It seems like blockchain technology is everywhere these days and yet many people still don’t understand what it is or how it works. If you’re unsure how to make sense of things like cryptocurrency, blockchain and crypto mining, you’re not alone.
At Addition Financial, we want our members to have all the information they need to navigate their finances. That includes helping to build a basic understanding of the terminology of blockchain and some blockchain fundamentals. Here’s what you need to know.
What is Blockchain Technology?
The phrase that is used to describe blockchain technology is that a blockchain is a distributed ledger. Let’s talk about what that means.
A ledger is a place where transactions are recorded. In a physical ledger, the transactions are kept in one place. If the ledger were to be destroyed, the records would disappear with it. In a blockchain, the data contained in the ledger is maintained across an array of computers and computer networks. In other words, they are distributed. Each computer or network is known as a node.
Another characteristic that differentiates a distributed ledger from a non-distributed one is that a blockchain transaction may only be changed by consensus. More than 50% of the computers in the network must agree to the change for it to become part of the ledger.
The distribution of a blockchain and the difficulty of changing it make it far more secure than a non-distributed ledger. While the best-known use of blockchain technology is to track cryptocurrency transactions, it has applications in many other areas.
Now, let’s explore seven blockchain concepts to expand your knowledge.
#1: A Blockchain is Made Up of Data Blocks
The first blockchain fundamental you should know is that a blockchain is composed of individual data blocks that are added to the blockchain by the consensus of users. For example, if someone buys cryptocurrency, the transaction data is put into a block. When the block is full, it is then verified through a process known as mining.
Mining involves a computer or group of computers solving a hash – a complex mathematical formula that will, when solved, add the block to the existing chain in its proper place. Solving the hash requires an enormous amount of computer power. The individual or group that first solves the hash gets credit for it and receives a reward, usually cryptocurrency.
The location of a block in the blockchain is known as its height and the height cannot be changed. The reason is that the hash assigned to a newly-minted block will contain the hash of the previous block as part of its input. It can only sit in the spot on the chain where it is placed and may not be moved.
#2: There Are Three Types of Blockchains
Not all blockchains are created equal. There’s a common misconception that all blockchains are public, which may explain the reluctance that some people have about participating in cryptocurrency trading.
The three types of blockchains, which all relate to who has access to the information stored there, are as follows:
- Public blockchains – A public blockchain is powered with open-source code and open to anybody who wants to access it at any level. The best-known example of a public blockchain is the Bitcoin blockchain.
- Permissioned blockchains – A permissioned blockchain controls the various roles that people can play in the system. Permissioned ledgers may or may not use an open-source code and people are limited in what they can do within the system according to their permissions.
- Private blockchains – As its name suggests, a private blockchain is not open to the public. Private chains are usually smaller than public ones and are used to track and transfer confidential information to a trusted group of participants.
Many industries are interested in the potential uses for permissioned and private blockchains for things such as storing protected health information or creating smart contracts.
#3: Blockchain Technology Is Used to Secure Cryptocurrencies
Blockchains are used for the purpose of securing cryptocurrencies. While blockchain technology has roots that go back to the early 1980s, the white paper that preceded the launch of the very first blockchain was published in 2008. The first blockchain was created by the writer of that paper. We’re talking about the Bitcoin blockchain.
One of the key benefits of cryptocurrency as it currently exists is that it is a decentralized currency. That means that unlike fiat currencies such as the US dollar, it is not controlled by a central authority. Users add blocks to the blockchain by consensus and they may only be changed by consensus. This combination ensures the security of cryptocurrencies by making it both difficult and expensive to tamper with the structure or integrity of the blockchain.
#4: Blockchain Technology Can Be Used in Many Ways
One of the most common misconceptions about blockchain technology is that it is synonymous with Bitcoin technology. The misunderstanding is not surprising considering that the Bitcoin blockchain was the first blockchain ever created and its emergence was how most of us learned about blockchain technology.
While cryptocurrency is still the most commonly implemented use of blockchain technology, leaders in every industry are exploring the possibilities of adopting it for a wide variety of purposes. Some of the potential uses of blockchain technology include the following:
- Secure voting and elections
- Storage of protected health information
- Creation of smart contracts
- Establishing provenance of creative work
The technology has the potential to revolutionize many areas of our lives and we anticipate that we will see its adoption expanding as industries and organizations realize its potential. The government of Estonia adopted blockchain technology in 2012 and has used it to secure the country’s business, healthcare and property registries, among other things.
#5: It Isn’t Possible to Use a Hash to Reverse Engineer the Data in a Block
When people think about blockchains being public, they’re concerned because they worry that any person with access to the blockchain could use the hash of a block to reverse engineer the data in the block. That’s not the case.
A regular hash function may be used for common computing tasks, including the authentication of information or for confirming the integrity of data. The hash functions used in a blockchain are cryptographic, which means they combine the capabilities of a hash function with a high level of security.
It may be helpful to know that a cryptographic hash function is a one-way transaction. It takes inputs of variable lengths and returns outputs of a fixed length. They’re often described as collision-free, which means that no two distinct inputs will ever produce the same output. Nobody can use a hash and reverse solve it to calculate the input.
#6: A Smart Contract Is Not a Replacement for a Legal Contract
Smart contracts have been getting a lot of attention lately as a potential use for blockchain technology. It’s a common misconception that when people talk about a smart contract, they are talking about something that’s a replacement for a legal contract. That’s not the case.
A legal contract lays out the terms of an agreement, including the scope of the work to be completed, the price to be paid, and the delivery dates for the completed work. A smart contract is a program stored in a blockchain that will run automatically when predetermined conditions have been met.
For example, a company might create a smart contract to release payment for a milestone when the agreed-upon work is delivered. The benefit of creating a smart contract is that it ensures all parties involved in a contract understand the conditions for something being done and can be confident that the functions will be performed when the conditions are met.
#7: Blockchain Technology Can Be Used to Create Tokens
Blockchain trends are emerging as people become more comfortable with blockchain applications. One trend that you may have heard about involves the creation and sale of non-fungible tokens, or NFTs.
A non-fungible token is a digital asset that is unique and may not be used in a like-kind trade. That makes an NFT different from cryptocurrency, which is fungible. All that means is that one unit of Bitcoin or Ethereum can be traded for another. An NFT may be a piece of digital art or music or anything else that is unique.
The benefit of using blockchain technology to mint NFTs is that it creates a record of the item's creation. In the world of art, this is known as provenance. A creator who mints an NFT may sell it and the record of the sale will become part of the item’s history in the blockchain.
The potential applications for blockchain technology are endless and we anticipate that as more people understand the technology and how it works, its use will become widespread. We know that many of our Addition Financial members are interested in cryptocurrency and other blockchain investments and we’re here to help.
Do you need help managing your blockchain investments? Click here to learn about the MEMBERS First Financial Services Program and make an appointment with a financial professional today.
Posted on Apr 5, 2022
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