Blockchain: what is it and how does it work

1 December 2023 - 17:00

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Many people talk about the blockchain. However, few know how this technology works. Here is a practical guide to understanding what it is, how it works, and why it is so important.

Blockchain: what is it and how does it work

Blockchain is perhaps the most popular word today in the digital and techno-financial fields, so it is important to understand what it is, how it works, where it is used, and why it is considered a revolutionary technology. Explaining blockchain is not easy, but in this guide, we will do our best.

Blockchain is a large digital ledger in which entries are grouped into blocks linked in chronological order.

We think of the blockchain as a huge shared database to which new blocks can be added gradually and which everyone can access, but it cannot be modified and its security is guaranteed by cryptography.

Its origin is rather recent (it dates back to 2009), and is due to the mind of Satoshi Nakamoto, the mysterious inventor of Bitcoin.

Nakamoto’s revolutionary idea includes a type of data storage where everyone can see what’s inside and make sure it’s real. Not a single bit can be changed, and once something is on the network, it stays there forever.

Initially linked to Bitcoin and the world of cryptocurrencies and used to verify all transactions between users and avoid fraud, the blockchain has then expanded to various application areas, revealing its usefulness for countless industries, from banks to managed savings, up to works of art.

For example, blockchain can be used to certify the origin of an agri-food product, the exchange of securities and shares, or to make online contracts and votes secure and unalterable. It is no coincidence that many companies and investors have already jumped (or are thinking of doing so) on the blockchain bandwagon by investing in the sector.

Blockchain: what is it and what does it mean

In simple terms, a blockchain is a series of immutable records of data where each block of data is fixed and bound to each other using cryptographic principles (chain).

The blockchain is a simple and ingenious system that transfers information from A to B in a completely automatic and secure way. There are global blockchains, such as Bitcoin, but you can also create a blockchain for a separate company or community.

Its very definition makes the blockchain a constantly growing technology as new "complete" blocks are added to the previous ones. Once a new block has been added to the chain nothing can be done to modify it. To change something, a block will be added on top of the previous one, and everyone will be notified of this operation.

The peculiarity of the blockchain is that it does not have a central authority: by its very definition, it is a decentralized, democratized, and transparent system. Indeed, the blockchain is the backbone of the so-called DeFi (decentralized finance). Since it is a shared and immutable book, all the information it contains is accessible to anyone.

Blockchain: how does it work

To better understand the definition, meaning, and functioning of blockchain technology we can compare it to the conventional banking system. From this perspective, the blockchain can be defined as a complete history of banking transactions and the blocks as individual account statements. Bitcoin movements are entered into the system chronologically, exactly as happens with banking transactions.

Blockchain has no transaction costs (you can charge any amount in any quantity without worrying about third parties impacting your profits) but only infrastructure.

Here’s how it works: one party to a transaction starts the process by creating a block, and all of them can form a block of data. This block is verified and validated by thousands, perhaps millions, of computers distributed across the network, and is thus added to the chain permanently. As one block is completed, another is generated, resulting in a huge number of blocks.

All information is encrypted with mathematical encryption, which makes any attempt at fraud and forgery virtually impossible.

Furthermore, there is no need for intermediaries as all transactions take place from person to person and there is no central decision-making power as each user has a voice that counts.

The uses of blockchain

As mentioned above, the uses of blockchain are many, and potentially infinite.

For starters, money transfers are carried out with the help of cryptocurrencies: these are extremely secure transactions with no charges. Smart contracts are also advantaged by blockchain, since they are impartial and neutral towards all parties involved, they have no human emotions and no interest in cheating since they are fundamentally algorithms.

In a world increasingly exposed to hackers and violation of privacy, blockchain becomes an essential tool for verifying information. As we explained earlier, what is added to the blockchain remains there permanently and immutably.

This means that identities cannot be stolen or altered since there is only one identity for each person in the blockchain ledger. The same happens for objects: a person cannot say they wrote that book or took that photo if thousands of sources say that the author is someone else.

Let’s think again about cloud storage: blockchain becomes useful to anyone who needs to store huge amounts of data at a relatively cheap price. You take all the information, encrypt it, and store it in small pieces on all the computers on the network, securely. Since there are no intermediaries, you will only have to pay for the service.

Furthermore, blockchain can be very useful for providing a communication system between all machines within a company or system: essentially an Internet of Things on blockchain.

Finally, what benefits the blockchain is the production and distribution of goods, both from the point of view of the manufacturer (who can know, for example, if the pieces are defective before assembly), and from the point of view of the final consumer, who can know the exact origin of all the parts that make up a final product.

Blockchain: advantages and disadvantages

The system created to track Bitcoin operations therefore has a clear purpose, which is to avoid fraud by keeping track of every single movement and operation performed on the network.

HSBC has always been extremely convinced of the potential of blockchain and in 2017 announced a partnership with Bank of America Merrill Lynch to test this new technology with the aim of efficiently and effectively creating a commercial agreement.

Over $2 billion in business today depends on the physical exchange of documents”, Vivek Ramachandran, global head of global trade products and propositions at HSBC, said at the time.

To this, he added: “what we have demonstrated is that blockchain has the potential to completely eliminate paper, which could be totally revolutionary, if commercialized”.

According to Ramachandran, blockchain technology could serve as a trusted intermediary for sharing information between buyers and sellers. This would make international trade faster and cheaper.

In this sense, he stated that “(blockchain) makes the system much more efficient”, underlining the costs of this technology but also its enormous positive impact.

Companies have been betting on blockchain technology for a long time now. A study conducted by Juniper Research found venture capital investing $290 million in the development of blockchain technology in the first half of 2016 alone.

Several startups specializing in blockchain have received stellar funding. However, the same report advised investors and businesses to be caution.

While blockchain technology offers the potential for greater speed, transparency, and security within a number of vertical markets, rigorous and reliable testing is required for any type of use before making any decisions”, research author Windsor Holden said in a press release.

The blockchain has the disadvantage of being comparatively inefficient for carrying out transactions of value as Bitcoin operations are slow and less scalable (no more than a certain amount per second).

In light of these advantages and disadvantages, here is what blockchain is, how it works and what the potential of this technology linked to Bitcoin is. Original article published on Italy 2023-05-23 10:01:02. Original title: blockchain: cos’è e come funziona

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