Blockchain Technology Explained in Simple Terms

What is blockchain technology?

Blockchain is a framework for storing data in a way that’s almost impossible for it to be changed, falsified, or duplicated. Blockchain technology is simply a group of computer systems worldwide that reproduces and distributes a virtual record of transactions throughout the whole network.

A blockchain consists of blocks, and each block comprises several transactions. Each user's system—or ledger—receives a copy of every new transaction on the blockchain network. Once a block is verified to be true, it is added to the end of all previous blocks making it a blockchain. This concept is called Distributed Ledger Technology (DLT), where the entire database is governed by several users, making the blockchain decentralized. Decentralization refers to any network free of centralized oversight, such as a bank or a government.

How does blockchain technology work?

Blockchain technology combines three factors:

1. Cryptographic keys
2. A peer-to-peer (P2P) network
3. Computational methods to store and record transactions

Crypto wallets are designed in a way that they have a set of keys––private and public––which let users carry out crypto transactions on any given blockchain. If a user wants to send money to another user, they will sign the transaction with their keys and broadcast the transaction to the network. By signing the transaction, the user can confirm that they want the transaction to occur and that it came from their account.

A third party will view all transactions that are pending and add a subset of transactions to a block, grouped with other transactions. They’ll only add a transaction to the block if the sender is shown to have enough money in their account, calculated from summing up all previous transactions involving that sender. 

A consensus mechanism then selects which third parties can add the blocks to the end of all other blocks. Once a third party adds a block to the end of other blocks, they receive a reward, and that block is permanently added. 

Blockchain vs. traditional ledgers

We’ve established that a blockchain is a “digital ledger” for cryptocurrency transactions. The ledger essentially stores and records every transaction on its chain of blocks. For blockchains, there’s a decentralized ledger system that exists on its P2P network. 

Traditionally, ledgers are documents that consist of confidential information on credits and debits. They’re usually tables that contain data in the form of assets, revenues, equity, expenses, and liabilities.

The following table will give you a better idea of the differences between the two:

Blockchain vs. Bitcoin

While blockchain technology is a system that stores and records data through a global P2P network, Bitcoin is a cryptocurrency that needs a place to exist on the internet, which is the blockchain.

Blockchains power cryptocurrencies and allow them to exist virtually. Other cryptocurrencies—like Ethereum (ETH), Tether (USDT), DAI, and XRP—exist on their respective blockchains.

Why are there different types of blockchains?

Different blockchains have different technological purposes. Below are different technical factors that can change from blockchain to blockchain, thus affecting its utility:

Consensus Mechanism

Consensus mechanism is how security is guaranteed. All mechanisms involve selecting a subset of the community to add blocks to the blockchain and having others verify that the new blocks are valid. However, which subset of the community can add blocks and the effort and manner required to validate differ. Some popular consensus mechanisms are Proof of Work (i.e., Bitcoin), Proof of Stake (i.e., Binance Coin), and Proof of History (i.e., Solana). All have their own tradeoffs, mostly in the form of security, speed, and centralization.

Block Size

The size of a block means the amount of transactions that reside in each block. With the time between each block time held constant, increasing the size of blocks allows for more transactions per second and leads to reduced fees. However, increasing the block size means each validator must be able to process more data in the same amount of time, leading to hardware requirements to increase for each validator. This may lead to more centralization as only larger validators have the ability to perform their function. There was a whole civil war in the Bitcoin community about this, which ultimately led to the creation of Bitcoin Cash. 

Block Time

This is a similar design decision to block size, as a quicker block time means more transactions per second but also requires more powerful validators. 

Privacy

With most blockchains users are pseudonymous, meaning public blockchain addresses and transactions are open for anyone to see, but the identity of the owner of the blockchain address is unknown. On some privacy-specific blockchains such as Z-Cash or Monero, advanced cryptographic methods are utilized to further obfuscate transactions. These have received regulatory scrutiny because they present more risks in regards to anti-money laundering and other illicit activity.

Advanced Functionality

Advanced functionality allows individuals to transfer bitcoins to other individuals and store their cryptocurrency themselves. Ethereum (ETH) introduced smart contracts functionality. Other cryptos like Cosmos and Polkadot facilitate additional connectivity. Just because a blockchain offers more functionality does not mean it's strictly “better,” especially as many of these added features come with other tradeoffs.

How is blockchain technology used?

Contrary to popular belief, blockchains don’t exist for the sole purpose of cryptocurrency transactions. Instead, blockchains go beyond cryptocurrencies and can store information for various other things, such as:

Financial-type Transactions

Traditional banking and financial institutions usually take 1-2 days or longer to process transactions. Banks are typically server-dependent, which can cause hiccups and delays. However, blockchains can process transactions quickly and efficiently, sometimes confirming transactions within 10 minutes.

Currency

Blockchains enable cryptocurrencies to function through decentralization, reducing transaction and processing costs. Cryptocurrencies can also act as an inflation hedge, and blockchain tools can self-custody cryptocurrencies via crypto wallets.

Healthcare

Healthcare providers may use blockchains to preserve medical records safely. Once a medical record is created and signed, a patient receives assurance that nobody can alter or change their record. These sensitive health records are encrypted and secured by cryptography. Private keys allow only authorized individuals to access their medical records, ensuring their privacy.

Smart contracts

Smart contracts are algorithms built into particular blockchains. They automatically activate when two parties meet certain predetermined conditions, and facilitate agreements between parties without the need for a lawyer or other intermediaries. Blockchain platforms like Ethereum have grown in popularity due to smart contracts and other specialized dApps.

Property records

Recording property rights is a sluggish and monotonous task. It requires manual entry that goes through many individuals for scrutiny and approval. Blockchain technology can do away with the requirement of scanning papers by keeping property records on-chain, making owners confident of their accuracy.

Permissions and Controls in Blockchains

Although public blockchains are the most famous, blockchain permissions and controls can come in multiple flavors. Below are the four major types:

Public blockchains

Public blockchains are entirely decentralized, permissionless, and open-source, which means their data is available to everybody. They permit all computer systems equal access to the blockchain, the ability to add new data, and the power to verify existing data and new blocks. Public blockchains primarily use for mining, with the prime example being Bitcoin.

Private blockchains

Private blockchains, also known as managed blockchains, are not permissionless or completely decentralized. They’re managed by a single entity.

Consortium blockchains

Consortium blockchains are similar to private blockchains. However, instead of being controlled by a single organization, they operate under the management of a group of entities. They enjoy higher levels of decentralization than private blockchains, which means they're usually more secure than private blockchains.

Hybrid blockchains

Hybrid blockchains are managed by a single entity with some supervision by a public blockchain, which is necessary to carry out specific transaction validations.

What are the main advantages of blockchain technology?

Blockchain technology went mainstream with the launch of Satoshi Nakamoto’s Bitcoin whitepaper in 2008, which claimed blockchain technology and cryptocurrencies would act as an alternative to fiat currencies and traditional financial services.

Blockchains and cryptocurrencies are now cemented into the Internet, even helping it evolve. Here are the main advantages of blockchain technology that led to its growing popularity:

Decentralization

One of blockchain’s most appealing aspects is its decentralized nature, which helps eliminate the need for any intermediaries or central oversight. It majorly mitigates the risk of data tampering, and all transactions remain on the blockchain forever. It also helps in cryptocurrency transactions and has various use cases in financial services, healthcare, property rights, and more.

Transparency

Blockchains allow users to view all transactions present on their network. If an individual has a computer system linked to the network—called a node—they receive their copy of the blockchain and can explore transactions and data in real time.

Encrypted

Blockchains offer secure encryption for their users through private keys, which have digital signatures and unique codes only the owner can access. Only authorized individuals can view encrypted transactions and data, making them highly secure while preserving anonymity.

Security

Blockchains use a process called cryptography to keep them safe and secure. Cryptography, decentralization, and encryption boost blockchain security and reduce the likelihood of hacking and cyberattacks.

Process of transaction

Blockchain transactions usually have no processing or transaction fees and are much faster than traditional financial systems. Fiat currencies may take several days to see a transaction completed, while blockchain transactions can arrive in minutes.

Same access level for everyone

Blockchain’s decentralized nature enables a truly democratic ecosystem for one and all. Users with nodes have access to all data on the blockchain, allowing them to validate and approve transactions through common consensus.

What are the possible disadvantages of blockchain technology?

With it still being a new technology, many problems below may eventually be solved for. However, in its current iteration, there are definitely some disadvantages to blockchain over centralized technologies. 

Blockchain uses cryptography, which requires public and private keys. Private keys can cause users potential problems. For example, losing a private key or access to a crypto wallet could be detrimental to a user's digital assets, especially without the presence of any central authority to enable recovery methods.

Another drawback is the current limitation on scaling. As the number of transactions for each node is limited, completing many transactions could take a long time, sometimes even hours.

Blockchain’s permanence is another factor seen as a potential disadvantage. Immutability means that any data stored on the blockchain can’t be altered or modified. Once data is recorded on a blockchain, it remains that way forever. This is not desirable for all data, although it is for some. 

When is blockchain unnecessary?

Users often resort to blockchain technology due to its appeal and hype when other solutions might be more appropriate. For example, not every company needs to add a blockchain solution to their existing business processes. Many businesses view blockchain as a permanent record where nobody can alter their transactions. However, a blockchain isn’t required if these transactions are internal to the organization. Instead, the company can still use a traditional system.

The cost of blockchain storage can also be high, especially in periods of high demand. Trust, security, and governance levels of conventional cloud services are adequate for most current corporate applications. Additionally, several third-party data cloud storage platforms can offer greater protection with heavily reduced overhead costs.

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