What blockchain technology is in simple terms

Decentralization

The definition of blockchain as a database provides for the autonomy of each node connected to the network. If you analyze the structure of the Bitcoin cryptocurrency, it is noticeable that none of the wallets are privileged. At the same time, blockchains of other projects may have a more centralized hierarchy. In some cryptocurrencies, transaction confirmation is entrusted to control nodes(nodes). But even in this case, payment processing is decentralized and performed simultaneously on multiple devices. This feature is important in terms of security and user trust.

The server of an ordinary bank, exchange, credit organization can be hacked or disrupted. Information in this case will be lost. If customers do not have paper documents confirming their ownership of the deposit, their savings may be lost.

In decentralized networks, the failure of one or more nodes will not result in the loss of financial information: the data will be retained by the other participants. Even if the world’s internet or electricity goes down, the blocks of the blockchain will not be destroyed. Important information will remain on physical media and will be restored after the outage is resolved.

The blockchain platform can work as long as at least one computer is connected to it. To destroy or tamper with data, most nodes would have to be taken over, which is nearly impossible for large projects like Bitcoin.

Protocol

Blockchain projects use different schemes of interaction between network participants. The order of information exchange and ways of confirming transactions make up the protocol written in the source code of the application. This can be compared to the rules of companies that operate on ordinary websites. If you read the user agreement in any Internet service, it will specify:

• Terms of registration on the site.
• Methods of order placement and payment.
• Term of delivery of goods or performance of work.
• Dispute resolution procedure.

The blockchain network is organized in a similar way. With the help of a protocol in it are established:

• Mechanisms (algorithms) of transaction confirmation.
• Type of data encryption.
• The size and frequency of formation of new blocks.
• The conditions of mining and the procedure for calculating rewards for confirming transactions.

A key parameter of the blockchain protocol is the consensus (transfer verification) algorithm. This mechanism helps to determine whether a transaction is valid or not. A blockchain system can utilize such algorithms.

Miners

The first cryptocurrencies (including Bitcoin) used the Proof-of-Work consensus algorithm. To get a reward, a miner had to repeatedly solve problems (calculate hash functions). This process can be compared to an accountant or auditor checking the records of several companies:

1. The specialist compares the accounts of several companies and calculates their total balance sheet.
2. If the data coincide, it means that there are no irregularities and the transactions are recognized as reliable.
3. In case of a shortage at one of the companies, suspicions arise as to whether the employee who prepared the report has cheated. If there is such an assumption, the transactions between these counterparties are canceled.

Miners perform similar actions, but since the volume of information is very large, they have to use the computing power of computer devices (graphics or central processing units). To increase profits from block mining, special apparatuses – ASIC-farms – are created. This device looks like a beehive, in which instead of honeycombs inserted video cards. The computing power of farms for mining far exceeds the similar indicators of personal computers and laptops.

Nodes

Since blockchain projects are peer-to-peer, they do not have a main (primary) server. A computer connected to the network can transmit information to other users. Accordingly, each device is an independent node (node). The computers of the participants are not always equal. Usually distinguish such types of nodes:

• Full. Contains data about all transactions that occurred between users.
• Light. It is needed for client access to transfers within the network. Does not contain complete data. An example of a lightweight node is a mobile device with a cryptocurrency transfer application installed. Through it, the client makes new transactions, but does not see information about past transfers.
• Privileged (masternode). Possesses extended rights in terms of transaction verification. In some networks, the masternode status is assigned to the most reputable wallet owners. You can become a privileged participant for a reward (a large investment in the project).

Creation and verification of new blocks

The purpose of cryptocurrencies is financial settlements between users. Therefore, blocks store information about the transactions made. If we describe this process in clear language, the creation of a blockchain looks like this:

1. Miners select a certain number of new transactions to be entered into the blockchain. Requests with the highest fees are prioritized.
2. After a certain period of time (about 10 minutes for Bitcoin), the selected transactions are added to a new block.
3. The miners perform hash function calculations. If to explain on fingers, the process of transaction verification can be visualized as a comparison of data entered into the blockchains of different users. The correct chain is recognized as the one that matches the other participants in the network.
4. After transactions are verified, a new block is assigned its own digital signature (hash). This cipher is used to determine the authenticity of the transactions included in it.

Types of blockchains

A distributed ledger can be used in different spheres of activity: finance, voting, data exchange between users. In this regard, there are several types of blockchains:

• Public. For dummies, this type of blockchain can be described as a public project that any users join. Examples include Bitcoin, Ethereum.
• Private. In short, it is a closed community, registration in which is available only by invitation. An example of a private blockchain can be a decentralized voting application or the internal network of a private company.

In addition, exclusive (multi-level) blockchains are sometimes distinguished. In such networks, wallet owners have equal rights and free access, but only privileged participants can confirm transactions.

Private

Distributed databases are used not only as a means of payment, but also in other industries. With the help of blockchain technologies, they conduct voting, transfer files, conclude smart contracts. Closed (private) blockchains are suitable for these purposes. Access to registry records is granted only to individual clients. Within such a network, transactions are verified both by all participants and by a single, main server. Private registries have several advantages:

• Confidentiality. If the network is needed to transfer valuable information (personal documents, correspondence), only community members should have access to the chain.
• Speed of transaction processing. A transfer can be confirmed instantly by a separate masternode.
• Low costs. If there are no private miners in the network, it is not necessary to set attractive commission rates for them.

Public

The public blockchain is arranged as a fully decentralized network. Wallet owners have equal rights and can participate in verifying transactions and mining new blocks. There are several advantages of this type of registry:

• Protection from rash decisions by the administration. Each wallet owner can accept or reject changes to the source code proposed by the developers. This ensures the stability of the network.
• Broad access. Payment gateways, crypto exchanges and investment projects can attract users from different countries and constantly expand the client base.
• Trust. The essence of a public blockchain is the ability to verify the digital signature (hash) of each transaction. Customers replace any fraud in the chain.

Security of blockchain technology

The advantage of distributed registries is the inability of outsiders to change important information. This means that attackers do not have access to already mined blocks. Even if one node introduces unreliable data (a fake transaction) into the chain, the network will accept only those blocks that match on 51% of computers. The essence of hashing is that if at least one character is replaced, the function will be recalculated with a different result. As a result, the fake block will simply drop out of the chain, and the blockchain will return to its previous state.

Implementation in the Bitcoin system

An overview of distributed networks is usually made using Bitcoin, the most famous blockchain, as an example. The Bitcoin environment has these parameters:

• Transaction information is publicly published. Some sites store complete transaction data.
• Transactions are validated using the PoW method. Payments are verified by other users (miners) who provide computing power (ASIC farms or video cards) for this purpose.
• Digital fingerprints (hashes) are generated using the SHA-256 function.
• A new block is mined approximately every 10 minutes. The generation time is independent of the number of transactions. After the next 2016 blocks, the computational complexity increases. This protects the network from being taken over by large pools of miners.

The Bitcoin protocol is characterized by such pros and cons.

Applications in society

Blockchain technologies are used not only as the basis of digital currencies. Distributed registries have these applications:

• Automatic contract enforcement. An algorithm that prescribes the terms of a transaction between two parties can be brought into the decentralized network. Such a contract, called a smart contract, is processed without the involvement of an administrator (intermediary), which guarantees the fulfillment of obligations. For example, the parties can prescribe an algorithm by which money is credited to the seller’s account only after he transfers a program or other asset to the buyer.
• Electronic voting. Decentralized voting applications are reliably protected from fraud and interference of interested parties. The citizen’s wallet is credited with a virtual coin that will be applied as a ballot. Data encryption makes it impossible to identify the participant, but at the same time anyone can see the election results.
• Copyright registration. The digitized code of a painting, app, or other intangible asset can be stored in the blockchain. This technology is called NFT (non-fungible tokens).
• Stock asset trading. Digitized stocks, bonds and other securities can be traded on a decentralized network.

Advantages of blockchain technology

Distributed databases have these advantages:

• Security. A registry entry cannot be tampered with. Hacking requires control over 51% of the connected computers. Even in the event of a major disruption (such as a natural disaster), valuable information will not be lost.
• Automation. Decentralized networks function without the involvement of administrators. Transfers are processed automatically.
• Low fees. The amount of the fee does not depend on the amount of the transfer. Since the volume of the transaction does not affect the speed of inclusion of the transaction in the next block, it is advantageous for users to use cryptocurrencies for large transactions.
• Anonymity. To create a cryptocurrency wallet, it is not necessary to confirm personal data. At the same time, blockchains are not completely anonymous: information about transactions is freely available. The sender or recipient can be identified by various parameters, including IP address.
• Uniqueness of information.

Security

Centralized projects have a vulnerable place – the main server. Sometimes, stealing the administrator’s password and transferring savings to personal accounts is enough to steal money from a bank or exchange. In cryptocurrencies, each wallet stores a separate copy of the block chain. Transactions are processed not by the server, but by other users, and the rights to digital currency are confirmed not by a password, but by a private key. Under such conditions, criminals can only hack into an individual computer, but not the entire environment.

Automation

As digital technology evolves, it will be possible to move to blockchain in many areas. Instead of a single database of customers, it is more convenient to connect them to a decentralized network. Their requests will be processed automatically, without necessarily collecting personal information.

Reduced fees

In some blockchain projects, miners do not participate in the confirmation of transactions. Counterparties pay a minimal fee to support the management servers (nodes). Unlike banks and private financial companies, cryptocurrencies have no owner. Therefore, some decentralized networks can operate on a non-commercial basis and allow counterparties to transfer currency for almost free.

Anonymity

Banks and financial companies verify the identity of customers. This information can get to attackers. In addition, financial legislation is gradually becoming stricter. A number of countries have adopted laws prescribing to block any transfers if their essence seems suspicious to the checker. Cryptocurrencies free users from restrictions and allow them to transfer money without attracting attention.

Uniqueness of information

The hashing mechanism prevents changes to already mined blocks. This protects the community from hacks and scams. Blockchain as the basis for cryptocurrency makes each coin unique. From the perspective of a coin owner, it may appear that the wallet holds regular electronic money. But because each transaction is signed with a hash function, all crypto coins are entered into a distributed ledger.

Disadvantages of the technology

Over the time distributed ledgers have been in use, 3 generations of decentralized protocols have been developed. Despite constant upgrades, blockchain technology is not without its drawbacks:

• Technical complexity. The simplest software is suitable for filling a centralized database. Joint work of distributed nodes is possible only if there is a protocol regulating the order of data encryption and block verification.
• Impossibility to cancel transactions. Even if a transaction is made by attackers, community members cannot stop the transfer. The information entered into the chain remains there forever.
• High electricity costs for the operation of the network. This disadvantage is characteristic of projects that use transaction confirmation using the Proof-of-Work algorithm.
• Legal uncertainty. The legislation of many countries lacks a description of blockchain technologies and digital currencies. This creates the risk of decentralized payment services being banned in the future. Users find themselves without protection from the state in case of wallet hacking or coin theft.
• The problem of scalability. According to a number of experts, blockchain technologies have now reached the limit of scalability. Their use in household transactions is impossible due to slow processing of transactions, the large volume of the blockchain. As an example, we can cite the average daily number of transfers in Bitcoin: this indicator almost did not change from 2018 to 2021.

Summary

Distributed registries have been used to store information since around 1991. The discovery of hash functions made it possible to create the digital fingerprints needed to protect data from spoofing. In 2008, the first blockchain project, the Bitcoin cryptocurrency, was launched.

Advantages of decentralized storage and processing of information:

• Security.
• Anonymity.
• Automatic confirmation of transactions.

Simultaneous operation of nodes in a peer-to-peer network increases energy consumption during mining. Users are also concerned about the irreproducibility of transactions, even if they are made after hacking or theft of digital money.

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