An Introduction to Blockchain Technology
The SOMA Basics guide to blockchain technology
What is a blockchain?
Simply put, a blockchain is a special type of database that is often referred to as distributed ledger technology (DLT). In the case of cryptocurrencies like Bitcoin and Ethereum, this ledger consists of a list of transactions that anyone can view and verify.
The thing that makes a blockchain special is the way in which new data is added to the record, and how once added, it becomes virtually impossible to modify or delete.
Blockchain technology is a core piece of the underlying architecture for most cryptocurrency networks and provides a decentralized, distributed and publicly verifiable digital ledger that is capable of keeping an immutable permanent record of all previously confirmed transactions on a network.
How does a blockchain work?
Blockchain ecosystems are comprised of a peer-to-peer network of globally distributed computers that are referred to as nodes. Each node maintains an up-to-date copy of the complete history of the blockchain and contributes its resources toward the proper functioning and security of the network.
This distributed network of separate but identical ledgers is what makes blockchain networks so secure, as it would require changing each individual ledger in order to change the history of documented transactions. It's also what makes cryptocurrencies like Bitcoin decentralized, borderless, and censorship-resistant, requiring no middlemen or centralized organisation to operate.
The “block” in blockchain comes from the underlying structure of the technology, a process where data is gathered and added to “blocks”, with each block being built on top of the one before. As blocks are added, each one contains a piece of information that links the new block to the previous one, forming an immutable chain of data entries. For this reason, a simple way to check if a blockchain is operating correctly is to inspect the most recently minted block and verify that it was created after the previous one. If you follow the chain all the way back to its beginning, you will find the genesis block that started the whole process.
In the case of Bitcoin, each new block is minted and added to the chain of existing blocks. In exchange for contributing their computing power to maintaining the integrity of the blockchain, node operators are rewarded with a small amount of digital currency.
The Bitcoin network operates with what’s known as a Proof of Work (PoW) consensus algorithm where validators, who are often referred to as 'miners', use their computing power to “hash” the data they want to add until a specific solution is produced.
PoW is what allows Bitcoin to operate as a Byzantine fault-tolerant (BFT) system, which means that its blockchain is able to operate continuously as a distributed network, even if some nodes on the network operate inefficiently or with malicious intent.
Public vs. private blockchains
Networks like Bitcoin are what’s known as public blockchains, meaning that anyone can view the transactions that take place on the ledger as long as they have the proper software and an internet connection.
As more of the world’s businesses and data makes the transition to Web3 and blockchain technology, it’s completely reasonable that some entities might not want their data being fully accessible by anyone in the public sphere.
For this reason, there are other types of blockchains known as private blockchains that establish rules about who can interact with the blockchain and view the data contained within. These are also referred to as 'permissioned environments' and they serve a host of important functions in enterprise and private settings both inside and outside of the realm of finance.
Blockchain technology pros and cons
Properly functioning blockchain networks offer a variety of benefits across a multitude of fields including finance, logistics, agriculture and government records. While the technology has lots to offer in the way of increasing efficiency of many of the current systems of operation, no technology is without a trade-off.
- Ability to transmit payments and/or information with the need for an intermediary
- Less risk and lower fees due to the removal of intermediaries
- Permissionless networks reduce barriers to entry – all that’s needed is an internet connection
- Highly censorship-resistant
- Large distributed networks make it virtually impossible for attackers to compromise the network
- Numerous use cases
- Blockchains do not solve every problem and are not applicable in every setting
- Do not scale easily and thus have limited speed capabilities
- Limited scalability leads to higher transaction costs and slower processing times
- Limited block size means that data that is unable to fit will have to wait and be added to the next block.
- Difficult to change or upgrade – can lead to contentious hard or soft forks (i.e. Bitcoin and Bitcoin Cash)