What is Blockchain Technology, and Why Does it Matter?

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By Max
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What is Blockchain Technology

Whether you invest or not, the blockchain and crypto space has become too big to ignore. And for someone who never bought a Bitcoin, it can feel overwhelming. One of the reasons is that you can’t explain crypto without explaining blockchain technology.

It’s omnipresent. This term appears on whitepapers, the news, videos, and social media. If you heard anything about altcoins, NFTs, or the Metaverse, it’s all linked to blockchain technology.

This abstract term becomes broader as more use cases appear. But once you learn how blockchain technology works, everything that derives from it becomes so much clearer. So if you want to learn the basics and how to find the most promising projects, keep reading.

How does Blockchain work?

By definition, a blockchain is a distributed financial ledger.

The block is all the data related to a transaction. The chain is the way users add these blocks. The result is a chronological, immutable database of financial records shared by everyone in the network.

Want a more tangible explanation? Take Bitcoin for example:

  • There’s the transaction database, which looks something like this.
  • There’s a group of devices that keep an updated copy of this database (nodes). Anybody can become a node following the steps on Bitcoin.org
  • There’s a consensus mechanism (in Bitcoin’s code) that decides who should update the official database

Nodes can also become validators and earn financial rewards by verifying transactions. This is an automatic process that depends on the software (e.g., Bitcoin Core) and consensus algorithm. In proof-of-work algorithms like Bitcoins, they’re called miners.

Blockchain Technology Example

So how do all these pieces work together? Here’s a simplified sequence when making a payment:

  1. Validators add your transaction data to their block along with other transactions
  2. Once the block reaches the size limit, it will generate a unique code derived from that data (hash)
  3. The next block does the same. It generates a hash out of transaction data AND the previous block hash. Otherwise, the block is invalid.

This is why blockchain is nearly immutable. If you change a single number, the hash changes, affecting all blocks that follow. With enough blocks, the chain becomes irreversible.

However, every validator builds its own chain. Assuming they’re all valid, the consensus algorithm decides which one will be the official blockchain. In proof-of-work, the longest chain wins, and it’s a competition for computational power.

  1. Once your transaction has enough confirmations, the validator is chosen, and your transaction is complete.

(Confirmations are the number of blocks built after yours.)

Note: It’s not one transaction per block, but as many as the size allows. Bitcoin blocks are 1MB, which allows for ~500 transactions (hence why they take longer).

Lastly, blockchains can be private (permissioned, centralized) or public (permissionless, decentralized). Centralized blockchains are the same, except all nodes belong to one entity.

What are smart contracts?

Smart contracts extend the applications of blockchain to all services that would normally involve trust. Financial services for the most. Smart contracts are the foundation of DeFi platforms, NFT marketplaces, and Metaverse games.

Smart contracts are blockchain programs that manage financial services with full autonomy. To interact with these, you’ll need to create a WEB3 wallet, add funds, and connect to a blockchain that supports them. From there:

  1. Visit a decentralized application (dApp)
  2. Select your service and preview the quote
  3. Confirm the smart-contract fee to complete

When combined with oracles, smart contract possibilities are almost unlimited. For example, bet $100 of ETH if it rains in NYC tomorrow at 5 PM. 

What is a crypto wallet?

Unlike physical ones, crypto wallets aren’t exactly digital wallets. That’s the application linked to it, but the wallet itself is a cryptographic key. In other words, a password you enter on the wallet app to prove your ownership of all assets sent to your address. Cryptocurrencies, utility tokens, NFTs.

The simplest type is a custodial wallet. When you register in a centralized crypto platform, it will generate a wallet for your account. The platform holds the private keys (password), hence why it’s called “custodial.” If they close your account, you lose your wallet.

WEB3 wallets are the most popular because they can connect to 100s of dApps. Non-custodial wallets, however, are more complex:

  • There’s a public key that’s always visible and appears on top. This is the address you share to receive payments.
  • There’s a different private key for every network to access the address’ funds. It’s hidden in the Settings, and you should never share it with anyone.
  • There’s a seed phrase when creating the account. When you install the app on another device, you type this phrase to import all your private keys and funds.

If you lose your private key, you can always enter the seed phrase and reveal it. If someone has it, they can spend your funds on that network. E.g., If you have $1000 of crypto in BSC Network and $0 in Ethereum Mainnet, you won’t lose anything if someone steals your ETH private key.

A seed phrase would give access to all your funds everywhere. Luckily, the funds don’t show directly on new devices. You have to manually add every network and token address.

Difference between blockchain and cryptocurrency

We’ve used cryptocurrency examples because it’s the most relatable to blockchain technology. But there are many blockchain use cases that don’t need cryptocurrencies:

  • Smart contracts
  • Supply chain management
  • Clinical trial tracking
  • Financial data management
  • Central Bank Digital Currency (CBDCs)
  • Election fraud prevention
  • Decentralized oracles

Financial institutions prefer centralized blockchains for high-speed, low-cost transactions. Governments may want private blockchains where only verified citizens can participate. Blockchain doesn’t involve cryptocurrency necessarily:

  • Cryptocurrencies are one application of blockchains
  • Cryptocurrency can be anonymous, but blockchains are transparent
  • Blockchains can record any currency, not just cryptocurrencies

You can also invest in blockchain without any tokens. For example, buying companies that develop blockchain technology. Or brands that implement crypto payments (e.g., VISA stock).

What are the different types of blockchains?

Whenever you read “blockchain” in crypto, it typically refers to public, permissionless, decentralized blockchains. 

  • If it’s public, anyone can use the blockchain. If it’s private, a 3rd party sets an entry barrier to decide who can participate (e.g., company members).
  • Permissionless and permissioned blockchains are synonyms respectively.
  • If it’s decentralized, the blockchain is autonomous and trustless. If it’s centralized, a central authority controls the network. The number of validators, consensus model, smart contracts, token supply, and fees.

Note:

  • Private blockchains aren’t necessarily centralized. Maybe it’s a large organization, or you just need a minimum token amount to participate.
  • All blockchains are distributed, but not always decentralized. Distributed means that there’s no single point of failure. It’s several nodes holding copies of the updated database.
  • Cryptocurrencies can be somewhat centralized. The highest-performing networks (BSC, Solana, Ripple) trade decentralization for efficiency.

Decentralized blockchains often host the most innovative projects, including Pulsechain and LiquidLoans.

Private versus Public Blockchain

The difference between public and private blockchains is the authority. If there’s no central authority, it’s a public blockchain, and probably a cryptocurrency. If there is one authority, it’s a private blockchain.

If there are many authorities, it’s a decentralized variety of private networks. A consortium blockchain.

Public blockchains can become partially private, AKA hybrid blockchains. Users could vote to keep certain transactions private or limit who can join the network.

Advantages to Blockchain

There’s no doubt blockchain is the real deal. Not only has it changed a lot since the first Bitcoin, but there’s more and more money moving into blockchain technology. In the early days, experts used to say: “cryptocurrency could be a bubble, but blockchains are the future.”

What did they mean?

Blockchain is trustless

Imagine what people could build together if they didn’t need to trust each other. It’s already happening:

  • Decentralized autonomous organizations (DAOs). People get fair decision power on projects they believe in.
  • Central Bank Digital Currencies (CBDCs). Institutions can use blockchains to better store value and pay internationally.
  • Decentralized Oracles. We finally have reliable, trustless sources of information. Transparent data that can directly interact with smart contracts.

Before blockchain, trust was the only choice, and a costly one. You may not trust that the other party will comply. You may not trust the third party’s goodwill, or maybe the other party doesn’t.

Blockchain smart contracts don’t allow intervention. Any manipulation is futile because…

Blockchain is immutable and secure

It’s ridiculously expensive to attack a network. In proof-of-work blockchains, you need to have more than 51% of the computing power of the entire network. In proof-of-stake, you have to own +51% of the total-value-locked, which ranges in the billions.

If you want to manipulate a transaction block, it will only be accepted if you manipulate every block built after it. Every block makes cyber threats more expensive. And most blockchains add new blocks in less than 15 seconds (3s on Pulsechain).

Many altcoins update their chain version every few months. Their DAOs regularly look for bugs to eliminate and ways to improve efficiency.

Blockchain can be decentralized

Blockchain technology introduces decentralization. Private networks don’t necessarily need it, but there’s a lot of interest from developers. Because in today’s uncertain economy, people need reliable systems to manage finance.

The potential global crisis shows how ineffective traditional finance is to protect people’s interests. Blockchain, on the other hand, allows them to save, vote, and trade without having to trust anyone. Because there’s no authority, users can make decisions based on transparent information.

Blockchain is accessible

Everyone can create a crypto wallet. It’s so easy that anyone can. Download the app, click a button, set a password, save the seed phrase, and it’s ready to use.

There’s no registration, and it’s available everywhere worldwide. Unless you’re using Ethereum, cross-border payments are fast and inexpensive. The only caveat is, there aren’t enough on-and-off fiat ramps yet.

The more accessible, the more decentralized.

Disadvantages to Blockchain

While blockchain sounds too good to be true (and it is), it’s not as easy as it sounds. Every pro has a con, and blockchain technology is no different. The problem is…

Blockchain is work-in-progress

In traditional finance, at least we know everything wrong. It’s been hundreds of years. You can’t say the same about blockchain.

The most dangerous disadvantages are those you don’t know. If you can’t see them coming, how can you manage risk? The blockchain world is full of scam coins, DeFi rug pulls, Ponzis, exchange breaches, and bug exploits.

On centralized blockchains, the risk comes from the party managing it. On decentralized blockchains, everyone’s to blame, and no one to help you.

Blockchains are confusing legally

Not only can’t we see what’s wrong. But when things go wrong, we don’t know who is responsible for it. Users, developers, validators?

On centralized blockchains, the organization is clear. But if decentralized, even private networks are unclear. By legal definition, a DAO is a limited liability company (LLC) with no single decision body.

Decisions are made from the bottom up. For users, this means:

  • Due to the voting majority, DAOs will sometimes approve decisions you disagree with
  • The DAO might be responsible for your losses, but no one is required to repay you (if smart contracts don’t specify it)
Blockchains are either efficient or decentralized

You can’t find a single network example that hasn’t sacrificed one for another. If you research the fastest blockchains in CoinMarketCap’s Top 10, you’re going to find just that:

  1. There are only 21 validators
  2. A private company owns the public blockchain
  3. There are “super-representatives” with more voting power than others (e.g., 90%)

Because decentralization isn’t often a priority. For example, Bitcoin is a decentralized blockchain. It has 10 minutes of block time and average fees of $1 to $2 ($30 to $50 during network congestion).

The most efficient blockchains have block times below 1 second and fees below a cent. If you want to trade crypto at the best rates, would you choose Ethereum or the most competitive one?

Scalable networks gain more users, which means more revenue for validators. Many smart-contract competitors will give up decentralization to outcompete Ethereum.

And if you somehow achieve both, it may compromise security (see the blockchain trilemma).

Blockchain security is expensive

Proof-of-work is one of the most secure consensus mechanisms. However:

  • Every block mined makes the next one more difficult. Validators will need more computational power to succeed.
  • Block rewards tend to decrease over time. So there are fewer incentives to ensure network efficiency and security.
  • PoW isn’t scalable. More users joining the blockchain will reduce its efficiency.

A better alternative is proof-of-stake. This way, validators simply need to hold tokens for long enough to win blocks. Again, there are challenges:

  • High TVLs improve security, but also reduce staking rewards for smaller, newer users
  • Not everyone can become a validator on high-yield PoS blockchains. Just to qualify on Ethereum, you need to stake 32 ETH. On Binance, it’s 10,000 BNB ($1M+).
  • Running nodes requires minimum hardware and technical knowledge.

We’re yet to see a blockchain that balances scalability, security, and decentralization. Could Pulsechain be the one?

The Future of Blockchain

Blockchain is the beginning of many exciting movements: NFT marketplaces, P2E games, Metaverse companies, DeFi services, Web 3.0. All these need blockchain technology with smart contract functionality. That’s why Ethereum hosts more projects than any other network.

But Ethereum isn’t scalable enough to offer competitive fees and speed. Hopefully, the Pulsechain hard fork will remove those limitations. This way…

  • Developers can keep building on Ethereum
  • Users get lower fees on the largest dApp blockchain
  • Traders get a copy of all their ERC-20 tokens on Pulsechain
  • Smaller ERC-20 projects can grow faster as PRC-20s
  • And the Ethereum ecosystem remains relevant in the market

While no one knows what the future will bring, we know blockchain is here to stay. The easiest way to be ready is to find and hold the most promising utility tokens. Many are already on Ethereum and, very soon, on Pulsechain.

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Disclaimer:Please note that nothing on this website constitutes financial advice. Whilst every effort has been made to ensure that the information provided on this website is accurate, individuals must not rely on this information to make a financial or investment decision. Before making any decision, we strongly recommend you consult a qualified professional who should take into account your specific investment objectives, financial situation and individual needs.

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Max

Max is a European based crypto specialist, marketer, and all-around writer. He brings an original and practical approach for timeless blockchain knowledge such as: in-depth guides on crypto 101, blockchain analysis, dApp reviews, and DeFi risk management. Max also wrote for news outlets, saas entrepreneurs, crypto exchanges, fintech B2B agencies, Metaverse game studios, trading coaches, and Web3 leaders like Enjin.

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