After exploring what cryptocurrency is, how it works, and why people choose to invest in it, we thought we’d delve into the world of blockchain – crypto’s close cousin. While cryptocurrency and blockchain aren’t exactly aligned with Pearler’s investing ethos, we do like equipping our community with as much knowledge as possible. To that end, here’s your guide to how blockchain works.
What is blockchain?
Blockchain is like a digital ledger. It's considered a distributed ledger, which is a type of database spread across multiple locations, regions, or participants. Unlike traditional centralised ledgers, where a single entity controls the database, a distributed ledger is maintained and updated independently by each participant (or node) in the network. In the case of blockchain, it securely records transactions across many computers. This makes it nearly impossible to change or hack.
Blockchain was first popularised by cryptocurrencies like Bitcoin. But, it isn't just about digital money; it's changing how we handle and protect information. Blockchain technology is now used in various fields, including finance, supply chain management, and healthcare. It offers a new way to manage and share data, with a focus on security, transparency, and trust.
How does blockchain work?
Blockchain works like a highly secure and transparent digital notebook. Imagine each page in that notebook is a block that records transactions. When a page is full, it’s securely attached to the previous page, creating a chain. This chain of blocks makes it nearly impossible to alter any information without changing every previous page, ensuring the data remains tamper-proof.
When a new transaction is initiated, it's broadcast to a network of computers, or nodes. These nodes act like a group of friends who all have a copy of the same notebook. Each node verifies the transaction using consensus mechanisms like Proof of Work or Proof of Stake, similar to how the group agrees on the accuracy of the new entry. If most nodes agree the transaction is valid, it's added to a new block.
Once the block is filled with verified transactions, it gets a unique cryptographic signature, or hash, and is linked to the previous block. It’s just like adding a new page to the notebook. This process ensures every block is securely connected to the one before it, creating a continuous, unbreakable chain.
Because every node has a copy of the blockchain, the system is decentralised and transparent. Any changes in one copy are quickly flagged by the other nodes, maintaining the integrity and security of the entire blockchain network. This method ensures that blockchain is a reliable way to record and verify transactions, making it useful for various applications beyond cryptocurrencies.
How does blockchain relate to cryptocurrency?
Blockchain and cryptocurrency are closely linked, with blockchain serving as the foundational technology behind digital currencies like Bitcoin and Ethereum. Think of blockchain as the digital ledger where all cryptocurrency transactions are recorded. Each time someone buys, sells, or trades a cryptocurrency, that transaction is written onto a new page, or block, in this digital ledger.
Cryptocurrencies rely on the secure and accountable nature of blockchain to function. Blockchain’s decentralised and transparent system makes it suitable for cryptocurrencies, providing a reliable way to track ownership and transfer of digital assets without needing a central authority. Essentially, blockchain allows cryptocurrencies to operate independently and securely in the digital world.
Can blockchain technology be used for anything else besides cryptocurrency?
It sure can. Blockchain is suitable for various applications across different industries where record-keeping and verification are essential.
In supply chain management, blockchain can track products from manufacture to delivery. Each step in the process can be recorded on the blockchain, ensuring transparency and potentially reducing fraud. For instance, you can trace a product’s journey from a factory to your doorstep, knowing it hasn’t been tampered with along the way.
Healthcare is another area where distributed ledger technology can be utilised. Patient records can be securely stored and shared among doctors and hospitals, ensuring that medical histories are accurate and up-to-date while maintaining patient privacy. This way, healthcare providers can offer better, more coordinated care.
Blockchain is also making waves in voting systems. By recording votes on a blockchain network, we could theoretically create a transparent and tamper-proof voting system, ensuring that every vote is counted accurately and helping to prevent fraud.
Additionally, smart contracts are another powerful use of blockchain. A smart contract is a self-executing contract with terms directly written into code, automatically enforcing agreements when conditions are met. This can streamline processes in industries like real estate, legal, and finance.
Lastly, the Australian Government is also in the process of researching blockchain to see how it could be applied to government services and agencies.
Are there any risks associated with blockchain technology?
While blockchain offers many possible benefits, it isn’t foolproof. It also comes with significant risks, especially in the realm of cryptocurrency.
One major risk with blockchain is security. Although a blockchain network is designed to be tamper-proof, it's not immune to attacks. Hackers can exploit vulnerabilities, particularly in the case of smaller blockchain networks, or through sophisticated methods like a 51% attack, in which they gain control over the majority of the network’s computing power.
In the world of digital currency, volatility is a big concern. Cryptocurrencies can experience dramatic price swings, leading to significant financial losses for investors. This volatility makes cryptocurrencies risky as both an investment and a means of transaction.
Regulatory uncertainty also poses a risk. Governments around the world are still figuring out how to regulate blockchain and digital currencies, leading to a patchwork of regulations that can be confusing and restrictive. These policy implications can impact the adoption and growth of blockchain technology.
Additionally, there's the risk of human error. A poorly designed smart contract or mistakes in coding can lead to significant financial losses and system failures.
Finally, the anonymity of blockchain transactions can be exploited for illegal activities, such as money laundering and fraud, raising concerns among regulators and law enforcement.
While blockchain has potential, these risks highlight the importance of careful implementation, robust security measures, and clear regulatory frameworks to ensure its safe and effective use.
Blockchain technology - what you can take away
Blockchain is an exciting technology, and as far as cryptocurrency investing is concerned, it certainly presents a compelling framework for investing securely. That being said, these are new and complicated technologies that come with a high degree of risk. This is why it’s imperative to understand exactly what you’re doing before taking the plunge.
Do as much research as possible into cryptocurrency and blockchain before considering an investment. Weigh up important factors like your financial goals, time horizon, investing strategy, and risk tolerance, too (that last one is critical!). And, like always, reach out to a financial professional if you want personalised advice.
Happy investing!
