Blockchain: what it is, how it works, why it matters

Advantages of Blockchain

Having a cryptographically secure permanent record comes with perks:

More security

Cryptography and hashing algorithms ensure that only authorized users can unlock information intended for them, and that the data stored on the blockchain cannot be manipulated in any form. Consensus mechanisms, such as proof-of-work or proof-of-stake, further improve security by requiring network participants to agree on the validity of transactions before they are added to the blockchain. Additionally, blockchains operate on a distributed system, where data is stored across multiple nodes rather than one central location – reducing the risk of a single point of failure.

Improved accuracy

By providing a fully transparent, single-source-of-truth ledger, where transactions are recorded in a chronological and immutable manner, the potential for errors or inconsistencies decreases compared to centralized databases or manual record-keeping processes. Transactions are objectively authorized by a consensus algorithm and, unless a blockchain is made private, all transactions can be independently verified by users.

Higher efficiency

Besides saving paper, blockchain enables reliable cross-team communication, reducing bottlenecks and errors while streamlining overall operations. By eliminating intermediaries and automating verification processes – done through smart contracts – blockchain enjoys reduced transaction costs, timely processing times and optimized data integrity.

Challenges of Blockchain

While this emerging technology may be tamper-proof, it is not flawless. Below are some of the biggest obstacles facing blockchain today.

Transaction Limitations

As blockchain networks grow in popularity and use, they face bottlenecks in processing transactions quickly and cost-effectively. This limitation hinders the widespread adoption of blockchain for mainstream applications, as networks struggle to handle high throughput volumes, leading to congestion and increased transaction fees.

Power consumption

The computing power required for certain functions – such as Bitcoin’s proof-of-work consensus mechanism – consumes large amounts of electricity, raising concerns about environmental impact and high operating costs. Addressing this challenge requires exploring alternative consensus mechanisms, such as proof-of-stake, that consume significantly less energy while maintaining network security and decentralization.

Scalability issues

As it is now, each node of a blockchain network stores a copy of the entire data chain and processes each transaction. This requires a certain level of computing power, resulting in slow, congested networks and delayed processing times, especially during periods of high traffic. Scalability issues arise due to limitations in block size, block processing times, and resource-intensive consensus mechanisms. This is the reason why new approaches – such as layer 2 scaling solutions, splitting and alternative consensus algorithms – are being developed.

Regulation concerns

Governments and regulators are still working to make sense of blockchain — more specifically, how certain laws need to be updated to properly address decentralization. While some governments are actively at the forefront of its adoption and others prefer to wait-and-see, lingering regulatory and legal issues are hindering blockchain’s market appeal, stalling its technical development.

Blockchain Applications and Use Cases

Blockchain originally started as a way to protect digital records with tamper-proof technology. Since its induction into the mainstream with Bitcoin’s debut, the data management protocol has expanded beyond DeFi into its various industries across a wide range of applications.

Banking

For banks, blockchain makes it easier to trade currencies, secure loans and process payments. This technology acts as a single-layer, source of truth designed to track every transaction ever made by its users. This immutability protects against banking fraud, resulting in faster settlement times, and provides a built-in money laundering monitor. Banks also benefit from faster cross-border transactions at reduced costs and high-security data encryption.

Smart contracts

Smart contracts are self-executing protocols that automate transaction verification. They are coded into the blockchain and configured by predefined terms. In addition to reducing human error, their function is to facilitate decentralization and create a trustless environment by replacing third-party intermediaries.

Cyber ​​security

As a “new weapon in cybersecurity,” blockchain’s decentralized, tamper-proof ledger with built-in defenses against theft, fraud, and unauthorized users via cryptographic encryption and consensus mechanisms. As a result, blockchain has been adopted into cybersecurity arsenals to maintain cryptocurrency, secure bank assets, protect patient health records, strengthen IoT devices, and even protect military and defense data.

Healthcare

Healthcare services primarily use blockchain to securely encrypt patient data stored in their medical records. Particular functions, such as smart contracts, automate processes such as processing insurance claims and monitoring medication adherence, increasing efficiency and reducing administrative overhead. Blockchain also facilitates secure sharing of medical data between healthcare providers, patients and researchers, and is even being recruited by genome sequencing startups to help crack the genetic code.

logistic

In logistics, blockchain acts as a track-and-trace tool that tracks the movement of goods through the supply chain. The transparent system provides users with real-time visibility of their shipments, from manufacturing to delivery. These insights help curate data, determine faster routes, remove unnecessary middlemen, and even defend against cyber-attack interference.

NFTs

Blockchain enables the creation, ownership and trading of NFTs, or non-fungible tokens. The reason copying these digital assets isn’t as simple as a quick screen capture is because each NFT is encrypted with blockchain technology, which keeps a live record of ownership across the piece. Smart contracts control transactions, assigning and reassigning ownership and delivering royalties to artists as pieces move from wallet to wallet.

Types of Blockchain

As blockchain technology evolves, new variations have emerged. This section provides a brief introduction to four different models that have evolved according to demand.

Public Blockchain

Public blockchains are permissionless networks that are considered “fully decentralized”. No organization or individual controls the distributed ledger, and its users can remain anonymous. As long as a user can provide proof of work, they can participate in the network.

Private Blockchain

Private blockchains are permissioned networks. In the interest of gaining greater control or privacy over a network, private blockchains have a single operator who is in control of who has access to the network and whether participants can view, verify, or create data on the blockchain.

Adding limited access to an encrypted record-keeping ledger appeals to certain organizations that work with sensitive information, such as large corporations or government agencies.

Consortium Blockchain

Consortium blockchains, also known as federated blockchains, are permissioned networks operated by a select group. Multiple users have the power to set the rules, modify or cancel transactions. With shared authority, the blockchain can enjoy a higher rate of efficiency and privacy.

Hybrid Blockchain

Hybrid blockchains combine elements of both public and private networks. They feature selective transparency, which allows blockchain admins to restrict specific parts of the blockchain to certain participant pools, while maintaining public visibility over the rest of the thread. In this way, organizations are entitled to a certain level of privacy when they invariably share data independently of a third party.