Brought to you by the Liquid team to help you make sense of crypto.
Whether you are a new investor in cryptocurrency or a seasoned trader, at some point you will ask:
What is blockchain technology and how do blockchain platforms work?
In this article, we will look at:
The origins of cryptocurrency
- Cryptographic keys
- Distributed networks
- Protocol governing incentivization
The origins of cryptocurrency
The concept of blockchain technology – and Bitcoin in particular – rose to prominence in 2009 when a mysterious person – or group of persons – going by the name Satoshi Nakamoto published a whitepaper:
“Bitcoin: A Peer-to-Peer Electronic Cash System.”
The idea that Nakamoto put forth – and the technology that serves as the foundation of every cryptocurrency today – is the same:
The blockchain had a primary purpose:
To allow individual people to execute financial transactions without the participation of a third party, such as a government or bank.
Four existing technologies came together to power the blockchain:
- the Internet
- cryptographic keys
- distributed networks
- protocol governing incentivization
Nakamoto combined these to create Bitcoin, the first platform to enable peer-to-peer digital exchange of currency.
The technologies provide the access, security, public recognition of transactions, and incentive for community verification that makes the blockchain possible.
What are cryptographic keys?
Cryptographic keys are digital assets that allow individuals to authenticate their identity and make transactions on the blockchain. If you use the internet, you’re familiar with authentication.
It’s basically the way you prove who you are.
You open digital accounts for sensitive information – like your bank accounts – by authenticating yourself with personal identification like your birthday, social security number and home address.
There are several problems with this approach to authentication, and blockchain aims to solve them.
The first is that it requires you to authenticate your identity on multiple websites instead of having a single authenticated digital identity. This is time consuming and it makes your private information vulnerable to a hack on multiple websites.
In addition, enabling security to create authentication and protect your identity can be costly. Companies – particularly banks and other institutions that hold valuable assets – spend massive amounts of security to protect their customers’ private information (and it can still be vulnerable to a hack).
In addition, this form of authentication is a means of interfacing with an institution, but not an individual.
Cryptographic keys solve these problems.
First, they allow you to prove your identity in a single place, without providing personal data. Second, the exchange of keys is done between two parties – two parties looking to confirm trust with one another without a third party or institution.
Cryptographic keys work like this:
- An individual will have two keys in a digital wallet: a public key and a private key.
- When the two are combined, they create a digital signature that confirms identity and ownership.
How does this play out on a blockchain platform?
If Person A wants to exchange something with person B, they can use their private key to connect information about the asset or transaction to the public key of Person B.
Once Person B confirms the identity of their public key with their private key, it unlocks the transaction.
All this information combines to form a block, which has a digital signature, a timestamp and information about the transaction.
The block is then added to the blockchain
And now the next technology kicks in.
What are distributed networks?
Cryptographic keys enable individuals to prove their identity and authority of ownership. But to provide additional security, blockchain technology enables – requires – individuals to communicate a transaction over the blockchain.
The distributed network is a massive network of “nodes” (computers) that power the blockchain.
If, in the scenario above, Person A sends a message that he’s going to exchange 10 Bitcoin with person B, that message is communicated across the network.
Every node on the blockchain will get a notification.
Now there has become a public record – viewable by anyone on the blockchain platform – of that exchange. And it is added to the history of the ledger, which has recorded every single transaction in the history of the blockchain.
These blockchain networks are massive. The power behind Bitcoin’s security is measured in hash rate – hashes per second.
Bitcoin’s network is so fast, its security is measured in TH/s – one trillion hashes per second. The Bitcoin blockchain is secured by more than 3 million TH/s.
Ethereum is secured by 12,500 THs.
Protocol governing incentivization
Once a block is made, communicated to the network and added to the blockchain, computers (and the people running them) can begin “mining” the transaction.
Mining is the act of trying to complete an extremely complicated math problem.
This work ensures the block follows blockchain protocol and confirms that any block is specific and unique. This helps to prevent “double-spending”: the occurrence of the same coin being used for two different payments.
Users in the network receive incentive for doing this Proof-of-Work problem solving in the form of the blockchain’s cryptocurrency. The first user to solve the problem receives the coin generated by the transaction.
In turn, the work benefits the network because it ensures the block created by the transaction follows the blockchain’s protocol.
The entire blockchain process is summed up succinctly and clearly by Marc Andreesen, the legendary software engineer who co-authored the first web browser, Mosaic.
The practical consequence […is…] for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate.
The incredible benefit of blockchain technology has been seen not only by people in the cryptocurrency market but increasingly by various industries.
One reason for this is security.
Rather than having multiple websites where people need to input data to authenticate their identity (and expose themselves to identity theft), blockchain platforms enable the individual to own their authentication and use it as they want.
The distributed ledger provides a public record of transactions, which works as evidence of the transaction and proof that people in the network have seen and approved it.
Another is efficiency.
Because blockchains are decentralized, they do not require third parties to approve of these transactions. So not only are these transactions highly secure, they are also executed faster, because they’re agreed upon by two parties and approved by the network, reducing the approvals required for most transactions in traditional finance and other industries.
A third is the history of record the distributed network creates.
The history of all transactions is built into the blockchain, thus diminishing the time required to identify and verify every transaction that has taken place.
Imagine identifying every transaction in a bank’s history!
This recorded history has significant benefit to, say, government agencies, where oversight and management of record history is often important and time-consuming.
Blockchain platforms provide an efficient, effective and highly secure way for confirming transactions and communicating them.
Blockchain transactions happen thousands of times a day throughout the world. They allow for a method of transaction between people unlike anything we’ve seen before.
The future will see how this technology is adopted by industries and companies in the broader digital marketplace.
This content is not financial advice and should not form the basis of any financial investment decisions nor be seen as a recommendation to buy or sell any good or product. Trading cryptocurrency is complex and comes with a high risk of losing money, particularly if you trade on leverage. You should carefully consider whether trading cryptocurrencies is right for you and take the time to learn how trading works and decide how much money you are prepared to lose.
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