Summary - Blockchain is a stand-alone technology that strings together a series of transactions into blocks to form an incorruptible digital ledger that is distributed over a peer-to-peer network. Although most frequently associated with digital currency like Bitcoin and Ethereum, blockchain can be used for almost any kind of transaction with virtually any kind of information.
One of the core benefits of blockchain technology is that it is decentralized. The digital ledger is distributed over a peer-to-peer computer network which means no central authority is needed to validate data – and less risk of human error and/or fraud. There are five distinguishing characteristics of blockchain technology.
- All transactions receive a unique cryptographic hash that converts data into a fixed-length string of random letters and numbers. For added security, every block also contains the hash of the previous chain.
- It creates an immutable digital ledger in which the only way to modify a block is to modify the entire chain.
- It is the ultimate peer-to-peer network because the data is distributed among all the users who have their own copy of the blockchain. If one person attempted to change their blockchain, the other blockchains would remain unchanged.
- It uses a consensus protocol to ensure the validity of the ledger. In addition to requiring a Proof of Work to add blocks, the blockchain protocol will defer to the longest (i.e. most recent) blockchain in the event that different users have different but seemingly valid, blockchains.
- In some applications of blockchain, validation is done by computer “miners” who perform the Proof of Work needed to allow a block to be added to a blockchain.
The blockchain concept is most recognizable with cryptocurrency applications, but a significant number of companies are looking to take advantage of blockchain technology. There are many open source blockchain programs that are allowing companies to create a blockchain database for use in a supply chain or for protecting intellectual property. This is giving investors new ways to take advantage of the blockchain revolution without having to directly invest in cryptocurrencies.
When many people hear the word blockchain, they immediately think about cryptocurrency and they may even think blockchain is a cryptocurrency or a programming language. But it’s not. Blockchain is, however, integral to the growing acceptance of cryptocurrency as a mainstream currency, and it is becoming a technology that companies are continuing to find applications for.
In this article, we’ll provide an overview of blockchain technology including a definition and a detailed look at the process that is required to create a block. We’ll also review different applications for blockchain technology that is making it an exciting investment opportunity as well as ways for investors to invest in blockchain without directly investing in cryptocurrency.
What is blockchain?
Blockchain is a decentralized record-keeping technology that provides accurate and secure data storage on a digital ledger. In Investing terms, a blockchain records cryptocurrency transactions for the Bitcoin network as well as for other cryptocurrencies such as Ethereum.
Although at its most basic level a blockchain is just lines of code, it is best explained using a visual example of blocks being linked to a chain. The blocks, in the case of Bitcoin and other cryptocurrencies, are chunks of data that represent transactions. Some of these transactions can be small, but a typical block can hold up to 1MB of data, which makes it possible for blockchain technology to expand beyond simply buying and selling Bitcoin to facilitate other digital applications (DApps) that can create smart contracts or provide a receptacle for legal documents such as property deeds and medical records.
What information is stored on a block?
Each block of digital information captures specific information that is unique to every transaction. Since a block can hold up to 1MB of data, it’s easy to see how a single block could house thousands of small transactions depending on the application.
- A block will store the logistics of a transaction such as the date, the time and dollar amount.
- A block will store information regarding the identity of the participants. However, no actual names are used in a blockchain ledger. Instead, participants are identified by a public key which is a digital signature similar to a username.
- A block stores information that is unique from other blocks. Every block contains a “hash” – a unique code that distinguishes it from another block. That means if someone makes a transaction to one party, and needs to make another transaction to the same party for the exact same amount before the first transaction is validated, the two blocks will be unique even though the details would look nearly identical. This unique “hashing” is what helps prevent fraud and double selling (i.e. spending cryptocurrency twice).
How does new data get added to a blockchain?
There is a four-step process to add new data (i.e. a block) to a blockchain.
Step One: There has to be a transaction. This is the easiest one to understand. Basic supply and demand dictate there has to be a buyer and a seller.
Step Two: The transaction goes through a verification process. For most of our public records, there is a person who is responsible for verifying new entries. This adds time and the possibility of human error or malfeasance. With blockchain, the verification process is done through a computer network that consists of thousands if not millions of computers. The computers will verify the details of the transaction.
Step Three: A block is created for the transaction. Once the details are verified and the seller provides their private key (digital signature) to confirm the transaction, the transaction is stored in a block. In the case of the Bitcoin network, that transaction will be linked to every other Bitcoin transaction which has ever been made.
Step Four: The block is given a unique hash before being added to the blockchain. One of the most important steps for creating a block is the addition of a unique code, called a hash to the block. In addition to its own unique hash (which is typically the solution to a math problem of some sort), the block also includes the hash from the most recent block. After the block receives its hash, it is added to the blockchain.
Once the new block is added to the blockchain, it can be viewed for anyone to view. This raises questions about the privacy and security of blockchain technology.
Blockchain information is public but details are private
Social media users understand the concept of a news feed. Although Facebook and Instagram don’t use blockchain technology, the principle is the same, if a user is connected to the blockchain network, they will get “status updates” every time a new block is added. However, where a social media feed gives you information about the user who posted the updated, the blockchain are anonymous. The only identifying feature is a username which is also known as a public key.
More computers increase the accuracy of blockchain information
What makes blockchain a decentralized technology is that every computer in the blockchain network (called nodes) has an individual copy of the entire blockchain. When you consider that there are millions of Bitcoin users, you would have millions of copies of the Bitcoin blockchain. However, each blockchain is standalone meaning that they are virtually impossible to hack. If a hacker were to change one of the nodes (which is difficult to do because of the hashing), the other nodes in the network would remain the same. Blockchains operate on a consensus protocol which means that should the network encounter multiple, differing copies of a blockchain, the protocol will adopt the longest chain available. Since in the case of Bitcoin, blocks are added quickly (usually within 10 minutes), the blockchain of record will be the one most users trust.
Hashing adds security to a blockchain
The paper money we carry with us is regulated and verified by a central authority. In most cases, this would be a government or a financial institution. However, a blockchain is confirmed by computers. As part of the verification process, computers have to perform a math function that turns digital information into a seemingly random array of numbers and letters. This "hash" is applied to the transaction, along with the hash from the prior transaction. If any of the information in the transaction is changed, the hash has to change.
So if someone would attempt to edit a transaction, the hash for the transaction would change. But that would mean that they would have to edit the next block in the chain (because it also contains the hash). However, in doing so, they would change that block's hash. You can see how that would make editing or deleting a block virtually impossible.
Blockchain security requires proof of work to build trust
The usability of Blockchain technology can sometimes appear to be in conflict with trust in the network that is verifying the blocks. For obvious reasons, it is wise to limit the number of users/computers that can add blocks to a blockchain. However, in order to efficiently verify Bitcoin transactions (which is the signature application for blockchain technology), there have to be many users (known as "miners") to perform the tasks. But this creates a trust concern. To address this, blockchain networks require proof of work tests for any computers that want to join the network and add blocks to the chain.
It works like this. Before they can add a block to a chain, a computer must “prove” that it has the speed and computing power to solve a complex mathematical problem. If the computer is successful, then the user will gain the ability to add blocks to the blockchain. With Bitcoin mining, efficient verification is essential so each hash is assigned a degree of difficulty that allows a new block to be added to the bitcoin blockchain approximately every 10 minutes. To set a difficulty level, the computer establishes a “target” for the hash; a lower target means it is harder to generate a hash. This process requires a significant investment in both computer equipment and computing power. For this reason, miners frequently pool resources in their hope to increase their chance of mining blocks. In the case of Bitcoin miners, the miners will be compensated with transaction fees and, for now, they are issued newly-created Bitcoins (mining is the only way new Bitcoins can be created).
What are other applications for blockchain?
Although blockchain drew national attention when it became synonymous with Bitcoin, its distributed ledger technology is being adopted by other businesses that are looking for a reliable and secure way to store data about other kinds of transactions. In fact, a recent survey of 1,000 companies showed that approximately 75% of the companies either had a blockchain system in production or would were expecting to develop blockchain applications in the next 12 months. One of the obstacles to adopting the technology is its price tag. The survey showed that nearly 40% of the companies would invest $5 million or more for implementation of blockchain in the next 12 months. However many software companies, such as Microsoft are creating open source blockchain programs that are expanding the accessibility of blockchain applications in the areas of:
- Financial Services/Banking - blockchain would allow deposits and transfers to settle and clear faster which could potentially help the industry save up to $20 billion a year.
- Healthcare – blockchain can provide secure storage of medical records while giving patients the assurance that a record could not be changed. Plus, the use of private keys ensures that the records could only be accessed by certain individuals.
- Property records – blockchain would provide a way to store physical deeds helping to simplify and streamline the process of recording property rights.
- Smart contracts – blockchain has the potential to allow individuals to create a computer code within a blockchain that would allow parties to facilitate, verify, or negotiate a contract agreement. A smart contract is triggered by specific conditions that have to be met.
- Supply chain management – blockchain can help suppliers record the origins of materials, verify their authenticity, and allow different labels to be applied such as “Organic”, “Local”, or “Fair Trade”.
- Voting – by using blockchain to store individual votes it would make them virtually impossible to tamper with. The consensus protocol would also make the process transparent and allow instant voting results.
- Intellectual Property – the distributed secure nature of the blockchain concept makes it an ideal solution for businesses and individuals looking to secure their intellectual property.
How to invest in blockchain technology
Although blockchain and cryptocurrency are almost synonymous, investing in blockchain does not mean an investor has to risk money in cryptocurrencies. However, for investors looking to manager their risk while still taking advantage of the connection between cryptocurrency and blockchain, there are many cryptocurrency ETFs that allow investors to have exposure to a variety of cryptocurrencies and, by extension, blockchain technology.
Additionally, more companies are looking to take advantage of the blockchain revolution which is opening up more ways to invest in blockchain. One example of that is MasterCard. The financial services company could obviously benefit from technology that would allow it to clear payments faster. Another option is to look for companies such as Nvidia that are critical to providing graphic processors and other equipment that are the infrastructure to blockchain. Another company that is making a large commitment to blockchain is Overstock. The online retailer has created an SEC-regulated alternative trading system named tZERO that has a goal of using blockchain technology to maintain a global property registry to supply collateral to lenders.
The final word on blockchain
A blockchain is a digital ledger that is distributed throughout a peer-to-peer network. The blockchain maintains a list of records in chronological order called blocks. Each block contains a unique cryptographic hash and a link to the previous block. This makes the ledger virtually impossible to alter or delete. Users can only edit their part of the blockchain by using a private key which is a password that is needed to access and write to the file.
Cryptocurrency, particularly bitcoin, is most closely associated with blockchain technology however there are a growing number of companies that are finding useful digital applications (called DApps) for blockchain technology. Some of these include health care, supply chain, property records, voting, and smart contracts.
While once thought of as a futuristic technology, even a fad, blockchain is increasingly showing that it is here to stay – which is attracting the attention of investors. The good news is that as more companies are becoming involved with blockchain technology, it is opening new ways for investors to invest in blockchain without dabbling in cryptocurrency.7 Small-Cap Stocks that Present Long-Term Growth Opportunities
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