract technology are NFTs. We’ll discuss below what these are.
Non-fungible tokens (NFTs)
Non-fungible tokens, or NFTs, are digital tokens that are a unique (so non-interchangeable) representation of something. More specifically, NFTs are generally used to represent the ownership of a digital creation. Simply put: Rather than being something you own, it’s a piece of proof that you own something. Since this proof is unique, it can’t be falsified. It’s like a really specific digital certificate. Most NFTs these days are stored on the Ethereum blockchain. This is no coincidence, as Ethereum is great at the smart contract technology since it’s highly scalable. When an NFT is sold, a smart contract is used (see above) to transfer ownership. NFTs can express ownership over many different items and things, such as:
Songs Video games Tickets to events (Digital) art such as paintings Real estate
NFT owners often use their NFTs for trading and investing. Also, for many, owning NFTs is a status symbol. On the blockchain, an NFT is composed of four important elements:
The user name that identifies the NFT’s creator on the blockchain. Information that indicates the smart contract’s exact location on the blockchain. The smart contract’s identification number. Note that the smart contract includes important information such as the price of the NFT and the original owner. Information about the asset the NFT refers to. This could be a link to a digital painting, for instance.
The last category of information causes issues sometimes. After all, it’s not uncommon for links to change or disappear altogether. This means NFTs are vulnerable to link rot. Link rot will require a new NFT to be created and could be an expensive technical issue for the NFT owner. Note that all of the information mentioned above is hashed. This means it’s made to be unintelligible by an algorithm.
Industry and supply chain
Companies are increasingly using blockchain technology to record the supply chain process. More specifically, they often use it to record where their materials or products come from, what substances are added to them, and so on. This helps them to guarantee to their partners and customers that their products comply with certain standards or (niche) requirements. In the food sector, this is used a lot, for instance. As we discussed, a blockchain is a decentralized network and is very difficult to manipulate. This means they’re a great way to make sure foods are really “organic,” “local,” or “fair trade.”
The Blockchain – Pros and Cons
As we’ve discussed, the blockchain offers a plethora of advantages, such as:
Decentralization Transparency High degree of fraud resistance Convenience thanks to technologies such as smart contracts
Unfortunately, however, like any system, it does have its flaws. The main three blockchain flaws are related to the following three categories:
Privacy risks Adoption and scalability issues Facilitation of criminal activity
We’ll discuss all of these below.
Privacy risks
Many people believe that cryptocurrency and blockchain users enjoy complete anonymity. However, this is simply not true. What they offer is what some privacy experts call pseudo-anonymity. In order to send and receive crypto, for instance, you need a crypto wallet. This crypto wallet comes with its own address. This address doesn’t give away who you are to strangers, as it’s just a collection of random letters and numbers. However, if someone knows your wallet address, they can very easily track how much crypto you own and any transactions you make or have made in the past. Because remember, these public blockchain networks are available for anyone to consult as they please. For instance, on Blockchain Explorer, someone who has your wallet address can just copy it into the search bar and see tons of information about your wallet and transactions. That’s not all. Although not a flaw of the blockchain system itself, many platforms that allow you to interact with the blockchain in any way, ask for a lot of personal information. Crypto exchanges like Coinbase, for instance, ask for lots of personal details. This often even includes a scan of your passport or driver’s license to verify your identity. They are legally required to do so. Although this is not the fault of the blockchain system, they can’t seem to do anything to combat these privacy infringements. Read more about the privacy risks of crypto in our complete article about the privacy of cryptocurrencies.
Adoption and scalability issues
The blockchain has a lot going for it. However, so far, adoption and scalability aren’t part of blockchain’s advantages. Let’s look at blockchain’s transaction potential, which to many is the most interesting of blockchain’s facets. Bitcoin is able to process multiple transactions (seven) per second (TPS). With the rate of current Bitcoin transactions, that comes down to a transaction finality time (TFT) of 30 to 60 minutes. This might not seem that slow, but keep in mind that Bitcoin is nowhere near the most popular transaction method on earth. Ethereum is a lot faster: it offers a TPS of 30. Funds are generally transferred in about five minutes. That sounds pretty neat, but keep in mind that Ethereum is even less popular as a transaction method than Bitcoin. In other words, the loads Ethereum experiences are nowhere near as high as they could be. Some estimate that Visa handles about 600 million transactions per day. To give you an idea of the scalability issue: at its current TPS, Bitcoin would need more than 20,000 hours to process that many transactions. Make no mistake, there are definitely blockchains that allow for a TPS that comes a lot closer to, for instance, Visa’s claimed capacity of 65,000 transactions per second. However, these are much less popular than Bitcoin’s and Ethereum’s blockchains. This brings us to the next issue: blockchain adoption. It’s great that blockchains are decentralized and transparent. However, this might not be sufficient to cause enough people to adopt this technology to make it as impactful as it could be. Many people simply feel more sure about something if there’s a big company behind it, rather than a genius but anonymous creator who uses a pseudonym (as in the case of Bitcoin, for instance).
Facilitation of criminal activity
One blockchain related-issue that’s often grossly exaggerated (we can’t stress this enough), but still exists, is how it can facilitate crime. Especially when crypto just got on the scene, it was very easy to use the blockchain to buy some cryptocurrency without giving too many details about yourself. It’s not hard to imagine how this enabled illicit activities. After all, it created much less of a money trace than conventional payment methods (except for good old cash). These days, this has become a lot more difficult. After all, modern crypto exchanges have been forced to comply with strict regulations and now hardly offer any more anonymity than a bank account. However, there are still ways to get crypto anonymously, such as on P2P crypto exchanges and one-on-one trading. The latter can be done both online, as well as offline. Since it’s a lot easier for criminals to use crypto as a seemingly legitimate asset than cash, anonymously bought crypto could actually contribute to money laundering. Moreover, there are some private cryptocurrencies that use more private blockchain networks, such as Monero. People could actually use these cryptos for illegal online purchases.
Final Thoughts: Learn More About Blockchain and Crypto
As we’ve seen, blockchain technology can be applied in many different fields and has the potential to revolutionize many of these. Blockchain technology eliminates human errors, is very trustworthy and transparent thanks to its decentralized nature, and can help prevent fraud and manipulation thanks to its “block structure.” However, we’ve also seen there are some disadvantages, such as privacy concerns, scalability and adoption issues, and the fact cryptocurrencies can facilitate crime. If you want to learn more about blockchain and cryptocurrencies, be sure to check out these articles as well:
How to Buy and Sell Bitcoin Safely Bitcoin and Cryptocurrency Scams to Watch Out for Bitcoin Alternatives: Top 10 Leading Cryptocurrencies How to Mine Ethereum: Ultimate Beginner’s Guide to ETH Mining Crypto Pump and Dump Scams Explained: How to Avoid Them
