What Is Blockchain and How Does it Work?

October 19, 2023
5 min read

In simple terms, blockchain is a digital “accounting book” distributed among a network of computers called nodes that records and tracks transactions and stores different data.

What is unique about this ledger is that each record or block contains information about the previous one.

As the number of records grows, they create a chain of multiple blocks containing verifiable information, so once data is recorded and verified on the blockchain, it becomes almost impossible to change or delete it.

Although blockchain is mainly associated with Bitcoin and cryptocurrencies, it can store all kinds of data, and its use is not limited to cryptocurrency transactions only.

The beginning

Blockchain is mainly associated with cryptocurrencies because it is at the heart of Bitcoin and other virtual assets.

Bitcoin was first introduced in 2009 by Satoshi Nakamoto (a nickname for a person or a group behind the project.) It is one of the best-known products that use decentralized blockchain. However, the system has been around for decades and has other applications.

a megaphone speading the mssage that bockchan predates Bitcoin by 13 years

Main characteristics

  • Decentralized: Blockchains are not controlled by a single central authority. They operate on a distributed network of computers, also known as nodes, as mentioned before. That improves security and transparency and reduces the risk of a single point of failure.
  • Impossible to manipulate: Once data is recorded on the blockchain, it becomes nearly impossible to alter or delete. Each block contains a cryptographic hash of the previous block, creating a chain of blocks that are linked together. Any change in a single block would require changing the data on subsequent blocks, which is impossible.
  • Transparent: All transactions and data stored on the blockchain are visible to all participants in the network.
  • Secure: Blockchain technology uses advanced cryptographic techniques to secure data. The consensus mechanisms that the technology uses — for example, Proof of Work (PoW) or Proof of Stake (PoS), help prevent fraudulent activities and protect the network from attacks.

Examples of blockchain applications

As mentioned above, blockchain is associated mainly with cryptocurrencies, but that is not the system’s only application. Here are some examples of other uses:

  • Supply Chain Management: Blockchain can improve transparency and traceability in supply chains by recording every transaction or movement of goods. When things like the production of items, packaging, shipping, and deliveries are recorded on the blockchain, it’s much easier for businesses to identify delays and other problems related to their processes and improve them.
  • Healthcare: Blockchain can securely store and share patient records and medical data, making healthcare providers more efficient at recording and exchanging information while, at the same time, patients can have better control over their health information.

Blockchain has other applications. It is not limited to the ones listed above.

Different blockchains

There are many different blockchains, each with unique features and characteristics.

Bitcoin (BTC) is the most well-known blockchain used mostly for peer-to-peer digital currency transactions and uses the Proof of Work (PoW) consensus mechanism.

Ethereum (ETH) supports smart contracts and, unlike BTC, uses a Proof of Stake (PoS) consensus mechanism.

Cardano (ADA) With a focus on scalability and sustainability, Cardano is a proof-of-stake blockchain platform founded on peer-reviewed research and developed through evidence-based methods.

Polkadot (DOT) enables cross-blockchain transfers of any data or assets and has the lowest carbon footprint among proof-of-stake protocols, as analyzed in recent research.

Ripple (XRP) is designed for cross-border payments and settlements. It uses a consensus algorithm rather than traditional PoW or PoS.

The above are only a few examples of existing blockchains.

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How do blockchain systems work?

Blockchain systems follow several steps to verify, include, and add new data blocks to the chain. Once all steps are complete, the entire blockchain is updated, and all participants can see the changes.

Known challenges

Although blockchain technology is trustworthy, transparent, and very secure and has revolutionized various sectors, it isn’t perfect and comes with its share of challenges.

One such major concern is the environmental impact of blockchain, especially when talking about systems that use Proof of Work consensus mechanisms.

As mentioned, three main factors contribute to high electricity consumption related to cryptocurrencies and blockchain.

  1. The mining process and the mining equipment
  2. The number of people mining
  3. The validation process within the blockchain

Mining cryptocurrencies involves solving complex mathematical problems and that requires great computational power. As the number of miners grows, so does the energy consumed by the mining rigs in use.

While Bitcoin, which uses the PoW consensus mechanism, can’t compare to industrial data networks and data centers, it still consumes a substantial amount of energy — more than what Norway or Bangladesh needed for a year back in 2021.

The above raises concerns about carbon emissions and jeopardizes the sustainability of such systems in the long term.

And even though some blockchains are transitioning to Proof of Stake (PoS) or other consensus mechanisms that consume significantly less energy (for example, Ethereum), energy efficiency remains a central issue in the blockchain space.

Scalability is another known issue surrounding blockchain technology.

The consensus mechanisms used to validate and record transactions can be slow and require significant resources, as discussed above, which, in turn, poses challenges in terms of maintaining the network’s performance and efficiency.

The future

With crypto ownership growing to over 400 million and cryptocurrencies becoming more and more popular, it’s safe to say that blockchain technology will grow in popularity as well.

The adoption of blockchain by various Web3, Metaverse, and NFT projects further expands its use outside the realm of cryptocurrencies.

There are continuous efforts to “greenify” blockchain and reduce the carbon footprint. Recently, Ethereum moved to a PoS consensus mechanism — the more energy-efficient alternative to PoW. On the other hand, according to a Bloomberg analyst, the percentage of energy used for Bitcoin mining coming from renewable sources has exceeded 50%.

The promises of improved cost-efficiency on top of enhanced transparency, trust, and security are likely to lead to more widespread adoption of blockchain systems in the financial and healthcare sectors, education, and various government agencies.