What is a Blockchain?

What is a Blockchain? | ETC Group

What is a blockchain?

A blockchain is an ever-growing list of records collected in a series of blocks. Each new block of data or transactions is linked to the previous one using a type of complex mathematics called cryptography.

At their most basic level, blockchains are simply databases like Microsoft Excel or Google Sheets.

But you can only add information on a blockchain. You can't go into a blockchain and click on a cell like you would in Google Sheets and delete stuff you've already added. In other words, you can't change the data in a blockchain once it's there, or reorder the blocks in a blockchain.

Every block is timestamped and has a unique digital signature that connects it to the previous block. This leads to a never-ending chain of blocks, or a blockchain.

Blockchains were popularised by the creation of Bitcoin in 2008 but the technology is the result of decades of work by cryptographers. Blockchains can act as digital ledgers recording financial transactions but may also be used to store any type of data: identity documents, carbon footprint allowances, or even concert tickets.

Public blockchains are 'permissionless' which means anyone from the public with an internet connection has permission to view all of the activity that has taken place on it, or download a copy of its entire history. Public blockchains are also decentralised as transactions taking place on them are validated by independent computers spread across the world.

How does a transaction get into the blockchain?

Transactions on blockchains happen peer-to-peer between individuals, and rely on a type of advanced mathematics called public-private key cryptography.

To send cryptocurrency over the internet using a blockchain, a user has to request the public key of the person they want to send cryptocurrency to.

A public key is a string of letters and numbers that represents the wallet address of an individual. A public key is like someone's home address. Anyone who has someone's public key can send them cryptocurrency, just like anyone who has someone's home address can send them a parcel.

The other part of the equation for sending cryptocurrency over the internet using a blockchain is a private key. A private key is like someone's front door key.

A private key is used to sign each transaction that users send to the blockchain to guarantee that it was really signed by them and is not fraudulent. People need to keep their private key secure and not share it with anyone, just like they would not give out copies of their front door key to anyone who wants to send them a parcel.

Say for example someone wanted to send 1 Bitcoin to their friend. They would need to know their friend's public key - like knowing their home address. This person would make the request to send the Bitcoin online, and would sign the transaction with their private key.

On the other end, the friend will receive the request and sign the transaction with their own private key. Once the transaction is authenticated, a block that includes the transaction is created and broadcast to every connected computer on the blockchain network that is running the correct copy of the blockchain software.

These computers then compete to solve the difficult puzzle that confirms a block of transactions is valid. For their trouble, and as an incentive to spend their computing power to do so, they receive a block reward. The block is then added to the never ending chain of blocks, and this updated version of the blockchain is broadcast and shared with every connected computer on the blockchain network. Then, the transaction is complete, and the friend can go and use the Bitcoin however they would like.

What is consensus in blockchains and why is it important?

Consensus in blockchains just really means lots of computers coming to agreement on which transactions are valid and which are not.

To reach consensus, and to organise who owns what on the network, a majority of computers have to agree. Consensus mechanisms like Proof of Work and Proof of Stake are the methods by which these collections of computers reach this agreement.

Without consensus, there would be no reliable record of transactions on blockchains. This is the key selling point for blockchains and it is what makes them a better way of organising money that the methods that currently exist.

To reach consensus, 51% of a network's nodes must agree on whether a transaction is legitimate and be added to the blockchain.

Consensus is important because it maintains the security of a blockchain by making it more resistant to attacks.

Malicious actors must control 51% of the network to compromise it. This is a difficult feat to achieve on most scalable networks that have thousands of nodes supporting it.

What is a genesis block?

The first block in a blockchain is called the genesis block. It is sometimes called Block 1 and is usually embedded in the design of a blockchain. All blocks - or transactions - created after the genesis block can be traced back to it.

It's useful to remember that a blockchain is a series of transactions recorded digitally. The first batch of transactions on it would represent a second block being linked to the genesis block. The second batch of transactions would represent the addition of a third block and so on.

For example, Bitcoin's genesis block is the foundation of its blockchain. It was created on the 3rd of January 2009. It had a mining reward of 50 BTC that can never be spent because of a law in Bitcoin's code.

What does decentralised mean?

In blockchains, decentralised means spreading out the power to confirm transactions across multiple computers that are located all over the world.

Some blockchains are more decentralised than others. Ethereum is considered to be one of the most decentralised blockchains in the world.

While in the traditional world, a very limited number of people have the power to confirm ownership of a currency or an asset, in blockchains, the opposite is true.

Computers called validators - rather than banks or governments - are responsible for approving transactions on blockchains. Transactions are only added to the blockchain if these validators reach agreement (called 'consensus') on whether they are legitimate.

In blockchain networks, validators don't have to trust or know one another. Each validator has a copy of the blockchain's history and the same data. If one validator drops out of the network, the blockchain will continue to operate just fine.

This also means that blockchains have no single point of failure. This happens when a centralised system reaches a standstill if a core component is disrupted.

What is the difference between a Layer 1 blockchain and a Layer 2 blockchain?

The base layer of a blockchain is called Layer 1. It represents the rules and mechanisms that make a blockchain function.

Layer 2 solutions are networks built on top of blockchains with the purpose of improving scalability and efficiency.They serve as parallel networks that divert the intensive process of confirming transactions away from a blockchain's Layer 1.

By doing this, Layers 2s reduce a blockchain's congestion and lower transaction fees for users because they create increased throughput.

Bitcoin is an example of a Layer 1 blockchain while the Lightning Network is a Layer 2 solution constructed on top of it to accelerate transaction speeds.

Layer 2 solutions effectively sit on top of Layer 1 blockchains and only interact with them periodically. Layer 2 solutions don't tamper with the architecture of an underlying blockchain and also benefit from their overarching network security.

What is a fork?

A fork takes place when the development team behind a blockchain wants to innovate the chain or change the way it works entirely. Forks are often necessary for blockchain projects to stay in step with advances in technology.

They can also occur in response to security threats a network may face or due to developers and network participants disagreeing on the best way forward to improve a blockchain. There are two main types of forks: soft forks and hard forks.

Soft forks are like approving system updates to a phone or computer. They bring utility to a blockchain to the benefit of users. Hard forks are more like buying a new computer altogether.

Hard forks happen when developers vote to split up a blockchain and create a new cryptocurrency out of it. The old blockchain remains functional while the new one is built on a different set of code and rules.

Hard forks are backwards-incompatible software updates, which means that any miners or validators running the old software from before the fork will not be able to access rewards on the updated blockchain.

Some famous examples of hard forks include the emergence of cryptocurrencies like Bitcoin Cash and Bitcoin Gold that were borne out of the Bitcoin blockchain in 2017.

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About ETC Group

ETC Group has been created to provide investors with the tools to access the investment opportunities of the digital assets' and blockchain ecosystem. The company develops innovative digital asset-backed securities including ETC Group Physical Bitcoin (BTCE) and ETC Group Physical Ethereum (ZETH) which are listed on European exchanges including XETRA, Euronext, SIX, AQUIS UK and Wiener Börse.

With a track record of over three years, ETC Group is made up of an exceptional team of financial services professionals and entrepreneurs with experience spanning both digital assets and regulated markets. With product quality and safety at the core of our product creation approach, the company aims to continuously launch best-in-class institutional-grade exchange traded products.

As a company, ETC Group has previously launched BTCE - the world’s first centrally cleared Bitcoin exchange traded product on Deutsche Börse XETRA, the largest ETF trading venue in Europe, and also listed DA20, the world’s first crypto ETP tracking an MSCI index signalling a move towards investment management products. DA20 provides broad market exposure to investors by tracking an index of 20 cryptocurrencies which cover 85% of the total crypto market capitalisation.


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