News

Definition, Explanation, Pros & Cons

Published

4 months ago

20 July, 2024

Paid non-client promotion: Affiliate links for the products on this page are from partners that compensate us (see our advertiser disclosure with our list of partners for more details). However, our opinions are our own. See how we rate investing products to write unbiased product reviews.

Blockchain is a decentralized, digital database that stores transactions and other forms of data.
Key blockchain features include immutable records, distributed ledger security, and smart contracts.
Blockchain has many other uses outside of cryptocurrencies.

It’s almost impossible to say “cryptocurrency” without mentioning blockchain technology. A blockchain is a digital, public ledger that securely stores segments of data through a self-managing, peer-to-peer (P2P) network of computers. And some of its key components include irreversible records (i.e., unchangeable blocks of data), decentralized transactions, and smart contracts.

Decentralized digital assets like crypto and stablecoins use blockchain technology for buying and selling assets. Centralized banking digital currencies (CBDCs) are centralized currencies and don’t use a blockchain.

Here’s how blockchains work — along with a closer look at their pros, cons, and potential applications.

Blockchain key terms:

Nodes: Strong computers connected to a blockchain network in order to process, maintain, and verify crypto transactions. Nodes rely on consensus algorithms and need to be connected to an open-source operating system. Types of blockchain nodes include mining nodes, full blockchain nodes, master nodes, and light nodes. For example, bitcoin uses light nodes to save storage space that only downloads key data.
Decentralized currency: Currencies, such as cryptocurrencies and stablecoins, that are not issued by a government or financial institution in order to cut out banks as the “middlemen” of trading. Instead, decentralized currencies use peer-to-peer trading and a general system of trust.
Digital currency: Also referred to as electronic money or digital money, is a form of currency without a physical equivalent and can only be accessed digitally. Examples of digital currencies includes cryptocurrencies, stablecoins, and central bank digital currencies (CBDCs).
Peer-to-peer networks: Transactions are completed directly between merchants and consumers. It eliminates the need for bank loans or money borrowing. Some prominent examples of P2P networks include file-sharing (sites that allow users to share and download content), media streaming (such as YouTube, which allows users to upload content for viewers to access), and crypto trading platforms.

What is a blockchain?

A blockchain is a digital database that stores “blocks” of data in chronological order. These blocks are linked together on what’s known as the “chain,” and unlike traditional databases that utilize a third party or intermediary, a blockchain is completely decentralized.

This means that no third parties can monitor or interfere with transactions. The blockchain system is basically self-regulating, thanks to a P2P computer network of nodes (i.e., individual computers) that verify all new data and distribute cross-network copies of the blockchain to keep it secure.

“Blockchains are made of, well, blocks,” explains Lorien Gabel, co-founder and CEO of Figment.io. “Each block contains a timestamp, transaction data, and a mathematical function from the previous block. Computers that mine blocks or run validating nodes that sign blocks will include that mathematical function — called a cryptographic hash — from the previous block into the current block to form a chain.”

Quick tip: Blockchain is not to be confused with bitcoin. Bitcoin transactions wouldn’t be possible without blockchain technology, but the two are completely different. While bitcoin is a tradeable digital currency, blockchain is merely the underlying technology that makes secure transactions possible for bitcoin (and other digital assets).

Wealthfront Investing

Icon of check mark inside a promo stamp
It indicates a confirmed selection.

Perks

Fund your first taxable investment account with at least $500 in the first 30 days of account opening and earn a $50 bonus.

Account Minimum

$1 ($500 for automated investing)

Fees

$0 for stock trades. 0.25% for automated investing (0.06% to 0.13% for fund fees)

Pros

Check mark icon
A check mark. It indicates a confirmation of your intended interaction.
Low annual fee for investment accounts; crypto trust investments available
Check mark icon
A check mark. It indicates a confirmation of your intended interaction.
Tax-loss harvesting, portfolio lines of credit, 529 college savings plans available
Check mark icon
A check mark. It indicates a confirmation of your intended interaction.
Cash account
Check mark icon
A check mark. It indicates a confirmation of your intended interaction.
Mobile app and investing and retirement tools

Cons

con icon
Two crossed lines that form an ‘X’.
You need at least $100,000 to utilize additional investment strategies
con icon
Two crossed lines that form an ‘X’.
No human advisor access

Product Details

Consider it if: You’re balancing several goals and want to streamline your finances.
Promotion: Fund your first taxable investment account with at least $500 in the first 30 days of account opening and earn a $50 bonus.

How a blockchain works

Cryptocurrencies would essentially be nonexistent without a blockchain. This technology relies on a distributed ledger that keeps a record of all past, present, and future data (e.g., transactions or accounts).

“A blockchain is commonly used to build a distributed ledger,” says Gabel. Ledgers, he added, track accounting transactions and accounts — we can think of it as a database that stores information. “Distributed ledgers don’t have to be on a blockchain to be considered ‘distributed,’ they just have to be shared with other computers on the network.”

But several other features separate blockchain technology from traditional databases controlled by financial institutions. These include immutable, or unchanging, records and smart contracts.

Irreversible transactions

Each transaction that the nodes add to the blockchain is permanent. So once the computer network verifies the data and adds it as a new block, that record is permanent. And this serves much more important purposes beyond simply keeping the system running.

“Transactions are irreversible, permanently recorded, and available for everyone to see. It’s challenging and complicated for any one actor to change or falsify data recorded on a ledger,” explains Gabel.

In order to change the data on the ledger and have the modified chain become the majority chain, someone would have to both alter their duplicate of the ledger while adjusting at least 51% of other users’ copies of the database. Therefore, the immutable records component makes it extremely difficult to hack the system.

Smart contracts

“[A smart contract] is a self-executing contract with the terms of the agreement directly written into lines of code on the blockchain,” Gabel explains. This allows them to execute once the terms are met.

But as for the blockchain process, here’s how it works: Whenever a new transaction takes place (e.g., a bitcoin or ether buy order), that data is sent to a network of computers (nodes) that solve math equations to validate the transaction.

If the transaction is rejected, it won’t show up on the blockchain. But if it’s confirmed, the nodes will add the data as a new block on the ledger, chaining it to the prior blocks (and the ones that follow) to maintain the chain’s security. Once this step is done the transaction is complete.

The blockchain process can be broken down into simple steps.

Alyssa Powell/Insider

What is a blockchain used for?

Cryptocurrency is likely the first thought many people have when it comes to blockchain, but this technology has many other uses:

Banking and finance: Blockchain has many uses for money transfers, especially for fiat currencies (e.g., USD, EUR, or JPY) that individuals typically exchange through financial institutions like banks or payment services.
Cryptocurrency: This is perhaps one of the most well-known uses of blockchain technology. The blockchain stores data for all cryptocurrency exchanges.
Healthcare: Blockchain has several applications within the medical industry. It can be used to secure medical records, healthcare data, and other related electronic records.
Records of property: Whether it be property deeds or other assets, this technology can additionally validate property transactions between two parties.
Voting: Though not currently in effect, the idea of using blockchain to improve the voting process has become a topic of discussion. Arguments in favor urge that it could prevent voter fraud and offer a simpler way of counting votes. Those against it insist that such a system could pose national security concerns.

Quick tip: Since blockchain isn’t a digital currency, you can’t directly invest in it. But you can still gain portfolio exposure by investing in the stocks of blockchain companies or platforms that offer cryptocurrency products.

“Blockchain technology provides a solution to the challenges of storing, managing, and protecting data,” says Gabel. “It provides a useful and secure way of authenticating information, identities, transactions, and more, creating a secure ledger that can be updated in real time.”

Blockchain: Pros and cons

Blockchain has several uses, including cryptocurrency transactions, fiat transfers, and more. However, there are also pros and cons to consider.

There are many perks to blockchain-secured transactions. Its efficiency, security, and lack of intermediaries can make it an ideal option for those looking to safely store a range of data.

However, since there’s no centralized party to govern the database, you can never recover any assets if you lose your private key. This is important to keep in mind if you’d like to take advantage of blockchain-powered transactions.

Insider’s Featured Crypto Apps

Public Investing
Wealthfront Investing

Chevron icon
It indicates an expandable section or menu, or sometimes previous / next navigation options.

Editor’s Rating

4.14/5

A five pointed star

Editor’s Rating

4.34/5

A five pointed star

Building a blockchain

You can create your own blockchain (or build onto/modify an existing blockchain) if you have coding and/or advanced computer knowledge. By building your own blockchain, you can design your own cryptocurrency for others to trade. You’ll be able to choose its purpose, tokenomics, functionality, and legality.

You create a blockchain by:

Designing your own by scratch: If you’re especially skilled at coding and computers, you may be able to create your blockchain from scratch. You’ll need to establish a secure network, create a functioning algorithm, choose a protocol, follow legal regulations, and make sure your code has strong defenses against hacks and other fraudulent activity.
Modifying an existing blockchain: A slighter simpler (not necessarily easier) method of creating a blockchain is by modifying an existing chain’s open-sourced code and revising it to your liking. This way you can expand upon already functioning algorithms and possibly even improve functionality.
Building onto an existing blockchain: This method isn’t necessarily “creating” a blockchain, but instead allows you to design your own cryptocurrency on top of an already existing blockchain, like Ethereum or Binance. It’s easier than the other two methods but also more restrictive.

Creating your own blockchain isn’t recommended for beginner crypto traders or beginner coders. Creating a functioning and secure blockchain is an exceptionally difficult project, and the competition is steep. Only advanced traders and computer experts will be up to the task.

Blockchain technology

Blockchain technology utilizes a P2P network of computers to securely process and store transactions in a digital database. Unlike traditional databases that rely on central authorities, blockchain completely removes the need for intermediaries.

Security is another major component of blockchain technology. Some of its key features — including immutable records and smart contracts — work to keep all data secure.

Overall, blockchain technology has many uses in both the crypto world and beyond, but it’s important to understand how it works before you utilize it.

Rickie Houston

Senior Wealth-Building Reporter

Rickie Houston was a senior wealth-building reporter for Business Insider, tasked with covering brokerage products, investment apps, online advisor services, cryptocurrency exchanges, and other wealth-building financial products.
Before Insider, Rickie worked as a personal finance writer at SmartAsset, focusing on retirement, investing, taxes, and banking topics. He’s contributed to stories published in the Boston Globe, and his work has also been featured in Yahoo News.
He graduated from Boston University, where he contributed as a staff writer and sports editor for Boston University News Service.

CHAINFEED.INFO

News