Bitcoin and blockchain are in the news more and more these days, and clients are likely to ask about them. Here’s a crash course on cryptocurrencies and the technology behind them.
Bitcoin and blockchain are often thought to be the same thing, but it’s important to understand the difference between the two. Bitcoin is a digital currency, and although it is the most popular cryptocurrency in use today, there are many other digital currencies out there, such as Ethereum, Litecoin and Dash.
What makes all these digital currencies special is the fact that they are built on blockchain technology.
It’s easy to confuse digital currencies with the technology that makes them possible, as digital currencies are the most visible and practical implementation of blockchain technology. However, blockchain as a technology has far greater uses outside the world of finance, and many believe it will be the key driver that pushes many industries to become decentralized.
One way to understand it is to think of blockchain as a groundbreaking technology, like the internet, and cryptocurrencies as a very popular application that uses that technology, in the way that email needs the internet to function.
Bitcoin was the first major practical application of blockchain technology, and blockchain has become a backbone technology to other cryptocurrencies. It is sprouting a new wave of innovative and remarkable startups.
Looking at the projects that are using blockchain technology, the potential seems truly limitless. Even the way some projects fund themselves is the result of blockchain-based innovation.
What Exactly Is Blockchain?
A blockchain is essentially a public ledger or a list of records. It resides online and is distributed across a network of decentralized computers, recording events and transactions in a secure, incorruptible manner. Once something exists on the blockchain, it is impossible to alter or change it in any way.
For example, let’s say you send one Bitcoin to your friend. This transaction creates an entry in the block, which updates itself to record the transaction. The details of the transaction then spread across the network, and every other computer in the decentralized network updates the ledger as well.
The key differentiator with blockchain, in contrast with traditional record-keeping systems, is that instead of residing at a single location (usually a trusted third party, such as a bank), the ledger is maintained collectively by a global network of computers.
Why Do We Need Blockchain?
Blockchain is needed for the same reason a bank needs a ledger: to keep track of transactions. Every time a bank processes a transaction, it records it in a ledger via its core banking platform. This allows the bank to keep track of how much money is in each account. A blockchain does the same thing for cryptocurrencies. Every time a transaction occurs, it is recorded into a block, which you can think of as a page in a ledger. Once the block is full, it is added to the blockchain, a chain of linked blocks that is similar to a ledger containing multiple pages.
Although this analogy serves as a good starting point, there obviously are certain subtle differences between how a bank maintains a transaction and how it is maintained with digital currencies. For one, there is no central party for crypto transactions, such as a bank, so the blockchain itself has to ensure that no fraudulent transactions are allowed.
This is where miners come in. Miners verify transactions and add them to the blockchain.
How Does Mining Work?
Although your bank can verify that you indeed have $100 in your account to send to someone else, digital currencies have no bank or centralized party that can make that verification.
Miners are users with high-powered computers spread across the world who serve as auditors for the network. Their role is to keep the ecosystem honest and to prevent users from sending digital currency that they don’t have.
In other words, mining is the critical backbone that powers decentralized networks. Without mining, it would be impossible for blockchain to exist.
Miners aren’t just powering networks out of the goodness of their hearts; they are being compensated by the network for their work in the form of whatever digital currency they are mining.
Operating digital currency miners is expensive, complicated and extremely labor intensive. Mining started out as a hobbyist activity, and today it has evolved into a highly competitive, highly lucrative, multibillion-dollar industry.
The amount miners are compensated and when they are compensated depends entirely on preset algorithms of the digital currency they are mining.
What Makes Blockchain Secure?
The primary advantage of blockchain technology is that it is controlled by a network instead of by a single entity. This means that it has no single point of failure and no single point of corruption.
Furthermore, the information stored in the blockchain is public and the system is designed to verify the integrity of the blockchain on its own. Thus, the only way to create a fraudulent transaction on such a network would be to take control of the majority of the global network itself.
These features provide an unprecedented level of security to users of the blockchain.
How Can Blockchain Be Used Outside Of Finance?
Blockchain can be applied to nearly every industry, but it will especially benefit those industries that lack transparency, are at a high risk of fraud and are digital.
Here are 10 of the hundreds, if not thousands, of uses for blockchain technology:
1. Education: Digitizing and verifying academic credentials.
2. Nonprofits: Auditable trail of all donations and spending.
3. Voting: Preventing voter fraud and tampering.
4. Human resources: Background checks and credential verification.
5. Law enforcement: Evidence integrity and documentation.
6. Legal: Smart contracts with preset rules.
7. Media: Control of ownership rights and anti-piracy.
8. Health care: Drug supply chain integrity.
9. Real estate: Digitized transaction process and ownership.
10. Automotive: Vehicle ownership and history.
Although it’s difficult to know which digital currency will become the largest in the years ahead, many do believe that blockchain technology is here to stay and that its level of disruption has only just begun.