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Blockchain - what lies behind the success of cryptocurrencies?

The term "blockchain" derives from the English words "block" and "chain," meaning literally "chain of blocks." In other words, blockchain is information stored in a chain consisting of blocks.

Blockchain is a distributed database that contains information about all transactions in the form of a chain of blocks. Each block contains a certain number of transactions.

The word "distributed" in the definition means that there is no central organization that stores all transaction data. Each participant in the network holds a copy of the data. The idea behind such a decentralized system is to enable individual users to operate without intermediaries.

For example, traditional centralized networks like banks and payment systems are vulnerable because access to a single central server can allow someone to manipulate all the information stored on it.

In contrast, blockchain is an immutable digital record of the entire transaction history. Copies of the database are stored on each node of the blockchain network, and they are constantly cross-referenced with each other. This gives the system resilience even in the event of successful hacker attacks on its individual nodes. This reliability has allowed its use to enhance the efficiency of monetary transactions and information exchange among individuals and companies. Read more about the reliability of blockchain technology in "How to hack the blockchain?".

Although the underlying technologies were described several decades before the emergence of cryptocurrencies, the history of the term itself began in 2008 when an article was published that served as a kind of manifesto for fintech for years to come.

The article described the main characteristics and possibilities of creating a decentralized system for monetary transactions. In January 2009, the first currency using this technology, bitcoin, was launched. It remains the most well-known application of blockchain technology to this day.

However, despite the association of blockchain with Bitcoin and other cryptocurrencies, this is not entirely accurate. Blockchain is merely a method of distributed data storage that can have numerous applications beyond the creation of electronic currency.

Blockchain finds application not only in the banking sector, financial services, and payment systems.

It has been successfully used for providing government services, maintaining real estate registries, notarization, electronic voting, transportation and logistics, the Internet of Things, healthcare, intellectual property management, energy, and many other sectors.

But what makes the data stored in the blockchain immutable?

As mentioned earlier, blockchain technology assumes that all network participants have their own copy of the data. However, to make such a system usable, protection against manipulations is necessary. For this purpose, "mining" was introduced, which involves solving complex mathematical problems.

To ensure the connection between blocks, it was decided to use not only sequential numbering but also the inclusion of a unique hash value for each block and the hash value of the previous block.

The process of generating unique identifiers is called "hash calculation," and one of its methods is "mining."

A hash is, in a sense, a fingerprint used to identify a block, and each block has its unique hash.

Blockchain is secure because any modification of information in a block will change its hash value and all subsequent hash values, which would require a significant amount of computing power to recalculate all the blocks since each block contains the hash of the previous one. Tampering with data in just one block renders all subsequent blocks erroneous.

But if blockchain is so reliable and promising, why isn't it used universally?

  1. The first and most important problem is the inability to scale. Distributed ledgers currently cannot handle a large number of transactions, which leads to long waiting times for transaction processing.
  2. The second problem is a lack of confidentiality. "Pseudonymity" is both a plus and a minus of blockchain - anyone can see the entire transaction history, which achieves transparency, although it is not always possible to link a wallet to a specific individual.
  3. The third problem arises from the main advantage of blockchain - its decentralization. Due to the absence of any centralized governing body, losing the private key to a wallet essentially means irretrievable loss of funds in the account.
  4. Most blockchains, especially those using the "Proof of Work" algorithm, consume energy in an extremely inefficient manner. Energy-intensive internal processes remain a specific risk for the entire cryptocurrency sector, despite the popularity of other consensus mechanisms.
  5. Contrary to the reliability of the blockchain idea itself, almost any blockchain can be susceptible to a "51% attack" - when, in accordance with the system rules, a group of users with the highest computational power can manipulate records in a specific blockchain. In other words, if someone manages to capture more than half of the total power, they can change the rules of the game in their favor. However, in practice, this rarely happens even with small blockchains, and it has never happened with Bitcoin.
  6. The last problem is related to the fact that blockchain stores the entire transaction history rather than the account balances. Because of this, blockchain ledgers can significantly increase in size over time. For example, the Bitcoin blockchain currently requires about 430 GB of disk space. The constant increase in blockchain size requires increasing the capacity of hard drives for storing information, and the network risks losing nodes if the ledger becomes too large for users to download and store.

Despite all the pros and cons of blockchain, this technology has the potential to bring about revolutionary changes in various industries and business processes in the future. However, widespread implementation of this technology in our lives will require a lot of time and effort. In the coming years, companies and governments will continue to experiment with various ways of applying blockchain and try to derive benefits from it.

Most existing crypto projects will fail in the future, but thanks to them, experts will gain a lot of experience and knowledge about how to most effectively use this technology or where it will be unnecessary. Blockchain will certainly motivate people to acquire new skills, and traditional businesses will have to reconsider many work processes.

© – , updated 08/07/2023
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