What is Blockchain?

8-minutes Read

What is blockchain?

Blockchain is a time-stamped series of immutable records of data that is managed by a cluster of computers not owned by any single entity. Blockchain is literally a chain of blocks – each block has the hash value of the previous block and forms a chain. The data stored in the blocks includes information about a transaction, and the addresses that  participate in this transaction. Updating data in a block will change the hash value and will not validate with the hash stored in the next block, and thus making it tamper-proof.

Blockchain is a technology that can allow individuals and companies to make instantaneous transactions on a network without any middlemen. Transactions made on blockchain are  kept as a record of what happened like a ledger. The network has no central authority – it is very definition of a democratized system.

Blockchain system can break down to three important parts:

  • A network of computers/participants
  • A network protocol
  • A consensus mechanism

Depending on the permissions of the blockchain, it can be public, and open to anyone with a computer, or private, accessible only by specific members. Each computer is called a node, and it makes up the network of participants in the blockchain.

A network protocol is the way all nodes (or peers) communicate on the blockchain. Each node keeps an identical copy of the ledger of transactions, enabling peer-to-peer transactions without a middleman but network consensus.

A consensus mechanism is how a blockchain network verifies transactions and all nodes reach an agreement on which transactions are legitimate and can be added to the blockchain. There are many ways to reach consensus, and the three most popular consensus mechanisms are: Proof of Work (PoW), Proof of Stake (PoS) or Delegated Proof of Stake (DPoS).

Proof Of Work (PoW) is used by Bitcoin, so it is the first blockchain consensus mechanism. The PoW process is known as mining and the nodes are miners. Miners solve complex cryptographic puzzles which require a lot computational power. The first one to solve the puzzle can validate the transaction and create a block, and receive minted coins plus processing fee as a reward. The major drawback of PoW is that it consumes plenty of resources (electricity) and it can be very slow due to the lengthy process to reach consensus.

Proof of Stake (PoS) is more environment friendly and can process at a higher speed. Unlike miners using computer hardware to mine blocks under PoW, users stake their tokens (lock tokens for some time) to become validators and create blocks in a PoS network. The bigger stake a user has, the higher chance of becoming a validator and the reward is also in proportional to their total stake. Ethereum started with PoW and will move to PoS in Ethereum 2.0 upgrade.

Delegated Proof-of-Stake (DPoS) is a variation from PoS, where users can stake their coins to elect the delegates, and the voting power depends on the amount of the stake. The delegates that receive the most votes get to produce blocks. DPoS is even more efficient in processing transactions.

Three Pillars in Blockchain

There are three pillars of blockchain technology that help it gain widespread acclaim: decentralization, transparency and immutability.

Centralized systems are commonly used in our daily life, such as banks. The bank stores your money  and the only way you pay someone by using this money, is through the bank. There are some vulnerabilities with centralised systems. All the data is typically stored at a centralized place, which can easily become the potential targets of hacking. Moreover, corrupted or malicious members of the central entity may also lead to the failure of the system. Decentralization can cope with the above-mentioned issues. In a decentralized system, the information is not stored by one single entity. Everyone in the network owns the information. In a decentralized network, users can have full control of their assets with a private key and they can transfer them to other participants in the network. without going through a third party.

Another interesting concept about blockchain is ‘transparency’.  Users’ identity is well protected via complex cryptography and represented only by their public addresses. While the real identities of users are secured, all the transactions are visible on the public network.

The last pillar, immutability, in the context of blockchain, means that once something has been entered into the blockchain, it cannot be tampered with. Blockchain has this property because of the function of cryptographic hash.

In simple terms, hashing is the process of taking the input string of any length and turning it into cryptographic fixed output. Hashing is not an ‘encryption’ we cannot retrieve the original data by decrypting the hash. It’s a one-way cryptographic function. Any small change in the input will have big impacts on the hash. As mentioned above, each block has the hash value of the previous block, so changing any data will complete change the whole chain, which is impossible.

The blockchain network gives internet users the ability to create value and authenticates digital information. However, every coin has two sides. Compared to the traditional financial model, following are the advantages and disadvantage of Blockchain.

Advantages of Blockchain:

• Transparency

  • Transparency
    • Blockchain is a type of distributed ledger and all participants share the same version of ledger data.
    • All transactions can be viewed on public blockchain networks, or by those who have access on permissioned networks.
  • Security
    • Transactions must be agreed upon by the network and any update would also require consensus.
    • As a distributed network instead of a single server, it is difficult for hackers to attack the system.
  • Instantaneous Transactions
    • Without the need for a third-party mediation, some type of transactions can be automated and processed much quicker than the traditional process.
  • Traceability
    • As blockchain records all history, it can provide an audit trail that traces where an asset comes from and its whole journey.

Disadvantages of Blockchain:

  • Scalability
    • Blockchain are not so scalable as centralized systems. The Transaction Per Second (TPS) of Bitcoin or Ethereum is still far behind traditional organizations like Visa. Although many projects are trying to tackle the scalability issue, currently there is a ‘Scalability Trilemma’ that a blockchain network can only at most have two of the three properties: fast, secure and decentralized.
  • Costs
    • Blockchain is very energy intensive especially for PoW networks like Bitcoin, and the electricity power cannot be recycled anywhere but can only calculate the hash.
    • Blockchain ledgers can grow very large over time as it keeps all the history records, and there will be storage costs incurred.
  • Security of Private Keys
    • While users can have full control of their assets on blockchain with their private keys, they are also full responsible for safe-keeping the private keys. If a user loses the key, the funds will be permanently lost and there is no way to recover them.
  • Complexity
    • Blockchain knowledge is not easy to understand for non-tech savvy people and may hinder its mass adoption.

AI Link Group Limited, through its affiliates, AI Link Finance Limited and DeepAuto Limited (collectively “ALG” or “AI Link”) operates TradeFi, a financial technology platform that provides trade finance to customers in Hong Kong and Mainland China.

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