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Blockchain technology might be one of the most-hyped innovations of the 21st century. Developed to support Bitcoin, blockchains now power thousands of cryptocurrencies, and developers are working on integrating the technology into businesses, including medicine, art and finance.
To understand the growing interest, it can be helpful to understand how blockchain works, why it has value and what makes it different from other internet technologies.
Blockchain: A definition
A blockchain is a digital ledger of transactions maintained by a network of computers in a way that makes it difficult to hack or alter. The technology offers a secure way for individuals to deal directly with each other, without an intermediary like a government, bank or other third party.
The growing list of records, called blocks, is linked together using cryptography. Each transaction is independently verified by peer-to-peer computer networks, time-stamped and added to a growing chain of data. Once recorded, the data cannot be altered.
While popularized with the growing use of Bitcoin, Ethereum and other cryptocurrencies, blockchain technology has promising applications for legal contracts, property sales, medical records and any other industry that needs to authorize and record a series of actions or transactions.
» Dive deeper: What is cryptocurrency?
Blockchain technology explained
Using the Bitcoin system as an example, here’s how blockchain — also known as distributed ledger technology — works:
The purchase and sale of Bitcoin is entered and transmitted to a network of powerful computers, known as nodes.
This network of thousands of nodes around the world vie to confirm the transaction using computer algorithms. This is known as Bitcoin mining. The miner who first successfully completes a new block is rewarded with Bitcoin for their work. These rewards are paid with a combination of newly minted Bitcoin and network fees, which are passed on to the buyer and seller. The fees can rise or fall depending on the volume of transactions.
After the purchase is cryptographically confirmed, the sale is added to a block on the distributed ledger. The majority of the network must then confirm the sale.
The block is permanently chained to all previous blocks of bitcoin transactions, using a cryptographic fingerprint known as a hash, and the sale is processed.
The concept of blockchain technology first appeared in academic papers from 1982, in a dissertation discussing “the design of a distributed computer system that can be established, maintained, and trusted by mutually suspicious groups.” But it was a 2008 paper by the pseudonymous Satoshi Nakamoto titled “Bitcoin: A Peer-to-Peer Electronic Cash System” that brought an academic theory into real-world use.
» Learn more: How to invest in Bitcoin
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Blockchain pros and cons
Here are some of the pros and cons of how blockchain technology works when applied to cryptocurrencies:
While the U.S. dollar is issued by the Federal Reserve, no government agency issues or controls Bitcoin and other cryptocurrencies. This also means that the ability of any one government or agency to determine the fate of a public blockchain is eliminated. The lack of intermediaries reduces cost, as the fees associated with third-party transactions also are eliminated. Another byproduct of how blockchain works is time efficiency — the blockchain is open for business 24 hours a day, 365 days a year, unlike banks and other intermediaries.
Transparency plus anonymity
All transactions on the Bitcoin blockchain are recorded on computers across the network. Transactions are completely transparent because the address and transaction history of Bitcoin wallets, which hold the cryptocurrency, are publicly viewable, but the owners of each wallet connected to those public addresses are anonymous and not recorded.
Accuracy and security
Because the transaction involves little human interaction, there is a lower risk of error. Each transaction must be confirmed and recorded by a majority of the network nodes, which makes it vanishingly difficult to manipulate or alter information. This also prevents anyone from spending a Bitcoin more than once.
Public and private blockchain applications
Blockchain technology creates efficiencies that potentially extend far beyond digital currencies. For example, Bitcoin is on a public blockchain network, meaning anyone can join. But many applications for business can be created on private blockchain networks, where organizations can control who joins:
Blockchain supply chain: Companies such as IBM Blockchain are already providing private network solutions using blockchain technology to more accurately track product supply chains. For example, companies can use the technology quickly find out where recalled food products have been shipped and sold.
Health care records: Deloitte Consulting has suggested that a nationwide blockchain network for electronic medical records “may improve efficiencies and support better health outcomes for patients.”
Smart contracts: With blockchain technology, contract terms can automatically be changed or updated based on hitting a predetermined set of conditions.
Digital elections: Some developers are working on blockchain technology to be applied to elections.
Property transactions: Proponents say blockchain technology can be applied to a wide range of asset sales, be it real estate, autos or investment portfolios.
» Ready to invest? Here are our picks for best bitcoin and cryptocurrency exchanges.
Opportunities for the underbanked
In countries and regions with poor or corrupt financial institutions, cryptocurrencies based on blockchain protocol allow the transfer and holding of cash that bypasses unscrupulous third parties.
Criminals like crypto
Like a lot of new technologies, some of the first adopters have been criminal enterprises. They use cryptocurrencies such as bitcoin both as payment because of the privacy it provides and to target holders of bitcoin for scams. For example, Bitcoin was used by consumers of Silk Road, a black market online shopping network for illegal drugs and other illicit services that was shut down by the FBI in 2013. In the recent ransomware attack on Colonial Pipeline, the company paid $4.4 million in cryptocurrency to unlock its computer systems.
Meanwhile, Bitcoin investment scams have skyrocketed in tandem with its recent historic rise. The Federal Trade Commission reported nearly 7,000 people lost $80 million from October 2020 through March 2021 in schemes touting quick returns, a nearly 1,000% rise in reported losses year-on-year.
Blockchain cryptocurrencies are highly volatile
Some people wonder, "Is blockchain a good investment?" That depends on your investing goals and your risk tolerance. The popularity of cryptocurrency exploded in 2021, with Bitcoin hitting a record spot price of nearly $65,000. But by the spring of 2022, the price of Bitcoin and many other cryptocurrencies declined by more than half.
Crypto use is still niche
Many more exchanges, brokerages and payment apps now sell bitcoin, and many companies such as PayPal and Microsoft accept bitcoin for payment. Still, purchases with blockchain currencies such as bitcoin remain the exception, not the rule. Also, the sale of bitcoin for purchases on cash apps such as PayPal requires users to pay capital gains taxes on the bitcoin sold, beyond whatever state and local taxes are paid on the product or service.
Bitcoin mining takes energy
The process of bitcoin mining uses a network of high-speed computers that consume a lot of energy. If the bitcoin system were a country, it would be the 34th biggest consumer of electricity, behind the Netherlands and ahead of the Philippines, according to the University of Cambridge Electricity Consumption Index. Tesla CEO Elon Musk announced in May 2021 that the carmaker would no longer accept bitcoin until the cryptocurrency can find ways to reduce its carbon footprint. Developers of other blockchains have come up with less energy-intensive options.
Bitcoin blockchain is slow
The bitcoin blockchain can process about seven new transactions a second. By comparison, credit card giant Visa says it can process 24,000 transactions per second, according to the company. That presents the bitcoin system with a scalability problem. Other forms of blockchain-based cryptocurrency are working on this problem. An eagerly anticipated upgrade of the Ethereum system, known as Ethereum 2.0, is expected to be capable of handling 10,000 transactions per second, up from its current rate of 30 per second.
» Learn more: How to buy Ethereum
The future of blockchain technology
While the Bitcoin system is the best-known application of blockchain technology, there are thousands of cryptocurrencies that are built on the back of this emerging technology. While it remains to be seen if bitcoin will succeed in supplanting other forms of traditional payment methods, the applications of blockchain technology are growing fast, and proponents say they may lead to dramatic changes across industries.
The author Andy Rosen and the editor owned Bitcoin and Ethereum at the time of publication.