Cryptocurrencies and the DeFi industry that has emerged around them are built on computer technology, not something that most people understand fully. So, unsurprisingly, any questions about those things, no matter how simple they may appear at first glance, can be quite complex and can be answered on many different levels. That is definitely the case with the deceptively simple question “What is a Blockchain?”
The History of Blockchains
It is important to start with the origins of the concept and the word “blockchain” if for no other reason than to clear up a commonly held misconception. Blockchains may have been popularized by crypto, but they didn’t first appear in Satoshi Nakamoto’s Bitcoin whitepaper in 2008.
In fact, they were invented, or more accurately first suggested, as far back as 1982, in cryptographer David Chaum’s dissertation, entitled "Computer Systems Established, Maintained, and Trusted by Mutually Suspicious Groups.". The concept was then further refined throughout the eighties and nineties, with significant contributions from Stuart Haber, W. Scott Stornetta, and Dave Bayer in particular. What Satoshi Nakamoto’s whitepaper did first propose, though, was the idea of using a blockchain as a decentralized record keeping system for currency transactions. It was that proposal, along with massive advances in computer technology, that pushed blockchains to their current prominent positions and diversity of applications.
So, what is a blockchain?
Defining A Blockchain
On the simplest level, a blockchain can be described as a digital record-keeping system. That is true, of course, but that definition and description fail to differentiate a blockchain from other records and ledgers that can be digitized, such as an Excel spreadsheet, say, or a simple list of transactions in a word document. There are several things that make blockchains different from those conventional records, and those differences combine to make them uniquely suited to the worlds of crypto and defi, but they also give them utility elsewhere.
To incorporate those differences, any definition of a blockchain should include a few of its characteristics. Thus, a better description might be as “a permanent, immutable, trustless, record of transactions that is maintained across multiple computers in a peer-to-peer (P2P) network.” A bit wordy, maybe, but far more accurate.
Trustless & Immutable: What Sets a Blockchain Apart
The differences between blockchains and other digital records occur because, as the name suggests, a blockchain is a record of transactions that are stored in blocks of data which are linked together in a chain. That chain is then stored simultaneously on multiple computers. Again though, while accurate, that description is incomplete. There are other characteristics of blockchains that should be included to better understand them.
For starters, the blocks are linked by cryptography, which can be best understood as scrambling the data in the first block according to a complex code, then giving the key to that code only to the second block. A timestamp is then added to the record of the coupling of the chain’s blocks. As a result of that process, all data stored in a blockchain becomes immutable…it is permanent and cannot be changed. That is where the “trustless” part comes in too, the thing that is hinted at so graphically in the title of Chaum’s original dissertation where he refers to “…Mutually Suspicious Groups”.
With traditional, centralized record keeping, affected parties are forced to place some trust in the record keeper, be that a bank, a corporation, a government, or whatever. We must trust that although they control the records, they won’t go back and change them to their advantage at any time. Blockchains remove the need for that trust. Because the blocks, once formed and sealed, are secured by advanced cryptography, they cannot be opened and altered by anybody. Oh, and even if someone managed to crack the codes, the fact that they are stored on multiple computers at the same time mean that if they did that with one set of records, it would be easily identified as fraudulent by the others.
Transparency & Anonymity
For many people, and not just those operating with criminal intent, the anonymity that blockchains offer was once another advantage. The blockchain tracks the things transacted, such as the bitcoins and dollars, and it tracks the digital routing and landing place of those things. What it doesn’t do, though, is record who does the transaction on either side. Of course, as many have found out, the imposition of Know Your Customer (KYC) regulations on brokers and digital wallets means that in regulated markets, ownership can now ultimately be tracked by authorities should they choose to do so.
The other main advantage of blockchains to many is that they are transparent. Because all transactions are permanent and immutable, the things transacted can be traced at every step. While you frequently hear horror stories about “theft” of bitcoin, what is not so often said is that those bitcoins, once stolen, can always be traced. Stealing crypto is kind of like stealing hundred-dollar bills with embedded tracking devices. You may have control them, but the authorities know where they are, and spending or exchanging them without getting caught requires at least jumping through some hoops.
Uses of Blockchains
As outlined above, blockchains are immutable and trustless, two very important distinctions that give them multiple advantages over traditional record-keeping, and those things make them suitable for multiple uses, too. They are best known as the record-keeping system on which crypto is based and are ideally suited to that task. After all, Bitcoin, and other digital currencies’ very existence are based on what some would consider a healthy distrust of governments and/or banks. That makes their trustless characteristic valuable in that context, but it is also valuable in other use cases.
They can, for example be used to record real estate transactions, or legal documents, or, as they already are in some cases, election results. The latter might not stop some politicians claiming foul play in elections, but it would at least invalidate claims that the results themselves were somehow messed with after the event, and provide an effective, factual refutation of those claims.
Transaction Speeds
As my mom was fond of saying in her somewhat pessimistic, child of the London Blitz, British way, though, nothing is perfect. Blockchains do have disadvantages, or at least are perceived as having them. Most noticeably they have usually been seen as slow and clunky when compared to other ways of transacting, and of recording those transactions. For example, while Visa can handle 1,500 transactions per second, Bitcoin currently tops out at around 7. That, and the need for the same complex cryptography that makes blockchains secure but slows down transactions, often make Bitcoin transactions take minutes rather than a split second to complete.
However, Bitcoin isn’t the be all and end all of crypto, and other tokens utilizing more advanced technology offer much greater capacity in terms of transactions per second (TPS). Cardano, for example, using a scalability solution known as Hydra, has declared that it is aiming to get to a TPS rate of a million before too long, while Solana already has a TPS of over 2,800. Of course, that doesn’t mean that Bitcoin will ever get to those kinds of TPS numbers, but it does indicate that low TPS isn’t a blockchain problem so much as a Bitcoin problem. That, in turn is good news for tokens like SmartFi’s SMTF that use Ethereum based blockchains, where the advent of ETH2 before long promises a TPS of around 100,000.
Conclusions
As with so much in the crypto space, “What Is a Blockchain and How Does It Work?” are simple questions that, if to be answered properly, demand quite complex answers. A blockchain is a system for digitally recording and storing transactions, but its unique characteristics, its immutability, permanence, transparency, and its trustless, P2P nature, make it far more than that, and it probably isn’t an exaggeration to say that before too long, blockchains will be the world’s foremost form of record-keeping.
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