Analyses
30
Jun

This website has affiliate links. We may receive compensation if you visit partners we recommend. Read more about our advertising principles from the About Us page.

The Beginner’s Guide to Blockchain

Blockchain is one of the hottest buzzwords of the last few years. Understanding blockchain is also essential in the world of cryptocurrencies. This article is a beginner’s guide to blockchain. What are the benefits of using blockchain compared to traditional databases? You will get an answer to this and to many other questions!

The traditional way to store information

The blockchain enables a new way of storing data and verifying data. First, it is good to understand how information has been stored in the past.

We have had centralized data storage systems for thousands of years. Typical examples are the archives of cities, churches, and libraries. Fires and other disasters have destroyed valuable information since the beginning of time. This is because no copies existed.

When information is stored in one place there are no problems with synchronization. Before the digital age, maintaining copies was very difficult.

Advances in information technology have made digital storage possible. In developed countries, all critical information is stored digitally. The Population Register and the Vehicle Register are good examples of huge databases, including the history of citizens, vehicle ownership history, etc.

There are two big problems with traditional databases: trust and security. A centralized database is an attractive target for hackers. In recent years, countless data breaches have been reported around the world, with millions of people’s personal data being hacked.

The traditional model also requires trust in the data administrator. Important databases are held by government institutions, banks, and global corporate giants. The keeper of the data can control access to the information and, if they wish, block it completely.

Blockchain is a decentralized database

Blockchain is also referred to as distributed ledger technology – DLT. These three words sum up the principle behind blockchain very well. We will first look at blockchain from the perspective of Bitcoin. Later, we will also cover other solutions.

A blockchain is, in all its simplicity, a database. It is a new way of storing information. The purpose of a blockchain is to solve the problems of centralized databases – trust and security. How does a blockchain solve these issues?

Once the information is in the blockchain, it is stored in the servers running the network. These are called nodes. You can read out more about nodes from our beginner’s guide to Bitcoin.

The Bitcoin network consists of tens of thousands of nodes located all around the world. There is no central server or other critical points of failure that could be crippled by a hostile entity.

lightning network

A peer-to-peer network of nodes solves the security problem. The Bitcoin blockchain cannot be destroyed or turned off. Paralyzing ten, a hundred, or even a thousand servers would have no impact.

The data on the Bitcoin blockchain is also unhackable, meaning that it is impossible to modify. This is due to the massive hashing power of Bitcoin miners, which we will come back to in a moment.

The decentralized network also solves the trust problem. This is a great achievement and innovation of blockchain. The Bitcoin blockchain is not controlled by any single entity. No one can turn off the blockchain or prevent others from using it.

The Bitcoin network is also permissionless. Anyone can download the Bitcoin software, join the network as a node and start storing blockchain information. Nodes also make sure that the data stored in the blockchain follows the network rules.

Information stored in the blockchain

The Bitcoin blockchain is a decentralized database stored on thousands of computers. What information is actually stored in the blockchain? This is where the differences between different projects (cryptocurrencies) arise. However, certain principles are universally valid.

While blockchain is a revolutionary solution, it also has limitations. The main difference with a centralized database is the capacity of the networks and servers. Since a blockchain needs to be synchronized to thousands of servers over the internet, there are limits to how much data can be transferred.

It’s quite obvious that one shouldn’t store any unnecessary information in the blockchain. There are two good reasons for this.

  1. If the size of the blocks is large and the time between blocks is short, the network nodes will struggle to process all the data.
  2. The more data there is in a blockchain, the more space it requires from the nodes’ hard drives.

In the case of Bitcoin, we’re only talking about a couple of megabytes per block. In addition, the average block time is ten minutes. This makes it possible to become a node with very modest hardware. This has been one of the key values of Bitcoin from the very beginning.

The video below shows the installation of a Bitcoin node on a Raspberry Pi minicomputer.

Some cryptocurrencies have sacrificed this feature. If you build a high-capacity blockchain with block times of 1-2 seconds it leads to high network and hardware requirements. Only a small number of participants will be able to run a node. This will lead to a more centralized system.

What is stored on the Bitcoin blockchain? It’s mostly transaction data, meaning the transfers made on the Bitcoin network. Because the Bitcoin blockchain is open, transaction data is visible to everyone. One popular service for browsing this data is Blockchain.com explorer.

Each transaction contains, among other things, the following information:

  1. The hash (unique identifier) of the transaction
  2. Sender’s address
  3. Recipient’s address
  4. Amount sent in bitcoins
  5. Transaction fee paid in bitcoins

In addition to this, other details of the transaction are also stored, but the list above shows the most important pieces. You can view the details of an example transaction from this link.

At the time of writing (6/2022), the size of the Bitcoin blockchain is around 413 gigabytes. It has been growing by about 65 gigabytes per year in recent years.

Miners maintain the blockchain

Now that the blockchain and its benefits have been introduced, we can move on to data maintenance.

In the case of Bitcoin, information enters the blockchain in two stages. The aforementioned nodes forward all transactions to the mempool. This can be thought of as a mail sorting center. The mempool may have tens or hundreds of thousands of transactions waiting to be processed. Next, the miners step in.

Miners have two essential tasks.

  1. Collect new transactions from the mempool and store them in a new block.
  2. Try to beat the other miners in a mathematical calculation and get the right to create the next block.

The miners are custom-built computers, known as ASICs. They are nowadays mostly located in giant mining farms, which can contain (tens of) thousands of ASICs. Depending on the type, one machine costs several thousand dollars. Bitcoin mining is a billion-dollar business these days.

See more in the video below.

All the world’s miners compete with each other to create the next block. The process can be thought of as guessing the correct lottery numbers. Someone will always get lucky and guess the right numbers once every 10 minutes, after which the work starts all over again.

Because miners are expensive and mining uses huge amounts of energy, they need to get paid. This is where block rewards come in. With each block, new bitcoins are created – currently (6/2022) 6.25 BTC per block.

The block rewards are reduced every four years by fifty percent. This event is called the halving. After about 120 years, block rewards go to zero. At this point, all 21 million bitcoins have been mined. In addition to the block rewards, miners receive all the transaction fees in the block.

The block reward is an incentive for the mining farms. Indeed, the mining power of the Bitcoin network has increased enormously over the years. You can check the current data at this link. The Bitcoin network is by far the most powerful supercomputer in the world in terms of computing power.

Because of its huge computing power, the Bitcoin blockchain cannot be modified. A hostile party would have to carry out a so-called 51% attack. This means that it’d have to gain more computing power than all non-hostile miners combined.

Read our comprehensive guide to Bitcoin mining to learn more about the subject.

Blockchains of other cryptocurrencies

Bitcoin is currently one of the few popular cryptocurrencies that use the Proof of Work consensus algorithm. It is PoW that requires physical mining equipment to work. Ethereum is another one using PoW, but it is moving to the highly popular Proof of Stake consensus. You can read more about this process in our Ethereum 2.0 article.

Roughly 90% of the top 100 cryptocurrencies operate on a Proof of Stake consensus. No significant Proof of Work cryptocurrency has entered the market in five years. This is because new projects have started to focus more and more on the scalability of the blockchain.

The blockchain of a PoS system works the same way as in Bitcoin. It depends on the cryptocurrency what data is stored. But, the basic principles are the same. It makes no sense to store unnecessary information on thousands of servers. Hence, blockchains contain mostly transactional data.

Each blockchain also has its own explorer. The image below shows the Etherscan homepage. Etherscan allows you to explore the data on the Ethereum blockchain.

etherscan

A Proof of Stake system has validators instead of miners. These are servers that stake a certain amount of cryptocurrency. For example, validators of the Solana blockchain are staking the Solana (SOL) token. They earn their status as validators by taking the financial risk of holding large amounts of the coin in question. It depends on the cryptocurrency whether there are dozens or hundreds of validators.

The validator’s server consumes a fraction of the power consumed by the mining farm (99.99+% less). Therefore, it doesn’t matter if the block rewards are very low. In some cases, they may not exist at all. The validators may still have an incentive to support the maintenance of the network.

A beginner should understand how Bitcoin works. It is also important to know that other cryptocurrencies work a bit differently. There are also cryptocurrencies that do not use blockchain at all, like DAG technology. These are for example IOTA and Fantom.

Blockchain technology and the decentralized network

Finally, let’s close with a topic that comes up at regular intervals. The question is: is it reasonable to build a closed or private blockchain?

As mentioned earlier, blockchain has its own challenges. It is by no means the most efficient or optimal way to store data. While the Bitcoin blockchain is not the optimal accounting model, it is the only way to create a truly decentralized, secure, and corruption-free digital currency database.

The speed of the internet, the processing power of servers, and the capacity of hard disks all impose limits on blockchains. It currently makes sense to store only certain types of data on a blockchain. Digital, decentralized, money is the best application. It captures the benefits of blockchain without overcoming the practical constraints.

Blockchain technology will also be used and piloted in other contexts. Examples include supply chain monitoring and voting. Time will tell whether the use of blockchain will really bring significant advantages over other alternatives.

If blockchain data is not stored and maintained by a single operator instead of a decentralized manner, the benefits of the technology will be lost. A traditional database model might then be a smarter solution. Decentralization is therefore an integral part of the whole concept of the blockchain.

Photo by NASA on UnsplashPixabayPexels

eToro banner