If you’re just getting into cryptocurrency, you’ve probably heard of the mysterious “blockchain.” But what is blockchain technology, and how does it fit into cryptocurrencies? In this article, we’ll define the blockchain, explain what is blockchain technology, and give you a leg up on the investment competition in the cryptocurrency space.
This article will get a touch technical at a few points but bear with us. Understanding the blockchain requires thinking in a different sort of way—more like a computer network than a network of people using a currency.
The Blockchain Defined
So, how does blockchain work, and what is blockchain technology? Blockchains are universally viewable ledgers which keep track of all a cryptocurrency’s movements and storage locations from the inception of that currency’s existence and onward.
- Not controlled by any one entity but rather a software protocol
- Made of individual blocks of transactions
- Updated after a discrete amount of time with new blocks of transactions
- New blocks of transactions append to the end of the chain, meaning that older transactions come first and newer transactions come last
- Identical for everyone that views them
- Essentially endless ledgers of bank account transactions and balances in cryptocurrency
- Prevents fraudulent transactions using cryptography and unique identifiers of accounts
All cryptocurrencies rely on a central blockchain that is specific to them. When you first start using a cryptocurrency, one of the first tasks that you’ll have to do is get your wallets synched with the blockchain. Getting your wallets synched with the blockchain is the equivalent of looking at a board which tells you how much money is in your wallet—if you just created your wallet, the blockchain will tell you that you have nothing.
The key to understanding what is blockchain technology comes from the origins of cryptocurrencies.
Bitcoin was the first cryptocurrency protocol which made use of blockchain technology and was the first exposure that most people had to blockchains. Before Bitcoin, there was a lot of theoretical work which built up to the concept of the blockchain but didn’t quite reach implementation.
Early blockchain-like ideas included online currency protocols like “bmoney” which sought to introduce concepts like “proof of work” to spam control. The idea behind bmoney was that if email servers were forced to perform computational work and issue a token produced by that work along with any email it sent out, recipients of email could rest assured that the email they received isn’t spammed.
As an added assurance against spam, email recipients could check whether the token they received showed up on a list of tokens which was public on the internet—the proto-blockchain. If the token didn’t show up on the list, it wasn’t valid, and the email was probably spam.
Adding a proof of work to outgoing spam emails would massively decrease the efficiency that spam mailers would be able to reach, and cut down on global spam quite substantially.
Unfortunately, these concepts never took off, but they did provide concepts which Bitcoin would integrate into its protocol later on in drastically different ways.
In 2008, these concepts came together in a proposal by a person named Satoshi Nakamoto. The proposal outlines a protocol for a cryptocurrency—a new concept at the time—based off of proof of work and a distributed iterative ledger called a blockchain.
The initial proposal would go through some edits until eventually a final copy of technical specifications was ready to publish, which happened in 2009. Once the Bitcoin protocol was “live,” its blockchain began by issuing the first block. The “origin block” offered a specification for the iteration of future blocks based off of proof of work contributed by anyone on the internet, and declared certain wallets as having certain amounts of value. And so, Bitcoin was born.
Soon, people were submitting computational proofs of work that their computers had made to the Bitcoin protocol’s blockchain. More and more blocks issue; each new block informed everyone about the work performed and the currency dispensed as a result. Bitcoin was then off and running as the world’s first blockchain based application and cryptocurrency.
The Benefits of Decentralization
What is blockchain technology, if not a platform for distributed ledger systems?
One of the core features of the blockchain is decentralization; no single person controls which blocks issue to the blockchain. In fact, the blockchain itself is a consensus-based system. How does this work, exactly?
- Users pick a cryptocurrency to interact with and download a copy of its blockchain
- Users examine the blockchain, which tells them the kinds of actions will result in producing a proof of work that is redeemable for the currency that the blockchain represents
- Importantly, the blockchain typically dictates that only one proof of work will work for the upcoming block
- Users perform the work, producing a proof of work, and then make that proof of work public by sending it to the blockchain
- If the users are the first to send the proof of work to the blockchain, all other users validate the submission, and the blockchain reflects that the original user earned currency by being the first to submit their correct proof of work
- The user that “won” the currency then downloads the new block of the blockchain, which reflects to everyone that that user’s wallet credits new cryptocurrency
- All users download the new block and see all transactions and submissions of proof of work that occurred to form the block
- Information that didn’t change during the formation of the block, such as values stored which didn’t move or change, is still reflected in the older blocks, so it isn’t added to the block
- The next block begins to form after the old block publishes
Let’s look at an example of where decentralization would be helpful. Alice and Bob share their finances and go to the bank. Alice deposits some money, and Bob checks the balance on their account, expecting to see the new deposit as a credit. Bob sees that the bank has not credited their account with Alice’s deposit; they are out of luck, and will probably need to contact customer service.
Upon contacting customer service, the bank informs Alice and Bob that they were mistaken, and in fact, no money was deposited. Alice and Bob are getting robbed, and there is little they can do about it because the bank is a centralized system where they have no power.
Applications of a Blockchain
In a decentralized system, the above example wouldn’t be possible. Alice’s deposit would be visible to everyone, and if everyone were to report their opinion on the amount of the deposit, it would be the same as Alice’s because they stand to gain nothing by lying.
Thus, blockchains are useful in applications where truth needs to be established via consensus to defend against bad actors. Blockchains also establish the truth indelibly, and permanently. There’s no going back to correct the record—the past is set in stone. Consensus on one fact at one moment means that the consensus is permanent, preventing any tomfoolery or time traveling down the line.
Perhaps the most compelling applications of the blockchain are in smart contracts. Smart contracts use the properties of the blockchain to negotiate and enforce contract terms (which are typically regarding computational power spent on a given task) and penalties, all autonomously.
Many claim that smart contracts are the future of the legal world as it relates to corporate relations; it’s easy to envision a future where company A’s smart contract with company B is algorithmically negotiated based on company A’s access to raw materials and company B’s access to manufacturing power such that both companies are vertically integrated with each other in perfect synchronization.
Open vs Closed Blockchains
The concept of blockchain inherently implies openness—that anyone can immediately view the entire contents of a cryptocurrency protocol’s transactions and value storage at a glance. There are some who would rather popularize the concept of “closed” blockchains, however.
These closed blockchains are just “open” blockchains that retain a much tighter control over who has access to the protocol. Closed blockchains forfeit most of the benefits of the distributive nature of the blockchain because a restricted user base makes for a user base where it’s significantly easier to gain a controlling share of the proofs of work required to make each block.
Once you control the majority of each block, you can define the reality of the block however you want—other users disputing your vision of reality won’t have enough of a majority to overrule whatever you say. It’s right back to Alice and Bob getting robbed by the bank—their opinions simply don’t have enough power to change what’s on the bank’s ledger.
There is, however, an option for situations in which one party comes to control a dominating share of a cryptocurrency or blockchain’s power—hard forking.
Hard Forks Defined
If a significant portion of a cryptocurrency protocol’s users view that the current majority of the conditions of the protocol are unworkable or unequal, they can “hard fork” a new version of the protocol and start a new, parallel blockchain.
Hard forks involve altering the blockchain protocol’s source code to make the blocks that it issues incompatible with old blocks on the chain. The new blockchain typically has slightly different rules for submission of work, and so it won’t accept anything other than inputs designed specifically for it. Thus, the blockchain becomes forked, with one population of users creating blocks using the old rules and another population of users creating blocks using the new rules.
Hard forks tend to be big news in the cryptocurrency community because it represents an irrevocable exit of a large population of a protocol’s users to a newer version of the protocol. Newer protocol versions retain the value stored by the old protocol—usually—but offer improvements that may be controversial among adherents to the old way of doing things.
Hard forks are also used to “turn back time” to remediate damage caused by hacks. Because the new protocol must replicate the blocks of the old fork but discriminate between certain pre-and-post hack events, it’s necessary to differentiate it from the old version.
If the fork is different enough, it’s possible to consider a hard fork as a differentiation point between two entirely different cryptocurrencies. In practice, hard forks are typically joined by the old fork as time passes.
After the hard fork, there remains the old branch. If the old branch retains enough of a user base to keep producing new blocks, it can be thought of as an alternative blockchain relative to the newer and improved fork.
Alternative blockchains that differentiate from their parent enough to have a new name are typically delisted from the cryptocurrency exchanges because they don’t produce blocks consistent with the currency that’s traded by the majority of users on that protocol.
Because all of the cryptocurrency created in the blocks of the alternative blockchains is marked by the fact that it’s the alternative, the currency is effectively worthless. An apt example here would be if, after the adoption of the Euro, someone kept printing francs and attempting to use them as valid tender in France.
Aside from getting a lot of strange looks, the person producing francs would still follow the same old method of minting them at the press—the old protocol. But the new protocol, minting euros, is the only protocol adopted by the majority of people, and so is the only protocol which produces currency with any worth. Such is the status of alternative blockchains or “side chains.”
Hopefully, you now know enough about blockchains to get off and running on your new cryptocurrency, or at least to understand one of the extant currencies. Blockchains are powerful tools for truth verification in an automated fashion, and will almost certainly be a major part of the digital infrastructure of software in the future.