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Blockchain explained - A basic introduction

Let's start to define blockchain and, from there, move on looking at all possibilities.

Blockchain definition

Blockchain is a registration system that can register any transaction of some sort. This transaction can contain details on data, cryptocurrencies, contracts, or other pieces of information. A peer-to-peer network of several computers worldwide registers all the transactions. Registrations are immutable.

Blockchain's potential

The potential for blockchain technology is enormous. The predicted global market value is considerable and the impact of blockchain on various industries is called disruptive. Let's take a look beyond this hype and find out what blockchain means.

Why blockchain immutability matters

In essence, blockchain is an immutable record or ledger. That means that on the blockchain, you can record data in an immutable timestamped fashion. That can be any type of data, being the mileage of your car or the number of cryptocurrencies you possess.

The car mileage is a significant factor of influence on the price when you want to buy a used car. In many cases, you pay too high a price because someone tampered with the mileage of the vehicle. This so-called odometer fraud cost European customers approximately 10 billion Euro, according to Carfax. This is where the blockchain comes in.

Blockchain allows for applications that can register car mileage in an immutable and accessible manner. Using such an application protects you from odometer fraud, so you can safely buy a used car for a fair price.

What is the use of blockchain?

Bitcoin is the first and foremost application of blockchain. Bitcoin is a digital currency that can be exchanged between two people. In the physical world, you would simply give a banknote from person A to person B. In the digital world, it's like sending money via a digital message from person A to person B. But how would you know person A owns sufficient money? Or doesn't spend it twice? Or that the digital message is fraudulent? To prevent issues with digital messages, they are validated by intermediaries or banks. These central authorities use central databases to keep track of who owns what, thus organizing the transactions and creating trust. The problem with transactions through intermediaries is that they cost money, time, and they depend on our trust in these banks.

To tackle these problems, Satoshi Nakamoto released a whitepaper on October 31st, 2008. He developed a method to exchange money between people via digital messages without the need for a bank. Probably it was no coincidence that this whitepaper was released only a bit more than a month after Lehman Brothers declared bankruptcy in September 2008, when trust in banks was at an all-time low.

How blockchain works

So, how does the blockchain bitcoin technology work? How can you safely transfer money from one person to the other without a central authority? To achieve this, blockchain relies on three leading technologies:

  • A ledger
  • Cryptography
  • A distributed network of computers also called a peer-2-peer network

Ledger technology is centuries old, like cryptography. Peer-2-peer networks are relatively new. It's the new combination of these technologies that give blockchain its unique character.

What is blockchain technology: blockchain ledger

Consider the ledger as a system to track and manage ownership of assets such as a house or the amount of cryptocurrency you possess. Cryptography is a technique that teaches us how to prevent third parties or the public from reading private messages. And a distributed network of computers is a group of independent computers that collaborate to secure and validate transactions.

Now, let's look at the Bitcoin example and see how these technologies contribute. The ledger tracks who owns which amount of Bitcoin. Executing a set of transactions means some people will have more Bitcoin, some less, and for some, the amount they possess hasn't changed. A block is a group of bundled transactions. These blocks are linked together in chronological order and are collectively called the blockchain.

What is blockchain technology: blockchain cryptography

Cryptography ensures that data admitted to the blocks is valid and that the blocks stay linked in chronological order. The result is a documented immutable record of all consecutive legitimate transactions. An essential criterium for a valid transaction is that a person spending the money owns the money. In real life, you can give one banknote only to one person. You want cryptocurrencies to behave in the same manner, even though you can copy data in the digital world. So, in the digital world, we need to tackle this double-spending problem. Satoshi Nakamoto's whitepaper has introduced a solution to this problem.

What is blockchain technology: blockchain peer-to-peer network

The peer-to-peer network ensures that every computer has a copy of the shared digital ledger. That means that it's no problem if a few copies get lost because there are always sufficient other computers that maintain a copy. Also, given the large number of participants in the blockchain bitcoin network, it's virtually impossible to tamper with a documented transaction. Because by design, the majority decides, tampering would require that at the same time on 51% of independent computers, the shared digital ledger would need to be replaced by a new copy that contains the fraudulent transaction. This is virtually impossible, and that's why you can't hack the blockchain.

Banks vs. blockchain: transferring money from A to B

To a large extent, today, we still trust banks to transfer money from A to B. Blockchain offers us an alternative means to do the same. Let's look at a few fundamental differences between the two:

  • Banks use classical databases. In traditional databases, you can create, read, update, or delete a record. On the blockchain, you can only create or read a record. The update and delete function were removed by design to ensure immutability.
  • Banks use central databases. Central databases make them vulnerable for a digital attack because hackers may corrupt, delete, or hijack the data. Blockchain uses a distributed network of computers, making them less susceptible to such an attack because many nodes maintain a similar topic.
  • The bank is the owner of the network and the database. On the blockchain, the participants share the network and the same copy of the ledger
  • To transfer money, you need an account. Everyone can have an account on Bitcoin, but not everyone can have an account with banks.
  • You either trust the bank as an institution, or you trust the protocol (and its creators) that runs the blockchain network.

In summary: What happens on the blockchain stays on the blockchain

So, what have we learned during this basic introduction on the blockchain?

  • Blockchain allows us to record data and transactions in an immutable manner: "What happens on the blockchain stays on the blockchain!"
  • The blockchain network bundles transactions in blocks and links these blocks together in chronological order. Hence the name blockchain.
  • Blockchain transactions do not rely on an intermediary. Instead, they rely on a combination of ledger technology, cryptography, and peer-to-peer networking.
  • Applications vary from exchanging digital currencies between people to recording car mileage to prevent odometer fraud when buying used cars.

More characteristics of blockchain

We introduced two applications of blockchain so far. But why is blockchain claimed to be potentially disruptive for many industries? Let's look at a few characteristics of the blockchain.

  • If you can transfer cryptocurrencies from A to B, you can transfer anything of value from A to B. For example, houses, digital rights, or heritage.
  • Blockchain has removed the need for intermediaries. So the corresponding costs and lead time introduced by these intermediaries can be removed from the value chain.
  • The blockchain community is introducing many new features including smart contracts enhancing the value of the initial bitcoin blockchain

Smart contracts allow us to execute transactions on the blockchain once they meet a set of conditions. For example, a house transfers from person A to person B and a sum of money transfers from person B to person A, as soon as person B has deposited an agreed amount of money on account XYZ before a specific date.

Today a notary validates person A owns the house, and person B has the money and facilitates the exchange of money. Executing real estate transactions on the blockchain means the contribution of the notary is no longer required.

Based on this example, you can easily imagine that as blockchain features grow more substantial, and many more use cases are going live, many industries may be disrupted.

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