The Blockchain FAQ for Beginners

1. What is blockchain?

Blockchain is a digital register that processes and records monetary transactions and stores data. It does not need middlemen to approve, write, and save data on it. This property makes blockchain decentralized, meaning it does not depend on any middlemen to update the database. It is categorized as distributed ledger technology, which I've explained in the next question.

While there are no real blocks and no real chains in a blockchain, the cliche goes like this: the block in blockchain stores the data and each block is interlocked with the other previous blocks, creating the blockchain.

2. What is distributed ledger technology?

Distributed ledger technology is a database that is shared and stored by multiple entities or individuals and has no central authority. Those who store the database and operate the network are called nodes or validators or miners. The control over the database is equally shared between each of the nodes. And to make any change to the data stored in the database, those storing the database should reach an agreement, a.k.a consensus. This makes it extremely secure as no one can individually tamper with the data on the ledger. Besides, any changes made to the database is reflected in the database stored with each node in real-time.

3. How does blockchain work?

Different blockchains employ different algorithms to process and record new transactions. Generally speaking, hundreds or even thousands of blockchain nodes function in unison to run a blockchain. When there are no middlemen, someone must approve the transactions. So, the task rather than being given to a central entity is distributed across numerous nodes.

Whenever new transactions are requested on a blockchain, the network accumulates a set of transactions and sends a block creation request to the network of nodes. The nodes then run blockchain-specific operations (we discuss this in the next question) that help in deciding if the transactions of the block are legitimate or not. If a majority of the nodes on a blockchain approve the transactions, i.e. if they reach a consensus, the transactions are processed and recorded on the block that is added to the blockchain.

4. What is “consensus algorithm/protocol” in a blockchain?

Consensus algorithm is a pre-defined method in a blockchain or any distributed system that helps every participant agree to the real-time state of the database. In simpler terms, whenever new transactions are requested, the state of a blockchain will change if the transactions are approved and added to the blockchain. The consensus algorithm defines a step by step process for the nodes to authenticate the transactions and agree upon the new state of the blockchain.

However, it is not necessary that all nodes reach a consensus. Some nodes may not agree and may disapprove the transactions. So, these consensus algorithms are fault-tolerant, meaning that a consensus is reached as long as a majority of the nodes agree to one state of the blockchain. It doesn’t matter if a few nodes do not agree to it.

5. How are Blockchain and Bitcoin correlated?

The concept of blockchain is said to date back to 1992. But it was only put to real use in 2008 with the creation of Bitcoin. And no, Bitcoin is not just the digital/cryptocurrency that shot to the moon and was valued $20,000 per coin in 2017. Bitcoin is the first-ever blockchain that was created to act as a peer-to-peer transaction system. It supports a digital currency called BTC or Bitcoin that is used as a medium of exchange on the Bitcoin blockchain.

So, blockchain and Bitcoin not correlated. In fact, Bitcoin is itself a blockchain. And the cryptocurrency on Bitcoin blockchain is also called Bitcoin and is denoted as BTC.

6. What makes blockchain so secure?

There two main factors that make blockchains extremely secure.

a. It is a decentralized database so there is no central point of failure. Imagine this: If a hacker wanted to hack a bank's servers, he can easily target a single server that originates from a centralized source. But blockchains lack any central server. They are distributed across a network of hundreds or thousands of nodes. As long as a majority of the nodes are not compromised, the data on the blockchain will remain safe.

b. Data on blockchains is secured through cryptography. Blockchain uses a method of cryptography called the hash function. The hashing algorithm can take any size of input and convert it into a unique alphanumeric output, the hash, of the same length. Even the slightest change in the input drastically changes the output. This helps blockchain store data in an encrypted way.

Here’s an example of the most common hash function SHA 256:

Input: You are reading my blog

Output: 96523fd3448c2e80abcf8ec39051f364b27edb1253ad7d946e30cd093acc23cc

Now, let’s see what the result is if we change the first alphabet to lowercase.

Input: you are reading my blog

Output: ad275656fa16d9fcc1bc7d6368f4b78500f7d49b0954352e3864d5b1a2b2debb

Just changing one alphabet from upper to lower case changed the output completely. This makes the hashes unpredictable. It is also impossible to reverse engineer the hash and generate the input from the output. However, the same input always returns the same output, making it easy to prove that a certain hash represents a certain set of data.

7. What is a smart contract on blockchain?

A smart contract is a digital contract written in the form of computer codes. They are stored on a blockchain and are used to make sure two or more parties involved in any kind of transactions deal with each other ethically. They are a replacement for middlemen or centralized systems in our day-to-day transactions, be it transferring money, borrowing or repaying loans, purchasing a flight ticket or settling online disputes.

As the phrase goes in the community, it is a self-executing contract. The terms and conditions and obligations of the parties involved in a transaction are all written in the form of code. As blockchain is a decentralized ledger, these contracts are a good fit to execute transactions of all sorts in an automated way.

8. What is DeFi?

Decentralized finance, or DeFi, is a blockchain-based financial system that uses smart contracts and blockchain to completely automate the various finance processes. It is a peer-to-peer financial system and does not need any interference from third parties. The most common use case of DeFi is lending and borrowing, which shot to fame in July 2020 and has shown considerable growth.

Explore more about decentralized finance in my blog here.

9. What is Proof of Work?

Proof of work is a consensus algorithm used by Bitcoin, Ethereum, and many other blockchain networks. It requires nodes to solve a cryptographic puzzle to add new blocks of transactions to a blockchain. The puzzles cannot be solved manually and the only way to find the solution is random guessing. So, nodes use computing devices such as a CPU, GPU, and ASICs to run billions or even trillions of potential solutions per second through the system to find the right solution. Once found, a majority of the nodes must agree to the solution and only then the block is added to the blockchain.

As it takes a tremendous amount of work to prove the authenticity of the transactions in a block, the process is called proof of work or PoW.

10. What is blockchain used for?

The first use case of blockchain was a peer-to-peer transaction system called Bitcoin. It used Bitcoin (BTC) as its native currency and medium of exchange. But in the following years, blockchains have found a home across many industries as they have the potential to disrupt various industrial processes.

A PwC report suggests that blockchain in provenance will become a $961 billion industry by 2030. Blockchains impact on digital payments and financial instruments will add another $433 billion to the global GDP.

It has found multiple use cases across healthcare, supply chains, digital identity, online gaming and gambling, food provenance, and so on. This is because they make the process of storing data and proving their authenticity easy, transparent and cost-effective.

If you have more questions about blockchain, do let me know.

I will also soon publish a Cryptocurrency FAQ.

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