Blockchain is the innovative database technology that is at the core of almost all cryptocurrencies. By distributing identical copies of a database over an entire network, blockchain makes it very difficult to hack or cheat the system. While cryptocurrency is the most popular use for blockchain at present, the technology offers the potential to serve a very wide range of applications.
What is a blockchain?
At its core, blockchain is a distributed digital ledger that stores data of all kinds. A blockchain can record information about cryptocurrency transactions and ownership of Non Fungible Tokens (NFT).
Although any conventional database can store this type of information, blockchain is unique in that it is decentralized. Instead of being maintained in one place by a centralized administrator – think of an Excel spreadsheet or a bank database – many identical copies of a blockchain database are kept on multiple computers spread over a network.
These individual computers are referred to as nodes.
How Blockchain works
With blockchain, the digital ledger is described as a “chain” consisting of individual “blocks” of data. As fresh data is periodically added to the network, a new “block” is created and attached to the “chain”.
This means that all nodes update their version of the blockchain book to remain identical.
How these new blocks are made is the key to why blockchain is considered very secure. A majority of nodes must verify and confirm the legitimacy of the new data before a new block can be added to the ledger. For a cryptocurrency, they can mean ensuring that new transactions in a block were not fraudulent, or that coins had not been used more than once.
This is different from a standalone database or spreadsheet, where one person can make changes without supervision.
“Once there is consensus, the block is added to the chain and the underlying transactions are recorded in the distributed ledger,” said C. Neil Gray, partner in fintech practice at US-based Duane Morris LLP. “Blocks are securely connected, forming a secure digital chain from the beginning of the general ledger to the present day.”
Transactions are usually secured using cryptography, which means that the nodes have to solve complex mathematical equations in order to process a transaction.
“As a reward for their efforts to validate changes to the shared data, nodes are usually rewarded with new amounts of the blockchain’s original currency, such as new Bitcoin on the bitcoin blockchain,” said Sarah Shtylman, fintech and blockchain consultant at Perkins Coie.
There are both public and private blockchains. In a public blockchain, anyone can participate, which means they can read, write or revise the data on the blockchain. In particular, it is very difficult to change transactions logged in a public blockchain, as no single authority controls the nodes.
A private blockchain is meanwhile controlled by an organization or group. Only it can decide who is invited to the system, plus it has the authority to go back and change the blockchain. This private blockchain process is more like an internal data storage system except spread over multiple nodes to increase security.
How to use Blockchain?
Blockchain technology is used for many different purposes from providing financial services to managing voice systems.
Cryptocurrency
The most common use of blockchain today is as the backbone of cryptocurrencies, such as Bitcoin or Ethereum. When Australians buy, exchange or use cryptocurrency, the transactions are registered on a blockchain. The more people use cryptocurrency, the more widespread the blockchain can become.
“Because cryptocurrencies are volatile, they are not yet widely used to buy goods and services. But that is changing as PayPal, Square and other money-making companies make digital asset services widely available to suppliers and retail customers, “said Patrick Daugherty, senior partner at international law firm Foley & Lardner and head of the firm’s blockchain task force.
Banking
In addition to cryptocurrency, blockchain is used to process transactions in fiat currencies, such as the pound, the Australian dollar and the euro. This can be faster than sending money through a bank or other financial institution, as the transactions can be verified faster and processed outside normal working hours.
Asset transfers
Blockchain can also be used to register and transfer ownership to various assets. This is currently popular among digital assets such as NFTs, a representation of ownership of digital art and videos.
However, blockchains can also be used to process ownership of real assets, such as property and vehicle deeds. The two sides of a party will first use the blockchain to confirm that one owns the property and the other has money to buy. Then they could complete and register the sale on the blockchain.
Using this process, they were able to transfer the property deeds without manually submitting paperwork to update land registration records – it will be updated immediately in the blockchain.
Smart contracts
Another blockchain innovation is self-performing contracts often called “smart contracts”. These digital contracts are automatically adopted when the conditions are met. For example, a payment for an item can be released immediately when the buyer and seller have met all specified parameters for an agreement.
“We see great potential in smart contracts, using blockchain technology and coded instructions to automate legal contracts,” says Gray. “A properly coded smart legal contract on a distributed ledger can minimize, or preferably eliminate, the need for external third parties to verify performance.”
Supply chain monitoring
Supply chains involve enormous amounts of information, especially as goods go from one part of the world to another. With traditional data storage methods, it can be difficult to trace the source of problems, such as which supplier of poor quality goods came from.
Storing this information on a blockchain will make it easier to go back and monitor the supply chain, for example with IBM’s Food Trust, which uses blockchain technology to track food from harvest to consumption.
Voting
Experts are also looking at ways to use blockchain to prevent voting fraud. In theory, blockchain voting would allow people to submit votes that could not be tampered with, as well as eliminate the need for people to manually collect and confirm paper ballots.
Benefits of Blockchain
Higher transaction accuracy
Because a blockchain transaction must be verified by multiple nodes, this can reduce errors. If one node has an error in the database, the others will see that it is different and catch the error.
In contrast, in a traditional database, if a person makes a mistake, it may be more likely to go through. In addition, each asset is individually identified and tracked on the blockchain book, so there is no chance of double-using it (as a person who overdraws their bank account, thus spending money twice).
No need for intermediaries
By using blockchain, two parties in a transaction can confirm and complete something without working through a third party. This saves time as well as the cost of paying for an intermediary, such as a bank.
“It has the ability to provide greater efficiency to all digital commerce, to increase the financial authority of the unbanked or underbanked population of the world and to run a new generation of Internet applications as a result,” says Shtylman.
Extra security
Theoretically, a decentralized network, like blockchain, makes it almost impossible for anyone to make fraudulent transactions.
To enter into counterfeit transactions, they have to hack every node and change every ledger. While this is not necessarily impossible, many cryptocurrency blockchain systems use “proof-of-stake” or “proof-of-work” transaction verification methods that make it difficult, as well as not in the best interests of participants, to add counterfeit transactions.
More efficient transfers
Since blockchains operate 24/7, people can make more efficient financial transfers and assets, especially internationally. They do not have to wait days for a bank or government agency to verify everything manually.
Disadvantages of Blockchain
Limitation on transactions per second
Given that blockchain depends on a larger network to approve transactions, there is a limit to how fast it can move. For example, Bitcoin can only process 4.6 transactions per second compared to 1700 per second with Visa. In addition, increasing the number of transactions can create network speed issues. Until this gets better, scalability is a challenge.
High energy costs
Having all the nodes working to verify transactions requires significantly more power than a single database or spreadsheet. Not only does this make blockchain-based transactions more expensive, but it also creates a huge carbon burden on the environment.
Because of this, some industry leaders are starting to move away from certain blockchain technologies, such as Bitcoin. For example, Tesla CEO Elon Musk said last year that his company would stop accepting Bitcoin in part because he was concerned about the damage to the environment.
Risk of loss of assets
Some digital assets are secured using a cryptographic key, such as a cryptocurrency in a blockchain wallet. You need to guard this key carefully.
“If the owner of a digital asset loses the private cryptographic key that gives them access to their asset, there is currently no way to recover it – the asset is permanently gone,” says Gray. Because the system is decentralized, you can not call a central authority, such as your bank, to request access again.
Potential for illegal activity
Blockchain’s decentralization provides more privacy and confidentiality, which unfortunately makes it attractive to criminals. It is more difficult to track illegal transactions on a blockchain than through bank transactions linked to a name.
In fact, the Australian Competition and Consumer Commission (ACCC) has issued warnings that Australians are caught in crypto fraud.
How to invest in Blockchain
You can not actually invest in blockchain yourself, since it is just a system for storing and processing transactions. However, you can invest in assets and companies that use this technology.
“The easiest way is to buy cryptocurrencies, such as Bitcoin, Ethereum and other tokens that run on a blockchain,” says Gray.
Another option is to invest in blockchain companies that use this technology. For example, the US-based Santander Bank is experimenting with blockchain-based financial products. If you were interested in gaining exposure to blockchain technology in your portfolio, you can buy the stock.
For a more diversified approach, you can buy into an exchange-traded fund that invests in blockchain assets and companies. There are thousands of exchange traded funds (ETFs) that offer Australian investors exposure to foreign equities.
The bottom line
Despite the promise, blockchain is still something of a niche technology. Gray sees the potential for blockchain to be used in several situations, but it depends on future government policy. “It remains to be seen when and if regulators will take action. One thing is clear – the goal will be to protect markets and investors,” he said.
Shtylman compares blockchain to the early stages of the internet. “It took about 15 years with the internet before we saw the first version of Google and over 20 years for Facebook. It is difficult to predict where the blockchain technology will be in another 10 or 15 years, but in the same way as the internet, it will significantly change the ways we trade and interact with each other in the future. “
Obstacles remain, especially with transaction limits and energy costs, but for Australians doing their due diligence and seeing the potential of the technology, blockchain-based investments may be worth considering.
This article is not an endorsement of any particular cryptocurrency, broker or stock exchange, nor does it constitute a recommendation of cryptocurrency or blockchain more generally.
