So Blockchain ensures an easy way to exchange cryptocurrencies between a large number of unknown people. It makes it easy for you to transfer money without trusting the other person. You just have to trust the Blockchain system.
There are different blockchain networks for example Bitcoin or Ethereum. At first glance, they all seem similar, but the difference is in the detail. Let’s dig deeper into our Blockchain complete guide.
“Blockchain Complete guide” – Content:
- Why do we need Blockchain?
- What is Blockchain?
- How does a Blockchain works?
- Blockchain structure
- What is a Hash?
- What is a Hash function?
- What is a miner?
- All components of a Blockchain
- What is Proof of Work?
- What is Proof of Stake?
- Benefits of Blockchain
- Limitations of Blockchain
- Future of Blockchain
Why do we need Blockchain?
Before we start with our Blockchain complete guide, we need to answer the question, why we need Blockchain. So our current system is full of central organizations. In today’s organization’s decisions are made above and executed below. Thus, information must tile from the bottom up and concentrated there. But the problem here is the above-concentrated power and therefore leads to corruption. So the lack of integrity and trust makes it impossible for us to grow.
So peer-to-peer systems can solve the problem of power bundling with a decentralized computer network. Thus, they consist of individual computers of users who communicate over a network. So people join a system that they trust and help to make it save. Therefore, the integrity of the system is needed to build trust. But technical failure can cause parts in the network to fail. As a result, we might no longer trust the system.
Therefore, blockchain makes it possible to create integrity in a system where the number and trustworthiness of the members are unknown. As a result, we need blockchain technology because the system is not corruptible, and we can trust it. Learn more about “Why do we need Blockchain”.
What is Blockchain?
Blockchain is a decentralized transparent public append-only ledger. It is a mechanism of creating consensus between distributed parties. They don’t need to trust each other but trust the system.
How does a Blockchain work?
The most important part of the Blockchain is the network. It is decentralized. So this means there is no central instance that regulates the data exchange.
Our current system works like this: If you want to transfer money, the bank transfers the information from our input device to the bank server. After they checked your transaction, the bank carries out the money exchange. This often takes a lot of time and cost fees.
Blockchain can do all of that a lot cheaper and faster. It is based on a peer-to-peer system. So there are a lot of computers that create a decentralized network.
Anyone can connect their computer to the network. They then become a nodal point. So they can carry out tasks such as validating transactions. Since not every computer provides the same hardware performance, there are various kinds of nodes. They are different in their responsibilities. Learn more about the “Basics of the Blockchain Technology”.
Blockchain is a digital version of a ledger. It serves as a database for the entire network. All transactions are archived there in blocks. After a certain amount of time, a block is digitally secured and attached to the Blockchain. Thus, it provides a chronological listing of changes throughout the entire network. So the latest block always shows the most recent transaction.
Let’s have a look at the structure of a block.
A transaction block has this information:
- Status of transaction
- Return address
- Recipient address
There is also specific information to describe the block in the chain:
- Block number
- Memory size
- Hash (Hash total)
- Parent Hash (Hash total of the last block)
What is a Hash?
Hashes are one of the most important part of our Blockchain complete guide. A hash is a checksum derived from the block’s information. You can compare it to a digital fingerprint.
So each block contains the checksum of the previous block. This creates a direct link between the blocks making it tamper-proof. Thus, a change to an already documented transaction would cause all successive checksum to be incorrect. As a result, you can’t cheat the system.
What is a hash function?
For our complete blockchain guide hash, functions are an important part of a Blockchain. A Hash is a checksum derived from the block’s information. Each block also contains the checksum of the previous block. As a result, we have direct links between the blocks. This makes our blockchain tamper-proof. So, if someone wants to change an already documented transaction, all checksum of the previous blocks would be incorrect.
If you want to hack the system, you need to reverse every single hash function by randomly trying. So theoretically you could hack the system, but it’s practically impossible since nobody has that much computer power available. Learn more about “Cryptographic Hashfunctions”.
What is a Miner?
So a miner is a nodal point in our network. They provide the network with its hardware performance. So it is basically a computer. They validate incoming transactions and note them in the block. The Blockchain network verifies the block after a fixed time interval. All miners compete by solving a mathematical problem. If a miner found a solution, he proofed that he has done his job correctly.
So the first miner who solve the puzzle shares it with the entire network. The other miners check again if the block has been processed properly. So the new block can be attached to the Blockchain. After that, the transaction is considered confirmed. The first miner then receives a reward for his effort. He can get a Coin or transactions fees as payment.
All components of the Blockchain
Now let’s connect all the components. You need a digital account to create transactions and to send coins. Miners verify of all these transactions by solving a complicated mathematical problem. After everyone approved the solution everybody updates his own local copy of the entire Blockchain. As a result, all the transactions are secured, unchangeable and stored in the Blockchain.
What is Proof of Work?
The Proof of Work is maybe the greatest invention behind Nakamoto’s Bitcoin white paper. It creates a persistent transparent public append-only ledger. So Blockchain has a mechanism of creating consensus between distributed parties. As a result, you don’t need to trust each other but trust the system.
So there are always people who try to cheat the system. As a result, there has to be a way to prevent them from cheating. So to secure the system, miners validate incoming transactions and note them in the block. Therefore, they have to solve a complicated cryptographic puzzle. The first miner who solves the puzzle gets rewarded. So finding the solution is Proof of Work.
However, this process requires a ton of computing power. So Proof of Works gives more rewards to people with better equipment and connection. As a result, we have a situation where people are building huge mining farms. Miners even come together to push their chances even further to so-called ‘mining-pools’. So this is causing the blockchain to become more centralized. Therefore, we need to find a better way to validate a transaction with proof of work.
What is Proof of Stake?
So to avoid centralized mining farms, we need to implement Proof of Stake. Instead of rewarding miners in solving mathematical problems they are now chosen in a deterministic way. This depends on your wealth and stake. There they previously create all the digital currencies and their number never changes. The miners will not get any reward for creating a block. Instead, they get transactions fees as a reward. They are also no longer called miner, they are validators.
To become a validator you have to deposit a certain amount of coins into the network as a stake. So the higher your stake the better are your chances to validate the next block.
At first sight that sounds unfair because it favors the ones who deposit the most money. But it is not. The price rich people pay for the mining equipment and electricity bills don’t go up in a linear fashion. Instead, the more they buy the cheaper it will get. So they get an advantage over time. This can’t happen with Proof of Stake. Learn everything about the “Difference between Proof of Work and Proof of Stake”.
Benefits of Blockchain
Now that we learned about Blockchain in our Blockchain complete guide, we can now discuss the benefits of Blockchain. Blockchain has the ability to transform our industry. It can increase our transparency, enhanced security, improved traceability, increased efficiency and speed of transactions, reduce costs and much more.
Hash functions secure every transaction. So each block contains the checksum of the previous block. As a result, every block is linked. This makes blockchain tamper-proof. So, if someone wants to change an already documented transaction, all checksum of the previous blocks would be incorrect.
So if someone wants to cheat, he needs to reverse every single hash function by randomly trying. And because nobody has that much computing power, it is impossible to hack the network.
We don’t have traceability when we want to buy goods. So if you bought the goods you want to know when your product arrives at your place. The problem that many companies have these days is that they produce something complicated. They have to manage all different vendors across the supply chain. So not everyone has the same database. They don’t use the same infrastructure. So it gets really hard for customers to track their delivery. With blockchain, you have the possibility to trace everything back, since all data are immutable stored and available for everyone.
When you want to transfer something, there is a lot of paperwork, human errors and third-party mediation. But with blockchain, we can transfer money way faster and more efficiently. Since you can use a digital ledger that includes all the information needed. As a result, everyone has access to the same information. So the process is faster and it becomes easier to trust each other without the need for third parties.
With blockchain, you don’t need third parties anymore. You don’t have to trust your trading partner anymore. Instead, you just have to trust the data on the blockchain. You also have less paperwork and can use the time for more useful stuff. This reduces your costs by a lot.
Blockchain allows us to create a distributed platform on which we can store any reports about any person from any source. So this allows us to create a user-controlled identity. This will help facilitate trade or interaction by revealing the cryptographic proof that these details exist and are signed off on. These kinds of portable identity are in the physical and digital world. So that means we can do all kinds of trades in a totally new way. This is one of the benefits of blockchain technology.
We don’t have transparency in our transactions. Blockchain allows you to have a decentralized database that can not be changed. It is distributed all over the world. As a result, everyone has access to the network and can view the data whenever he wants.
Limitations of Blockchain
The rise of blockchain technology is as impressive as the hype that people built on top of it. Most people expect blockchain to be perfect without any limitation. But it is not perfect and right now it still has some limitations.
So if you want to store information on a blockchain database every node in the network has to store it. As a result, you can’t delete anything because everyone else has a copy. So data storage imposes a huge cost on a decentralized network. Also, every node has to store more and more data. As a result, storage is a huge problem for Apps that are built on top of the blockchain.
Blockchains, Smart contracts or DApps (decentralized Applications) are programmed by humans. Humans are not perfect and tend to make mistakes. So for example, if you forget an important rule for your blockchain or create a coding error, nobody trusts the system anymore. As a result, the whole system fails.
Ethereum is, for example, the fastest blockchain when it comes to processing transactions at the moment. It can support around 15 transactions per second. In comparison to Visas 45000 per second, it is quite slow. So to be able to compete with the current system it needs to improve a lot.
There are always bad actors. So to prevent them from destroying the network a blockchain has to be big. Thus, the size of the blockchain represents to the security of the system. If it is not large, it is not possible to gain the trust of the users.
Limitation of consensus mechanisms
Blockchain has some issues with the consensus protocol Proof-of-Work. So miners carry out complicated and high-cost calculations. The system rewards the fastest miner with a new coin or transaction fees. So the rest of the computer power has no value. So the Proof of Work has a lot of waste, but a solution might be Proof of Stake.
Limits of Scalability
Blockchains like Ethereum has a mechanism of consensus. It needs miners to verify a transaction. This limits the total number of transactions a blockchain network can process.
It is theoretically possible that someone manages to convince 51% of all the nodes in the system. So more then half of all the PCs working as nods can tell a lie. As a result, it then becomes the truth. This is called the “The 51% Attack” and it might be an unavoidable security flaw. The only thing you can do is closely monitoring the system to make sure no one unknowingly gains such an influence.
Transactions on a public blockchain are private. People often think that they are not directly linked to their personal information. But that is actually a mistake. Everything is recorded on a public ledger and can be observed.
Import external data
It is really difficult to import data from external systems. So if you want to import external data the query will get executed repeatedly and separately from each node. Thus, since this source is outside of the blockchain, there is no guarantee that every node will get the same response. So maybe the source will change its answer between the requests. It might be temporarily unavailable. In both cases, there is no consensus and the entire blockchain fails.
The future of Blockchain
At the end for our complete Blockchain guide we need to discuss the future of Blockchain. Blockchain provides a transparent picture of all the economic data. So everyone can have access to economic data. As a result, you can mine your big data now with analytics and create your own algorithms and apps. This will create a lot of new jobs.
In economic theory, the optimum market is where you sell at marginal cost. Marginal cost is after fixed costs. Once you pay for your technology the marginal cost is what it costs to produce a unit. But we never expected a technology that could actually reduce the costs for some goods and services to near zero.
They allow you to dramatically increase your efficiency at every step of conversion on your value chain. And as a result, they dramatically increase your productivity. Therefore, dramatically reduce your ecological footprint, and with it your marginal cost. Some marginal costs are gonna get so low they head to zero marginal costs. And when that happens, it gives rise to a completely new economic system.
So Blockchain can transform our industry dramatically. As a result, we can increase our efficiency, reduce cost and reduce emission. We hope our complete Blockchain guide was helpful.
If you like our complete Blockchain guide and want to know more, here you can learn everything about Blockchain 2.0.