The Theory Behind Blockchain and Digital Ledger Explained

“Blockchain is the biggest opportunity set we can think of over the next decade or so” – Bob Greifeld, Nasdaq Chief Executive

In the modern-day world, terms such as blockchain are very relevant and widely used. Most people are familiar with the terms like bitcoin and blockchain, but in reality they don’t know how they work.  

Bitcoin is one of the many versions that result due to the ledger system distributed by blockchains. As a result, beginners should at least be aware of the term blockchain, what it means, and what it offers.

What is meant by a Blockchain?

Stated, a blockchain can be said to be a system that can be used for storing and recording various information. This process is done in such a manner that it is almost impossible or tough to be able to cheat, hack, or change the system.

In technical terms, a blockchain can be defined as a digital ledger that helps in facilitating transactions. This ledger is duplicated at first and then distributed among the entire computer system network using the blockchain. As the name suggests, blockchain consists of multiple blocks present in the chain. 

There are quite several transactions present in every block of the chain. Whenever another new transaction is done through the blockchain, the record of the new transaction is included. This record gets updated on the ledger of every member or participant. Many participants or members use DLT or the Distributed Ledger Technology technology to manage the decentralized database.

How do Blockchains Work?

Blockchains use the Distributed Ledger Technology in all the transactions made. As a result, it helps in recording every transaction that is made. The recordings are done with a hash, which is a cryptographic signature. This signature cannot be changed or tampered with time. Hence, the recordings can always be used as a reference.

Hence, even if a single block in a single chain has been altered, it is a sign. There will be clear evidence that tampering has been done with it. As a result, the security and integrity of a blockchain can be maintained in this manner. Hackers cannot typically corrupt a blockchain. If they want to hack the system, every block in every chain among the distributed versions needs to be changed.

Two of the most prominent uses of blockchain technology are seen in cryptocurrencies such as Bitcoin and Ethereum. These two blockchain systems are growing continuously. With the constant addition of blocks in different chains among different versions, bitcoin and ethereum continually improve their ledger security.

Why is Blockchain Technology Being Hyped so Much Around the World?

Ever since digital transactions and money transfers online were made possible, there have been striving to improve them. Along with it, the demand for the creation of digital or online money had increased manifolds. Multiple attempts were made to do the same. However, every single attempt to create digital money always failed.

The main reason for the failure is not the improper implementation of technology but a lack of trust. The idea is very simple. If a person can create a new digital currency, where is the guarantee that he won’t create a million such currencies for himself? 

The creator of the digital currency can have unlimited money then. Also, others having the same digital currency can get robbed by the creator. There was no transparency, and people were unable to trust any such creators.

However, blockchain technology helped to get rid of this situation. The very first cryptocurrency that stormed the market and became globally accepted as bitcoin. One of the main reasons behind bitcoin’s success is the usage of a particular database type, the blockchain. 

Usually, in the case of simple databases such as SQL, someone remains in charge. This person is the only one who can alter or change the entries. If anyone could corrupt the system, it was the guys who were in charge. 

With blockchain, though, this fear didn’t remain as no one was left in charge. Every member and participant runs the entire system in the blockchain. Bitcoins gained the trust of billions as they cannot be spent doubly or can be hacked or faked. As a result, any Bitcoin user knows that the currency is secure and there is value.

How Can Transactions Be Included in a Blockchain System?

To make the system safe and secure, blockchains use many security methods. Whenever a transaction gets added or included into the blockchain system, it must undergo authentication and authorization beforehand.

Many steps need to be followed for doing so. These steps are a must before a transaction can get included in the blockchain system. Both authentication and authorization have some essential steps. These include the use of cryptographic keys for authentication and proof of work for approval. 

Other key measures include verification of stake protocols and the role of mining. The later networks of blockchain all use such key steps before adding any transactions.

The steps have been discussed in detail below.

• Authentication Process

Initially, the blockchain system was so designed that no central authority was required to operate it. This means that the transactions were not operated or controlled by regulators, banks, or any financial institutes. However, the need for authenticating the transactions was always needed.

As a result, a unique authentication procedure was started in the blockchain systems. Nowadays, the authentication process is done with the help of cryptographic keys. A password-like data string is used for identification that allows a user to get their wallet or account access.

Every single user has their own set of private keys. Also, each account has a public key that anyone can see. The public key is used as the address and is essential for identification, while the private key authorizes the user to access the account. 

With both the public and private keys, it is possible to form a highly secure digital identity. As a result, the users can get the authentication with a digital signature. This allows the users to make transactions with their accounts.

• Authorization Process

When the transaction needs to be done between two users, the process needs to be authorized. This authorization or approval process is necessary to allow the transaction to happen. This will enable the transaction to get added to the specific block in the particular chain.

For public blockchain systems, the consensus decides whether to add a transaction to a chain or not. As it stands, if the majority of computers present in the network or nodes agree that a valid transaction is taking place, it will be added. 

The owners of these computers present on the web get incentives to do so. They need to verify the transaction in exchange for rewards. This is called ‘Proof of Work’ and is another way of verification.

• Proof of Work Process

This process is a complex way to verify the transactions. The owners of the computers present in the network are presented with a tricky math problem. If solved, the block will be added to the chain. This problem-solving method is known as mining, and the ones solving the problem are called miners. Once solved, the miners get cryptocurrency rewards.

However, the process of mining isn’t easy by any means. Every single problem is highly complex, and only trial and error methods can solve them. As a result, the miners take the help of extensive computations that require colossal energy and resources. 

For instance, there is the cost of computers, chips, electricity, and multiple devices. The mining is only successful when the rewards received from solving a problem are much more compared to the investment.

• Mining Power

The mining power required to solve these complex mathematical problems is insanely huge if European countries per year spend 20 to 80 terawatt-hours, or TWh of electricity on an average, to mine bitcoins.

• Limitations of Proof of Work Process

To scale the economy, multiple miners come together to join their resources. As a result, companies bring together a considerable number of miners and use all of their resources. With the mining, the fees and rewards provided by the blockchain network are then divided among them.

With the growth of a blockchain, more computers are needed for mining. Also, with mining, the following problems are even more complex, and this expands the network. The chain gets distributed even further, and the mining process becomes more complicated. As a result, hacking or sabotaging the system becomes extremely difficult. 

However, in reality, few mining companies hold the most power for solving these problems. As a result, they validate the process by maintaining the blockchain network with their insane electrical and computing resources.

• Proof of Stake Process

With time, new consensus protocols for validation have been adopted by blockchain networks. One such process is the Proof of Stake. In this case, every participant needs to have a stake in the network. This can be done by buying the cryptocurrency, allowing for the selection, verification, and validation of the transactions. As no mining is done, a massive amount of computing resources get saved in this method.

Additionally, many blockchains use technologies that use smart contracts. Some conditions are present in the network. Whenever the conditions are met, the transactions get executed automatically.

What Kind of Risks are Associated With Public Blockchain Systems?

Public blockchains contain certain risks too. The major ones are discussed below.

• The Majority Attack (51%)

Since many blockchain networks use consensus rules based on the majority, many people can influence many people to come together. Based on the simple majority, having the minimum amount of preference, or 51% favor in the outcomes, is enough. 

With any cryptocurrency, if any group of miners can control at least 51% of the mining power, they have absolute control over validation. They can decide which transactions need to be added or validated in the blockchain. With the Proof of Work protocol, this attack can be carried out with fraudulent transactions as well.

Since the majority of the mining power is in their hands, the frauds can create their alternate chain. This is based on the actual blockchain, and with validating and adding their transactions, they increase this chain. Thus, the alternate chain becomes longer than the actual chain and becomes the ‘main’ chain.

In widely-used cryptocurrencies such as bitcoin or ethereum, this is almost impossible to do. However, in promising cryptocurrencies with a small number of miners, it is possible to launch a 51% attack.

• Forks Attack

This usually happens when a Proof of Work protocol is changed with the Proof of Stake protocol. With many 51% attacks happening over smaller blockchain networks, many cryptocurrencies changed their strategy. They decided to opt for Proof of Stake instead of Proof of Work. 

While it successfully wards the 51% attack problem, it creates new issues, such as Forks. This is where splits or schisms occur when significant stakeholders have different opinions on what should be added to the blocks. As a result, new currency can be created. As a result, many small cryptocurrencies have opted back to the Proof of Work protocol for safety issues.

• Double Spending Issues

Double spending has always been a risk that exists in the blockchain network. For instance, a bitcoin holder may be able to use the same amount of bitcoin twice. As a result, cryptocurrency can be spent doubly, or an additional profit can be made fraudulently. 

However, this issue is not limited to cryptocurrencies only. Every type of system that uses digital or electronic money will face this issue. As a result, transactions can be problematic. To deal with it, settlement systems and clearing principles have been implemented in all types of currencies.

Advantages of Private Blockchains

With private blockchains, however, there have been many advantages. As a result, a significant rise in private blockchains has been seen in recent times. The main benefits include making the transaction procedure transparent. Additionally, the overall fairness and money and time-saving factors have been highly convenient in private blockchains.

Any financial institution or bank can start its private blockchain. They will be the sole controllers deciding which transactions are to be added or removed from the chain. However, the participants will only come if they have trust in the banks of the said institutions.

Final Words

Even though blockchain technology is comparatively new, it has already gathered the attention of the world. It has tremendous potential and is already proving its worth in the online currency market. 

However, technology is still evolving, and there are certain risk factors. At the same time, there is a huge scope for improvement. Security factors are already in place and will surely improve with time. Blockchain is expected to become one of the fundamental structures of digital currencies soon.