What is blockchain?

Blockchain technology can be overwhelming at first, but understanding some of these key features can make you a Web3 expert in no time. You might think that all blockchains are as secure as Bitcoin, and all blockchains are as powerful as Ethereum. But in reality, there are huge differences between different blockchain networks. From blockchain governance to the creation of new coins to who can join the network; blockchains have features that change the way the entire network operates.

Some blockchains are better than others for specific use cases, but different blockchains have their own strengths and weaknesses. So, in this article, Ledger Academy will take a closer look at what blockchain is, how it works, and the different types of blockchains and their uses.

But before we dive into the technical details, let’s first understand some basics.

What is blockchain?

In simple terms, blockchain is an immutable, distributed digital ledger that records transactions and tracks the transfer of digital assets on the network. Initially used to track financial assets, blockchain has become an ideal means of storing value, and its use cases are growing. Blockchain has some key features that can open up a world of new capabilities, a concept also known as “Web3.” So what are these key features?

Key features of blockchain networks

There are many other features of blockchain that cannot be ignored. But these features are based on two pillars: distributed ledger technology and immutable records.

Distributed Ledger Technology

Instead of hosting its information on a single centralized server, blockchain distributes its ledger to every computer in the system. These computers, called nodes, are responsible for storing, sharing, and recording information and the transfer of digital assets. This is the basis of “distributed ledger” technology and the only way blockchain can store information securely.

Unchangeable records

Secondly, blockchain uses a unique way to store information: in-block storage. The blocks that store new information are arranged in a chain and distributed throughout the network, hence the name “blockchain”. It should be noted that this specific data structure ensures that once information enters the blockchain, it cannot be changed. These characteristics make blockchain almost impossible to be hacked.

What is the purpose of blockchain?

You might be wondering why this is so important, aren’t you doing digital transactions all the time? But sending money digitally is very different from sending information like emails or pictures.

For money to have value, its supply must be limited. A successful digital transaction must have the receiver receive value and the sender’s account deducted by exactly the same value. Otherwise there is a double spending problem.

You may not be familiar with this term, but it is a key foundation for our entire financial system and the banks we trust. Blockchain technology solves the double-spending problem while eliminating the need for a centralized entity to verify transactions. This means that large-scale peer-to-peer value exchanges can be transparent, secure, and anonymous. What does this mean?

Simply put, solving the double-spending problem means that the blockchain allows you to exchange value with your friends, ensuring that your assets are transferred from your account to the other party’s account. The key point is that it must be able to achieve the transfer while not allowing participants to use the assets to pay again, ensuring that no new assets are generated in the system.

Types of blockchain

There are many ways to build a blockchain network, more than you might think. When most people refer to blockchain, they are referring to a decentralized blockchain like Bitcoin. But it is worth mentioning that this technology can also be used to build centralized systems.

Blockchain supports peer-to-peer transfers and decentralized value exchange, but this does not mean that all blockchains operate in this way. Blockchains include public blockchains, private blockchains, permissioned blockchains, and blockchains established by consortiums. Some are even a combination of several of these types.

So we need to understand the difference between different types of blockchain networks and their importance.

Private blockchains, permissioned blockchains, and consortium blockchains

Permissioned blockchains are operated by a single entity, such as a government or company. As a result, the centralized entity can restrict access to the system and who can run a node. Also, those who run nodes have a lot of power and the potential to abuse that power.

Next up are private blockchains. Obviously, these types of blockchains are always permissioned. But there’s more to it than that. Private blockchains not only restrict who can run a node, but also who can access the system. It’s a completely centralized system that allows entities to protect the identity and data of users. Therefore, governments or trade organizations tend to use these types of systems to maintain control over the system and its data.

Hyperledger is a typical example of a private blockchain. In this case, using a private system prevents others from snooping on user data (such as delivery information). Using a public and transparent blockchain would bring privacy risks.

Secondly, consortium blockchains are also permissioned blockchains, but instead of being governed by a single entity, a group of organizations are responsible for managing the blockchain. Many financial systems that are willing to cooperate tend to adopt this approach. This type of blockchain uses a voting system to verify information changes, so transactions can be processed quickly.

However, all of the above are extremely centralized solutions, which means there is a single point of failure and is very unsafe.

Permissionless and public blockchains

In contrast, permissionless blockchains allow anyone to run a node in the network. Such systems tend to have more participants, who can run nodes from anywhere in the world.

This characteristic does make it slower than private and permissioned blockchains. However, the larger the system, the easier it is to police malicious actors. The decentralized nature of permissionless blockchains makes them more secure than private blockchains.

Obviously, public blockchains are also permissionless. Not only do they allow anyone to join the network, but they also treat all nodes equally, and every participant can easily access all data on the network. Public blockchains are transparent, secure, and auditable, making them ideal for cryptocurrencies. The Bitcoin network is a classic example of a public blockchain.

How does blockchain work?

As mentioned earlier, a blockchain network stores data on all computers participating in the network, also known as nodes. Cryptocurrency nodes contribute to securing the network by participating in the transaction verification process. Each node stores information in the form of blocks. All these blocks are then arranged into a chain. Every time a transaction is processed by the network, the chain grows.

However, nodes do not store information in a human-readable form. Instead, they use a cryptographic hash string. To protect sensitive information contained in transactions, nodes convert the information into a string of numbers and letters that is then stored in each block.

These cryptographic hash strings include not only the information of the corresponding block, but also the information of the previous block on the chain. In other words, if someone wants to change a block, they will change the corresponding hash string, and all subsequent blocks on the chain will also change. This makes any modification have a very obvious impact on the entire network, so it is very secure. The earlier the transaction in the blockchain occurs, the more difficult it is to change the transaction data. This ability makes the blockchain an irreplaceable medium for storing important data. For more details, read the full article on blockchain transactions and nodes and how to run a node.

Next, we need to understand how blockchain stores information.

But you may be wondering, “Why wouldn’t nodes lie about the state of the network for their own benefit?”

It all comes down to the type of blockchain and its consensus mechanism.

How does blockchain ensure security?

For private, permissioned blockchains, the controlling entity often uses a voting mechanism, but public blockchains such as Bitcoin or Ethereum have found a more decentralized way to ensure security: using a consensus mechanism.

What is a consensus mechanism?

This is the smartest part of public blockchains: there are thousands of nodes distributed around the world, and every new transaction must be verified by a majority of nodes before it can be added to the blockchain. After a block is added, the state of every node on the blockchain must remain consistent. This is also called reaching consensus.

The management of the blockchain ledger is so widely distributed that no single entity can control the network or verify false information. Therefore, the security of the entire network is guaranteed. However, due to the different consensus mechanisms used by blockchains, these nodes process transactions in slightly different ways. In addition, each method has its own advantages and disadvantages.

For a deeper dive into the differences, read this full Ledger Academy article on what is consensus .

Different consensus mechanisms

There are two main types of consensus mechanisms for public blockchains: proof of work and proof of stake. However, there are several other less common consensus methods that are more centralized.

Proof of Work (PoW): This is a slower, more secure consensus mechanism that uses miners to create new coins and process transactions, requiring miners to solve complex puzzles that require a lot of computing power. This mechanism ensures network security because mining using large amounts of energy is extremely expensive, and it is pointless for miners to try to cheat the system. Bitcoin is a classic example of a proof-of-work blockchain.

Proof of Stake (PoS): This consensus mechanism uses validators to process transactions, which is faster and more energy-efficient. Instead of using computing power to prove their trustworthiness, validators in a proof-of-stake blockchain use large amounts of cryptocurrency as collateral. For more information, read this full article on cryptocurrency staking , but basically, validators are incentivized to behave honestly. In short, they are rewarded for good behavior and punished for bad behavior. Ethereum is an example of a blockchain that uses proof of stake.

Blockchain: What else is worth watching?

You might associate blockchain technology directly with cryptocurrency, but it actually means much more than that. Blockchain is not just about cryptocurrency and finance, there are several other new uses for blockchain networks.

For example, some blockchain networks are able to execute smart contracts , which are like the blockchain version of computer programs. Smart contracts are not very technical, but they have set off a cultural revolution in the field of blockchain technology.

These computer programs make it possible to create blockchain applications with a variety of use cases .

For example, only with the support of smart contracts can it be possible to create decentralized financial applications that provide lending services . In addition, blockchain games and blockchain artworks in the form of non-fungible tokens are also inseparable from it. These programs also create opportunities for decentralized metaverse platforms such as The Sandbox and Decentraland .

Not only that, blockchain technology even has the power to change the way we govern. It is thanks to the emergence of coins and tokens that we can create complex decentralized voting mechanisms in the form of decentralized autonomous organizations (DAOs).

As innovation in the Web3 industry continues to grow, the potential for more use cases also increases. In short, blockchain technology is here, and no one knows how much more it will create in the future.

Ledger