How Does Blockchain Work?
In 2008, an obscure cryptography message board received a post from user Satoshi Nakamoto. Titled Bitcoin: A Peer-to-Peer Electronic Cash System, this whitepaper introduced the world to Bitcoin, a completely digital currency that was built on a decentralized, peer-to-peer network and the genesis of the digital assets known as cryptocurrencies. Though electronic cash and payment systems had previously existed, such as PayPal, what made Bitcoin unique was the innovative combination of a distributed ledger system along with cryptographically secure information transmission; thanks to these two core characteristics, the Bitcoin protocol proved to be anonymous, private, and immutable. These features made Bitcoin popular with groups familiar with cryptography, the art of protecting and securing information. The data-security experts in the cryptography forums lauded Bitcoin for its ability to serve as a truly private, protected form of peer-to-peer transacting, completely removing the need for a third-party to act as a facilitator.
Bitcoin was capable of acting as a secure, peer-to-peer transaction platform thanks to the underlying software protocol. This protocol was a form of distributed ledger technology. Distributed ledgers are forms of data management where the record of data, such as a transaction history or log of values associated with given accounts, exists across several nodes as opposed to one central server or warehouse. This creates redundant, publicly verifiable records of transaction history, building stability and immutability into the system. Distributed systems are more resistant to outside attempts at interference, such as hacking, and malicious attempts to gain control of the system. Thanks in large part to the inherent security features of distributed systems, they were a natural choice as a foundation for the protocol underlying Bitcoin.
This protocol is called blockchain. Blockchain is a form of distributed ledger where new transactions and interactions added to the ledger are collected and verified in groups referred to as blocks. A block is a cluster of transactions, gathered and cryptographically proven. Every ten minutes, a block is verified across the public ledger, granting each user in the network the ability to view the entirety of the network’s transaction history. This history is made up of a long chain of blocks of transactions, thus the name ‘blockchain’.
The Byzantine Generals Problem
The Byzantine Generals problem is a computer science problem referring Byzantine fault tolerance in computer systems, meaning a system which displays different output to different users. The Generals problem is essentially an issue in provability in systems that require consensus.
Overcoming this issue was crucial for an effective form of digital payments- in a distributed network without a single, centralized authority, group consensus is a key component in maintaining network functionality. Because of the open nature of blockchain protocols, they require intense levels of cooperation in order to be successful. In order to coordinate this level of cooperation, consensus much be reached among the majority of the users. Given the distributed nature of the user base, as well as the volume, achieving consensus requires sophisticated mechanisms to coordinate and direct users through system choices and to ensure all users are working together.
The Double-Spend Problem
The double-spend problem is an issue with digital assets where the owner can copy the digital asset or digital currency and use it in multiple transactions. Blockchain technology gets around this by making the ledger of transactions publicly distributed across each node in the network. This means all network participants have the same ledger of transactions available, so each amount of Bitcoin can be tracked from user to user. Traditional, physical fiat currencies are not susceptible to double-spend problems because parties involved in an exchange can instantly verify the legitimacy of the funds in the transaction. Handing cash over from one person to another is an instant transfer of value. Thanks to the public, open nature of distributed ledgers, blockchains provide viewable, verifiable history for all digital currencies, plainly demonstrating the authenticity for all parties involved.
Satoshi Nakamoto introduced a concept into the creation of Bitcoin and blockchain technology called Proof of Work. Proof of work is a measure to prevent fraudulent or unnecessary transactions on a network, requiring that the initiator contribute a designated portion of CPU power or other resource to the network. Proof of work is an alternative to transactions time stamped and facilitated by a mutually trusted third party. The lack of need for a third party to handle the transactions is one of the hallmarks of blockchain-based cryptocurrency; Bitcoin, thanks in large part to the blockchain protocol, is a true peer-to-peer system with no centralized authority like a bank or government in charge of maintaining or producing the currency. Traditionally, without a trusted payments network or other third party to verify and approve transactions, two individuals would be unable to transfer funds to each other without undertaking significant risk of transacting with an unknown party. Using Bitcoin or other cryptocurrencies, the transparency of the blockchain ledger and the proof of work system ensure that all transactions are legitimate and prevent fraudulent or double spending.
Distributed ledgers are secure and the redundancy of information storage makes the networks resilient to attack and immutable- meaning that, thanks to their decentralized nature, no individual can change the transaction history. This creates a permanent, public network.
One of the most important aspects of distributed ledgers and decentralized networks is the ability to create “trustless” environments where individual actors in the network do not need to know or trust each other. Because individuals are transacting using cryptocurrency, they are unable to spend money they do not possess, meaning it’s not necessary to doubt the validity of any payments. By accessing the public, distributed ledger, at any point one individual can verify that any given wallet, the blockchain equivalent of a bank account, possesses the necessary funds.
Blockchain in the Real World (Use Cases)
Blockchain technology and the cryptocurrencies that have been developed using the technology, such as Bitcoin, Ether, Litecoin, Dash, and Ripple, to name a few of the most widely known, have revolutionized the worlds of financial services. Storing wealth, banking, payments processing, and international transacting are just a few of the areas where Bitcoin and its cousins have had significant impact. Though Bitcoin is the most recognizable and arguably the most widely adopted cryptocurrency, as the code is open source, many alternative currencies have been developed that specialize in certain aspects of the payments chain. Monero, for example, is primarily focused on anonymity and privacy, while the team behind Dash has focused on instantaneous transaction settlement. This diverse ecosystem has made it possible for individuals to accrue a diverse selection of different cryptocurrencies, each tied to a particular system, use case, or purpose.
Strides have been made in many industries researching blockchain and cryptocurrencies as progressive solutions to many of the contemporary challenges faced in day to day operations. Blockchain-based smart contracts can create immutable ledgers of legal contracts which prove beyond a shadow of doubt the original owners or signers and timestamp of agreement, ideal for Intellectual Property, trademark, and patent enforcement. Contract law has become overwhelmingly complex along with the development of new technologies, and blockchain-based contract management presents an opportunity to create unbreakable, self-enforcing contracts.
Records management in healthcare, itself a multi-billion dollar industry, often creates pain points for individuals relocating, traveling, or transitioning between healthcare or insurance providers. WIth blockchain-based medical record management, an individual can be in sole possession of their complete medical history, sharing the exact information any healthcare professional or institution would require at a given time. This type of identity management can also streamline public programs such as social security or identity documentation for traveling internationally.
Blockchain technology has also been turned towards supply chain management for international shipping logistics as well as food and agriculture supply documentation. Using blockchain-based systems, shipping companies can easily track and confirm the location, dates, and contents of all goods in their care on a verifiable platform, offering a degree of transparency for consumers and customs officials never offered before and even has the potential to help prevent the spread of disease and other health issues caused by spoiled or tainted consumables and black market food sales.
With a high multitude of industries poised to use blockchain technology as a means to enhance efficiency and reduce funding waste and operational costs, it comes as no surprise that the world’s most massive enterprises are investing heavily into the technology and cryptocurrencies that make the blockchain so powerful and appealing. As more research is conducted, more unique, innovative use cases come to light, inspiring more confidence and interest in blockchain. This growing interest results in increased financial investment, growing the cryptocurrency market beyond $140 billion USD.
Want to explore the cryptocurrencies that have been developed using blockchain technology and learn how you could potentially benefit from investing in them with your retirement account? Our team of specialists are here to help. Schedule a call today.