Quick Explainer, Blockchain
Investors have heard of cryptocurrency*. What they may not understand is how those assets are accounted for. All transactions for crypto assets are stored in blocks that live on the blockchain.
Our definition for blockchain is:
Blockchain: A distributed digital ledger that records transactions across a network of computers in a way that is verifiable, permanent, and resistant to modification. Blockchains underpin cryptocurrencies like Bitcoin and Ether, as well as smart contract platforms and other decentralized applications.
Distributed digital ledger is a term most investors won’t be familiar with. If we pull it apart, it becomes much easier to understand as a concept. A ledger is a record of transactions. Every bank and exchange keeps these. A digital ledger is one that’s stored on a computer in a file. Distributed is where unfamiliarity can creep in. Instead of just one master version(s) of a ledger being held by a single bank or exchange, it is held simultaneously on hundreds or thousands of nodes* across the world.
This distributed nature requires new transactions to be validated across the entire network before they’re added to the end of the ledger as a block. That structure is what makes the ledger verifiable and resistant to modification.
A block is a group of transactions that have been validated by the nodes in the network and added to the blockchain. Every block also references the prior block in the validation chain with a cryptographic signature. This reference is what creates the “chain” in blockchain. Blocks are mathematically linked together, and attempting to change any block would break the chain. This is one of the major structural reasons why blockchain records are viewed as permanent. Tampering with data would require an actor to change, repost, revalidate, and redistribute the entire chain before the rest of the network adds to the chain. In practice, that’s infeasible.
The methods of validation diverge across different blockchain networks.
Bitcoin* uses a proof-of-work methodology where computers (or miners*) compete to solve a computational puzzle. The first to solve that puzzle adds the next validated block to the chain and receives a block reward* of newly created cryptocurrency.
Ethereum* uses a proof-of-stake methodology. Validators* are selected based on the amount of cryptocurrency (usually Ether*) that they have committed, or staked*, to the network. Validators are rewarded for confirming transactions honestly but also penalized for any dishonest or inaccurate confirmations.
Proof-of-work versus proof-of-stake is an ongoing debate within the crypto community, but they both solve the same validation question without the need for a central authority.
Validation is what lets blockchain accomplish its primary objective: recording the ownership of assets. This is the underpinning of Bitcoin and other cryptocurrencies.
Some blockchains play other roles. Ethereum is built to execute smart contracts* in addition to recording transfers. These contracts have enabled an entire ecosystem of digital platforms and applications.
Blockchain is the glue that holds crypto together. It’s a vital part of understanding the ecosystem and how value is proven across networks. Investors that can grasp this fundamental concept are better positioned to make sense of everything else in crypto.