At first glance, blockchain technology looks quite complex, but getting to know its key features will help you quickly understand what is happening inside the Web3 industry. In general, it may seem that all existing blockchains can be compared to the Bitcoin network in terms of security or the Ethereum network in terms of capabilities. However, in reality, blockchains are different from each other. They have functions that determine the general principles of operation of the entire network. This may include the governance system, the rate of creation of new coins, and even the users who are allowed to join the network.
Some blockchains are better suited for certain tasks, although each has its own strengths and weaknesses. In this article, Ledger Academy will share all the necessary information about blockchain and the basics of its operation, as well as the differences between different types of such networks along with their purpose.
However, before we get into the technical details, let’s get the basics down.
What is blockchain?
In short, a blockchain is a distributed and immutable digital ledger that records all transactions and the movement of digital assets in the network. Initially, blockchains were used to track financial assets, but today the number of applications for this technology is growing. Still, such networks are a great tool for storing value. There are also some important differences between blockchains, which have led to the formation of a new separate concept known as “Web3”. What are they?
Key Features of Blockchain Networks
Blockchains have something to please their users. However, one way or another, this product is developed on the basis of two fundamental components – distributed ledger technology and immutable records.
Distributed ledger technology
Blockchain does not store all information on one centralized server: instead, data from the distributed ledger is sent to every computer within the chosen system. These devices are called nodes. They are responsible for storing, distributing, and recording information, as well as moving digital assets. This is the basis of distributed ledger technology, and it is the only way blockchains can keep data secure.
Immutable records
Blockchains are also distinguished by the method of storing information, which in this case is represented by blocks. The latter receive new data and are added to the chain, along with which they are distributed throughout the network. In fact, this is where the name “blockchain” comes from, which means “chain of blocks”. This data storage structure was chosen for a reason, because thanks to it, it is impossible to change the information added to the blockchain earlier. As a result, the contents of blockchains are almost impossible to hack.
Why do we need blockchains?
This may raise the question of the expediency of the blockchain. Indeed, why is it needed if people are already constantly conducting digital transactions? However, it is not that simple, because sending money and a picture over the Internet are completely different things.
For a currency to have value, its supply must be limited. For a digital transaction to be successful, that value must appear in the recipient’s wallet and disappear from the sender’s account. If that doesn’t happen, the so-called double-spending problem occurs.
The term is not used very often, but preventing double spending is the foundation of the new financial system and its independence from banks. Blockchain technology solves the double spending problem without the need for a centralized authority to verify transactions. It makes it possible to have completely transparent, secure, and anonymous peer-to-peer exchange at any scale. But what does this mean in practice?
Solving the double-spending problem means allowing blockchain to exchange value with friends, with the participants being confident that the assets will go from one person to another. And it should happen without creating new coins and tokens in the system, allowing its users to spend those assets twice.
Types of Blockchains
There are several ways to create a blockchain network, and there are certainly more than you might think. Still, when most people think of blockchains, they think of decentralized chains like Bitcoin. However, that’s not all, because this technology also allows for the creation of centralized systems.
Indeed, while blockchains can support peer-to-peer transfers and decentralized value exchange, they do not operate solely according to these rules. So chains can be public, private, permissioned, or even consortium-based, with some being a combination of several of these.
So it’s time to understand the difference between the types of blockchain networks and the importance of what’s happening.
Permissioned, Private, and Consortium Blockchains
Permissioned blockchains are run by a single party, such as a government or company. Here, a centralized controller can restrict access to systems and control of nodes within the network, and node operators are given a lot of power that can be abused.
Next on the list are private blockchains, which are permissioned by default. However, in reality, things are a little different here, as private blockchains are able to limit the number of nodes that can run and even access to the system itself. Such networks are completely centralized and also allow certain organizations to protect the personal data of users. They are becoming the preferred choice for governments or trading groups that want to control what happens in the system and its data.
A striking example of private blockchains is Hyperledger . The project uses a private system to protect user data such as delivery addresses from outsiders. And this is logical, because a transparent blockchain in this case would create obvious risks for the privacy of users.
Last in this block are consortium blockchains. These are also considered permissioned chains, but they are not managed by a single organization, but by a group of specific companies and associations. This type of scheme is a popular choice for financial systems that want to interact with each other. Consortium blockchains are also able to process transactions quickly, as they use a voting system to confirm changes.
However, all the listed options are centralized. Accordingly, they are characterized by the presence of a single point of failure – and this is not at all safe.
Permissionless and Public Blockchains
At the same time, there are so-called permissionless or inclusive blockchains that allow anyone to join what is happening on the network and become a node operator. Such systems are usually distinguished by a large number of participants from all over the world.
This feature makes such chains slower than their permissioned counterparts, but the large size of the system also makes it easier to monitor participants with bad intentions. Ultimately, the decentralized nature of permissionless blockchains makes them much more secure.
There are also public blockchains, which are permissionless by default. They allow anyone to join the network, treat nodes within it equally, and also provide equal access to the data in the blockchain. In general, public blockchains are ideal for cryptocurrencies, because they are transparent, secure, and verifiable. An example of such a network is Bitcoin.
How does blockchain work?
Blockchain networks store data about what happens on them inside special computers, also known as nodes. Cryptocurrency nodes are the key to the security of the blockchain, as they participate in the process of validating transactions. Each node stores information in blocks, while each of these blocks is added to the chain. As each new transaction is processed, the network grows larger.
Nodes do not store information in a readable form, as they instead use cryptographic hashes to protect sensitive information. This means that nodes convert data into a string of letters and numbers, and then store the resulting combinations in each block.
The mentioned cryptographic hash contains information not only about the current block, but also about the previous one. This means that if someone tries to change one block, they will also change the corresponding hash, which in turn will affect every subsequent block in the chain. Thus, any possible edits to the data in the network are easy to spot, which makes the blockchain itself very secure. And the earlier a transaction was added to the blockchain history, the more difficult it is to change the information about it, which makes blockchains a unique place to store important data. If this topic is of interest, be sure to read the full materials on blockchain transactions , nodes and their management.
Now we understand how blockchain stores information. But that’s not all.
For example, what prevents a node from lying about the state of the network for its own benefit?
This is where the type of blockchain and its consensus mechanism comes into play.
How is blockchain secured?
In permissioned and private blockchains, the governing party typically votes on what happens on the network. However, public blockchains like Bitcoin and Ethereum use a more decentralized way of ensuring security. This is called a consensus mechanism.
What is a consensus mechanism?
This question reveals the main advantage of a public blockchain. The fact is that there are thousands of nodes in the networks of various cryptocurrencies. They are scattered all over the world, and most of them must confirm each new transaction before it is added to the blockchain. After adding a block, each node within the blockchain must come to the same state, which is called reaching consensus.
The blockchain ledger is very widely distributed. This makes it virtually impossible for one network participant to gain control over the entire network — or to confirm false information in their own interests. This makes the blockchain secure. However, the way nodes process transactions differs slightly depending on the consensus mechanism the blockchain uses. In addition, each mechanism has its own advantages and disadvantages.
Different Types of Consensus Mechanism
Public blockchains primarily use two consensus mechanisms: Proof of Work (PoW) and Proof of Stake (PoS). However, there are other mechanisms that are more centralized and less widely used.
Proof of Work (PoW) is a slow and secure mechanism with miners at its core, who process transactions by solving complex problems with their computing power and thus receive new coins. This protects the network from possible threats, since it is not profitable for miners to try to cheat the system. However, the cost of electricity and other resources for such attempts is too high, making them simply pointless. An example of a PoW blockchain is the Bitcoin network.
Proof of stake (PoS) is a fast and energy-efficient consensus mechanism in which transactions are processed by validators. Instead of using computing hardware to prove their reliability, as miners do, validators of PoS blockchains use large amounts of cryptocurrency as collateral. More details about this mechanism are written in the article on staking cryptocurrency , but in essence, validators are incentivized to behave diligently. Still, they receive a reward for fulfilling their duties, and also pay fines for harmful actions. An example of a PoS network after the corresponding transition in September 2022 is Ethereum .
Where does all the hype around blockchains come from?
And while blockchain technology is primarily associated with cryptocurrencies, it can be used for other purposes as well. Indeed, such networks have found new applications.
For example, some networks are capable of running smart contracts , which are the equivalent of computer programs in the blockchain world. They have already led to a cultural revolution within the technology.
Such programs allow you to create blockchain applications with various use cases.
In particular, decentralized finance applications are opening the door to cryptocurrency lending and borrowing, while blockchain games and art are being implemented in the form of non-fungible tokens (NFTs). Such programs have also led to the creation of decentralized metaverse platforms like The Sandbox and Decentraland .
We can’t forget about the governance system that the world of blockchain is changing. In this case, tokens and coins have helped develop complex systems for decentralized voting in the form of decentralized autonomous organizations , or DAOs.
As innovations in the Web3 industry develop, the number of possible applications for blockchain also increases. This means that this technology is definitely not going anywhere. Well, what its potential will be in the future – we will find out in practice.
FAQs
- What is blockchain technology and how does it work?
Blockchain is a distributed and immutable ledger technology that records transactions across a network of computers, making it secure and transparent. It supports peer-to-peer digital transactions without a central authority.
2. What are the main types of blockchains?
Blockchain networks can be public, private, permissioned, or consortium-based. Each type has distinct characteristics that make it suitable for specific applications in finance, governance, or data management.
3. Why is blockchain technology considered secure?
Blockchain uses a decentralized network of nodes and consensus mechanisms like Proof of Work or Proof of Stake to verify transactions, making it difficult for any single participant to alter transaction data or compromise network integrity.
4. How does a consensus mechanism work in blockchain?
Consensus mechanisms are processes by which nodes in a blockchain network agree on the validity of transactions. The two main types, Proof of Work and Proof of Stake, differ in energy consumption and efficiency but both secure the network.
5. What is the role of blockchain in Web3?
Blockchain is the foundation of Web3, enabling decentralized applications, financial services (DeFi), and digital assets that operate independently of traditional institutions, providing greater autonomy to users.
