Our economic, political, and legal systems are defined by transactions and contracts and the records of these. These are a necessity to protect the assets and to establish organizational boundaries.
In the traditional ecosystem, most financial transactions except for the direct cash dealings, require identity verification of the parties involved which are monitored and governed by third-party institutions such as banks or any other financial authority. These are intermediaries who verify the parties using KYC or any other form of verification ahead of approving the transaction, charging a commission fee, and making the transaction a time-consuming process.
For example, if you want to send an amount of money to your friend in another part of the globe, you will most likely use your bank's system to transfer or PayPal for the process. For this to successfully happen and your friend to get the money, a third party has to be the validator to process this transaction. The bank in this case validates both the participants and then checks if you have enough balance to proceed further. This whole process is in a black box for both the user as you are not aware of what is going on.
This is the main idea around centralization - a financial institute controlling all the transactions which are based on trust. In the fast-paced digitally transformed world, these bureaucracies have failed to keep up with digital advancement. In a blockchain network , when a transaction happens, everyone in the network can verify the transaction without depending on the intermediaries or any other participant .
What is Blockchain Technology?
Blockchain technology refers to the nodes or network of computers which contains a distributed database. The ecosystem of blockchain is essentially a digital ledger of all the transactions. All the transactions that happen between two parties are recorded permanently and are immutable.
Each time a transaction occurs, it gets distributed and duplicated to later form the blocks in the original chain of transactions. Each participant in a blockchain network has a participants' ledger. When a transaction takes place, the participants' ledger gets an additional transaction added to it.
Storing the data with multiple participants across the network is known as Distributed Ledger Technology or DLT where each participant on the blockchain can access the entire database and all the relevant history because of the distributed database structure of a blockchain network.
Since there is no intermediary validating or monitoring the transactions, all communication occurs between the peers directly where each node stores data and transfers it to other nodes which invalidate the use of any central node in the system.
The biggest boost to blockchain technology is that it is the core technology to create digital currencies. A blockchain is in essence a global ledger that contains blocks of individual transaction data. In a decentralized data structure, the storage and duplication of the records happen across the network of computers which is different from data centralization where the information is stored at one location centrally.
What is Bitcoin?
Every informed person needs to know about Bitcoin because it might be one of the world's most important developments.
Bitcoin is a form of cryptocurrency that uses cryptography for security. Unlike, normal currencies, it is not issued by the Government but a decentralized authority. It was created in January 2009 by Satoshi Nakamoto, an individual or a group of individuals.
The transaction fees in a Bitcoin are lower than those of the online or existing banking systems. There is no physical existence of a Bitcoin but can be found only on public ledgers for anyone to see. To verify any transaction, there is a process called “ Mining ” which involves solving puzzles also adding new Bitcoins, and also to maintain the ledger of transactions. Bitcoin is the first digital currency to use peer-to-peer (P2P) technology.
Even though Bitcoin or BTC is not a legal tender in most parts of the world, due to its popularity, it has triggered the creation of many other cryptocurrencies, known as altcoins. Bitcoins are increasingly being accepted as payment for services provided or products sold. However, Bitcoins to are fraught with regulatory risks where they can be used for money laundering and other illegal activities. Also, since Bitcoins are traded on a digital medium, this makes it vulnerable to the attacks of hackers and malware.
Why is Blockchain Technology important?
"We have elected to put our money and faith in a mathematical framework that is free of politics and human error."
A huge advantage of blockchain technology is trust . In the traditional ecosystem, the sender of the money and the receiver both must trust the intermediary to safely process their transaction and also protect their sensitive data such as credit cards or any other personal details. However, data leaks and hacks into such systems are common knowledge and when such an incident occurs, every participant becomes vulnerable to such hackers.
In a blockchain network, every transaction and the participants' details can be viewed by anyone who would have a personal node to the blockchain. To view a blockchain transaction, all you would need is a blockchain explorer. Any Bitcoin in the ecosystem can be tracked by anyone with a node to the blockchain. To encrypt a piece of information in the blockchain, the sender uses the public key whereas the receiver decrypts the encrypted information using the private key. This is known as the public-private key pair .
When there is a new transaction, this goes into the pool of unconfirmed transactions to be validated and added to the chain by the peers. After the confirmation, each party present in the network gets the new copy of the transaction with the newly added block of a transaction to the original chain.
The property of transparency is due to the decentralization of blockchain. This increases the trust of the users as any nefarious activities can be identified by anyone since this would need validation from all the users and hence could be closely monitored and prevented.
Blockchains cannot be hacked because the addition of each new block to the original chain depends on hash keys. Hash keys work on the principle of generating a fixed length in output to an input of variable length where the hash function combines the feature of passing message or transaction data with an added layer of security.
Even a very minute change in the blocks will change the hash in the new block to be added and thus this will not match the blocks in front of it in the chain. Thus, due to this mismatch, it will not for confirmation from the nodes in the network.
Another way blockchain protects against wrongful transactions is by forking. Forking refers to splitting the blockchain network by introducing software change protocols by creating new tokens. A wrong transaction can be canceled from the point in the chain where this transaction has occurred if enough peers vote for the same. Litecoin, a clone of the popular Bitcoin which started with the method of forking.
Blockchain-based applications are actively used in the management of food supply logistics. For example, Walmart and IBM are jointly testing the Food Trust blockchain network. Suppliers can track and control the time of delivery, temperature conditions etc. online. Also, the use of decentralized ledger technologies is popular in the investment field.
Disadvantages of Blockchain Technology
- Blockchains rely on the quality of the nodes for their proper functioning. This structure is different from the distributed computing network where the network can perform independently without the participation of the nodes. Bitcoins incentivize participation from the nodes, but this is not true for all other blockchain networks.
- The scalability of the centralized networks is much more than blockchain technology based on a decentralized network. The more people join the blockchain network, the slower it gets due to congestion. One solution to address this problem has been to keep the transactions off the blockchain network and use this network only for the storage and viewing of the information.
- Another limitation to blockchain technology is the storage of a huge amount of transaction data. Also, every transaction that is confirmed adds itself to the original chain thus increasing its length as transactions increase. The solution to this could be to follow the system of First in first out where the size of the blockchain would be fixed and historic data that entered the chain first would be deleted retaining only recent blocks after a certain amount of time.
- The speed of a blockchain is also another limitation since it is dependent on the peers validating a transaction. Comparing Bitcoin to Visa, the former can process only 4.6 transactions per second whereas, the latter can process 1700 transactions per second. To solve, the validation of transaction should be limited to the only parties affected by the transaction and once they verify the transaction, it should be added to the global ledger for everyone to view. This could be a good way to increase the speed.
- Since blockchain technology is at a very early stage in maturity, the cost of implementation and maintenance is very high for any organization . Cost elements include building a team of developers and licensing costs if the organization chooses a paid blockchain solution that can easily cross a million dollars.
Blockchain technology has shifted the landscape of the digital world and in the near future reshape the economy. Starting from digital currencies overpowering the currencies that we have today to creating smart contracts and then reshaping transformative applications such as passport control, blockchain technology will have a widespread effect on everything.
However, when a technology is being chosen for a business, it is important to assess its multifunctionality and adaptability to existing technologies. The main disadvantages of blockchain as highlighted above is with regard to scalability, transaction speed, and energy consumption and many organizations are working towards building platforms that are solving these problems. In the near future, it is expected that blockchain adoption will gain momentum and it will be used as routinely as the global Internet network.