July 18, 2023, 10:45 am | Read time: 6 minutes
Some people consider it the greatest technological innovation since the invention of the internet. Others believe it poses a serious threat to the monetary world order. Still, others see it as a passing trend. Opinions often vary widely when it comes to blockchain. TECHBOOK explains the basics.
In the crypto world, various terms are used: from Bitcoin to Ethereum, coin and token, cryptocurrency to blockchain. The latter is much more than a database limited to financial transactions. But what exactly is behind a blockchain? TECHBOOK explains the term.
Overview
What is the Blockchain?
Simply put, it is a publicly viewable digital ledger where entries can be made but nothing can be deleted. The technology has existed since the early ’90s. First of all, it’s not THE blockchain, as there are many. There are now hundreds of blockchains operating in various ways, with more emerging weekly. They all have one thing in common: They record transactions, such as the inflow and outflow of digital tokens. These tokens are essentially vouchers that represent themselves or something else. They can be sent and received using electronic addresses.
We know such vouchers from our analog everyday life, for example, as deposit tokens for beer glasses at a fair. Such a token represents both the glass and the amount paid, which is refunded when the glass is returned. In principle, one could trade these tokens since they have value. Or they could be painted and sold as artworks, among many other possibilities. If you think of a cloakroom token instead of a deposit token, it becomes clear how difficult it can be to determine the real value. The same is true for tokens on the blockchain.
If the token has its own blockchain, it is called a coin. Everyone is likely familiar with the digital currency Bitcoin. If the token does not have its own infrastructure but runs on another blockchain, then it is “just” a token. The metaverse currencies SAND and MANA, for example, use the Ethereum blockchain, so they are tokens and not coins.
Read also: What is Ethereum? An Overview of the Cryptocurrency
Why Do We Need a Blockchain?
Blockchains have many applications–and new ones are constantly being added. Most people are familiar with their use for cryptocurrency transactions. Few know they can do much more. In the field of digital identity, they play a role in verifying who you are over the internet. Personal data, such as patient records, can be independently managed on the blockchain. There are even chains that reward the reduction of CO₂ emissions with tokens, contributing to the reduction of climate change. Many more applications are already available or in development.
What is the Difference Between Blockchain and Bitcoin?
To some, blockchain and Bitcoin sound like synonyms. However, this is incorrect. The Bitcoin blockchain is just one of many. However, it is the most significant of the available blockchains. Unlike a bank, there is no central authority to verify which transactions have actually taken place. Bitcoin transactions are grouped into blocks that, when linked together, form the complete ledger–like a bank. But unlike a bank, there is no central authority to verify which transactions have actually occurred.
The Proof-of-Work Method
The Bitcoin blockchain operates using a method called Proof-of-Work (PoW). Each block contains a cryptographic hash value that links to the previous block, adding it to the chain. The reward for this is a set amount of Bitcoin–which is why the process is also known as “Bitcoin mining.” The downside of this method is the immense energy consumption, which is why many municipalities and even entire countries have banned mining.
The Proof-of-Stake Method
The most recent method is Proof-of-Stake (PoS). Here, blocks are not “mined,” but a consensus mechanism determines who gets to add the next block to the chain–and is rewarded with coins. Unlike Proof-of-Work, no proof of work done–in the form of computationally intensive guessing tasks–is required. Instead, members of the blockchain network must already have invested in the respective cryptocurrency. This prevents malicious actors from simply taking over the validation of the blockchain. This method requires only a tiny fraction of the energy needed for PoW. It is considered more environmentally friendly, though slightly more vulnerable in terms of security.
Most newer blockchains use PoS. There are other, less common methods, such as Proof-of-Capacity or Proof-of-Authority. Overall, the mathematics behind blockchains is much more complex than most people can imagine. However, it offers a wealth of technological possibilities and security.
The Difference Between the Cryptocurrencies Bitcoin and Ethereum
Pros and Cons of the Cryptocurrency Solana
What Makes Blockchains So Secure?
Several factors make blockchains more secure than other digital technologies. For one, they have no single location; they are everywhere and nowhere. A decentralized network of globally connected computers creates the blockchain. Therefore, a burned-out data center or the theft of hard drives cannot harm a blockchain. This is the security factor of decentralization. Additionally, sophisticated mathematical security procedures make unauthorized access difficult. This is the security factor of cryptography.
Risks are more likely to arise from the periphery than from the blockchain itself. For example, so-called bridges have been used successfully by hackers multiple times. These are software that allows tokens to be transferred from one blockchain to another. There is also another significant risk: If I want or need to rely on convenience or necessity to store my digital keys with a third party, so-called third-party risks arise. If the operator of a crypto exchange is criminal, then my digital keys are in bad hands. Using crypto exchanges licensed by BaFin, the German Federal Financial Supervisory Authority, is a reasonable solution to minimize third-party risks.
Read also: Bitcoin is Rising! The Best Apps for Buying and Selling Crypto
How Will We Use Blockchains in the Future?
Proving identity over the internet is just one of the many potential applications of blockchain technology. Increasingly, AI applications are becoming a topic of innovative discourse within the blockchain community. With artificial intelligence (AI), blockchain could gain new capabilities.
For the near future, this could also lead to applications in journalism. A blockchain could use artificial intelligence to distinguish fake photos, videos, and audio from real ones. Every photo, video, and audio recording could be publicly verified. This is just one example of the many ideas that will emerge around blockchain and AI. Blockchain is more than just Bitcoin–it offers the potential for numerous technological solutions to various societal problems.