What Is Blockchain and How Does it Work?

Blockchain technology might be one of the most talked-about new ideas of the 21st century. Blockchains were made to support Bitcoin, but now they power thousands of cryptocurrencies, and developers are working on ways to use the technology in medicine, art, and finance, among other fields. Understanding how blockchain works, why it's valuable, and how it differs from other internet technologies can help explain its growing popularity. Read on to learn more!

What Is Blockchain and How Does it Work?

What Is Blockchain and How Does it Work?

Blockchain is the underlying technology that keeps the transaction ledger for bitcoin. Because the data can't be changed or deleted, it has changed the way information can be shared on the internet.

Blockchain is probably best known for its use in Bitcoin, among other things. Blockchain technology can be used by financial institutions, health care providers, businesses, and more to cut costs, speed up transactions, and make sure data is safe. That's good news for both investors and consumers. Even though blockchain technology isn't widely used yet, it has the potential to completely change how we do business by giving us a trusted way to exchange information using cryptography.

“Blockchains are record-keeping backed by fancy math.“ — Edward Snowden

What Is Blockchain?

The name "blockchain" refers to the way transaction data is stored—in blocks connected in a chain. In 2008, a white paper titled "Bitcoin: A Peer-to-Peer Electronic Cash System" introduced both blockchain and bitcoin.

A blockchain is similar to a book with a list of transactions that each person in a network or group must be able to see and it is owned by every member. The book's pages are each a "block" of information or as the term goes , a “node”. The first entry on each page is the "hash" of the previous page, which serves as the page number for each individual page in the book. The "chain" connecting the pages or "blocks" of transactions together is that very first entry. 

For example, Blockchain resembles a sizable shared spreadsheet. However, unlike something you create in Excel, an entry made in the blockchain cannot really be changed once it has been made. This is so that the spreadsheet can be distributed across a large user base and be encrypted.

Note: Blockchain is not the same as bitcoin. Blockchain technology is used to keep track of transactions for the unregulated digital currency known as Bitcoin.

How Does Blockchain Work?

New entries are always added to the end of the chain (in "blocks"); existing entries cannot be changed. Additionally, every block is linked to the one before it by a string of numbers. The result is an informational history that cannot be changed.

There are a few steps involved in adding a new block to the chain:

Step 1: Transaction—A transaction of some kind must take place in order to begin the block. For example, someone might send money to another person. All participants, or nodes, are continuously converting transactions into new data blocks. Each node in the network must independently confirm that a newly filled block is valid using a challenging mathematical formula every time a new block is created. 

Step 2: Verification—A computer network verifies that the transaction's specifics are accurate. When sending money, for instance, the computers check the parties involved, the sum, and the date the transaction took place. To solve the given puzzle, machines with identical copies of the ledger "team up." When a team cracks the code first, they win, and all other machines update their ledgers to reflect the winning team's. Because it has the most computing power to complete its puzzle first, the majority is thought to prevail. Only when members reach consensus, via the consensus mechanism, that the new block is valid, is it added to the chain.

Step 3: Storage The verified transaction is stored in a block, which may also contain thousands of other transactions.

Step 4: Hash— The block is given a hash, or identification code. The new hash is produced by combining the hash from the previous block with a set of special numbers and letters. Since changing one block would necessitate altering the hashes of every other block in the chain, the connection between each block prevents the blocks from being altered or changed.

Because the technology prevents "double spending," blockchain and consensus are used in the networks that power bitcoin and other cryptocurrencies. After being spent, a bitcoin cannot be recovered; it is transferred from the sender to the recipient. Because hackers can't easily alter the data blocks, the transaction cannot be changed or undone.

Note: Bitcoin or another cryptocurrency is given to blockchain miners in exchange for confirming transactions.

Additionally, blockchain can operate with protocols, or a set of guidelines, that make the data useful. In order to automate a series of transactions based on the terms, such as purchase orders, invoices, and payments, smart contracts are protocols that work with blockchain technology. Because they decrease transaction errors, processing times, and administrative burden, smart contracts are an effective tool. For users, this translates to lower costs and higher profits.

Types of Blockchain 

Members of a public blockchain are not identified. Anyone who has the necessary amount of computer resources can join the network, process transactions, and validate blocks. The data on a public blockchain is visible to all users.

A consensus mechanism is used by users of a public blockchain network, such as the one that underpins bitcoin. Members of the public network who validate data blocks are known as miners. The goal of mining is to validate data blocks by resolving challenging mathematical equations in competition with other miners.

Because cryptocurrency transactions take place directly between the parties without the use of a financial intermediary like a bank, they are conducted on "permissionless," networks. 

All participants in a private, or "permissioned," blockchain must be identified and have the appropriate credentials or permissions in order to submit transactions and validate data blocks. Some users of a private blockchain might have full access to all data, while other users are restricted. Private blockchains are better suited for a single company.

Can Blockchains Be Hacked?

Although every member of a blockchain has a copy of all transactions, blockchains are not completely impenetrable. That being said, to create and accept fraudulent transactions, hackers need to have access to numerous different members. Blockchain hacking is very difficult and expensive due to the enormous computing power needed.

The Benefits of Blockchain

Trustworthy:  You can trust a record if it cannot be altered (the bank cannot unintentionally remove a zero from the end of your account, for example).

Decentralized: Since the blockchain is distributed across a large network, no single entity or organization is in charge of directing the information flow (or money).

Security: It is virtually impossible for one person or an organized group of people to hack the information because it is encrypted and decentralized.

Blockchain & Bitcoin

Bitcoin, arguably the most popular cryptocurrency in the world, relies on Blockchain to keep track of its owners and to create new Bitcoin.

When a transaction is finished, computers called "miners" begin attempting to solve challenging math problems to confirm the transaction.

The next block can be added by whichever miner finds the answer to the issue first (the solution serves as that miner's "proof of work"). Bitcoin is given to the miner as payment. A chain is created by connecting each block to the one before it. These links in the chain are time-stamped, made public, and cannot later be altered.

It's crucial to adhere to best practices for online security if you choose to purchase and hold Bitcoin. For long-term storage, think about using a hardware wallet to maintain the highest level of security. 

To get started today, speak with one of our advisors, we would be happy to help!

The Impact of Blockchain on Banking and Financial Services

Blockchain is being used in a variety of ways by the banking industry and other sectors, with or without Bitcoin.

A secure "ledger," or tally of transactions, is a blockchain. Two important characteristics of blockchain—which are described below—are what make it useful.

1. Cheaper Money Transfers

Banks are already utilizing blockchain for remittances, which is an area that needs improvement in the sending of money to other countries. Every year, consumers and companies send and receive hundreds of billions of dollars internationally, but the process has typically been time-consuming and can be very expensive.

Despite the fact that Bitcoin offers an "alternative," traditional banks and service providers are also utilizing blockchain technology to enhance remittances and reduce exposure to cryptocurrencies.  In the past, the individual would have had to travel to a money transfer office, wait in line for an agent, pay cash, and pay a sometimes exorbitant fee to complete the transfer. The recipient might follow a similar process. But with blockchain technology, both parties can complete an electronic transfer with mobile phones—and pay far less.

2. Cheaper Direct Payments  

Processing costs that merchants incur when customers pay with cards reduce profits. For some businesses, less expensive blockchain payment networks might be an option. Increased competition should at least result in lower prices. Blockchain-based payments can give merchants certainty in a matter of minutes, for instance, when you have insufficient funds (or less).

 Although online "buyers" might try to con you, blockchain-based payments ought to be quick and irreversible, and they should also be simpler and more affordable than bank products. For instance, it's imperative to get paid before giving the keys away if you're selling a costly item like a car.

3. Blockchain Can Track Ownership

Ledgers can make tracking ownership simpler and more effective because they are difficult to alter. A reliable source of information about almost any type of property can be obtained by recording each transfer of ownership (as well as liens and other events) in the ledger.

4. Blockchain Can Reduce Fraud

Blockchain technology can be resistant to fraud and hacking. Through a blockchain-enabled digital ID, it can also assist banks and other organizations in quickly and accurately identifying individuals. Fraud is less prevalent, costs of doing business are lower, and presumably everyone benefits from the savings.

5. Economic Inclusion and Other Options 

Blockchain and other technologies can advance financial inclusion by keeping costs low and enabling startups to compete with large banks. Solutions based on blockchain may be more beneficial for those who avoid bank accounts due to high fees, minimum balance requirements, and accessibility issues. They require a mobile device, not assets or steady income. Digital IDs can offer a comprehensive solution in circumstances where it is typically challenging to identify specific individuals.

Wrapping Up 

Blockchain is a massive, uneditable public database of transactions. This increases the security of transactions and makes them harder for hackers to tamper with. The most well-known application of blockchain technology is Bitcoin, but it may also be helpful in other fields. 

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About the Author

As Managing Partner of Vincere Wealth, Josh assists clients in navigating financial challenges and making sound financial decisions. Having someone guide you in making sensible financial decisions today can have a substantial impact on your future financial wellbeing. Josh takes great pride in guiding customers through the complexities of taxes, real estate, businesses, employer stock and international financial planning.

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