What is Blockchain and What are the Benefits of Blockchain and Cryptocurrency?

To really understand digital assets and cryptocurrency, it's essential to understand blockchain.

What is a Blockchain?

Using Bitcoin to illustrate, a block is essentially a group of bitcoin transactions waiting to be settled. Think of it as being like a  collection of written checks you take to the bank to deposit or cash. You give the checks to the bank teller and ask them to deposit them into your account. The teller takes the checks, enters the information in the computer, and then the bank asks for the funds from the original bank the check was issued from. It then takes up to several days for the funds to be fully transferred and cleared. Until then, you don't really have the money in the account. Depending on the amount of the checks, the bank may give you access to the funds right away, or you may have to wait several days. If the check bounces or is returned for non-sufficient funds (meaning the person who wrote the check doesn't actually have the funds in their account), then the money is removed from your account and you're charged a returned check fee (even though it's not your fault) and potentially overdraft fees if you've spent enough money in your account to not cover the removal of the funds.

With blockchain there is no bank to complete the transaction. Instead, Bitcoin “miners” compete against one another for the role of verifying the funds from the sender and recording on the ledger that those funds are to be moved to the recipient's account. Each block is secured with a complex mathematical equation, called the hash, that bitcoin miners compete to solve. The first miner to solve the equation gets to verify and confirm the transactions in the block and add the new block to the ledger. The winning miner is rewarded handsomely for their effort with bitcoin. Currently miners receive 6.25 bitcoin for each block, which could be valued at more than $200,000.

After a block is added to the blockchain, a new block of transactions is started, like a new car or section added on to the back of a train. With Bitcoin, there is a new block every 10 minutes. That means a transaction could be completely verified and settled within minutes (or even seconds with the use of the Lightning Network), however, depending on the transaction fees it could take a little longer, but most likely no longer than a couple hours. There are even newer technologies the operate on top of the Bitcoin blockchain, such as the Lightning network, as well as more cryptocurrency blockchains that can settle transaction is seconds for as little as fractions of a penny.

Benefits of Blockchain Technology & Cryptocurrency

That's the basics of how a blockchain works, but what other benefits are there besides instant or near-instant settlement? Here are some of the main common benefits of blockchain technology and cryptocurrencies.

Visibility and Traceability

Immutability

Immutability means that once a transaction is recorded on the blockchain it cannot be altered or removed from the blockchain. The transaction lives there forever.  There are thousands of miners on the blockchain that record transactions on the blockchain. Because the blockchain is public, they all are able to verify and confirm transactions on the blockchain, so no single miner can add a fraudulent transaction or remove a transaction from the blockchain.

Security

Security of the blockchain and cryptocurrencies is established in multiple ways. One is the immutability of the blockchain ledger, as already discussed above, which is partly accomplished by encryption. Each block has a hash. If the block doesn't match the hash, then it isn't valid and is ignored in the blockchain. So no one can create their own block and add it to the blockchain since it wouldn't be able to be verified as valid.

The blockchain is also stored across a network of computers all over the world. There is no central location of the blockchain ledger or database to be targeted in a hack or some other attack. For example, last year when China banned Bitcoin mining (mostly because China wants to create their own digital currency to control it) and miners in China had to shutdown their operations, Bitcoin mining kept operating because it exists all over the world.

Another important aspect of security comes from the security of the accounts themselves. As mentioned in the previous Insights post About Those Objections to Cryptocurrency You May Have Heard.... each cryptocurrency account or wallet has a special passphrase or seed phrase. These are  typically a 12- or 24-word passphrase using the BIP-39 standard (there are other standards, but that’s the most common). You can go back and read that previous Insights post, but basically with a 24-word passphrase there are actually more possible combinations than there are atoms in the observable universe. Even if an account or wallet used only a 12-word passphrase it would take approximately 317 billion years to hack the account using the power of the entire Bitcoin mining network. Needless to say, without knowing most or all of the passphrase words, a hacker is not going to be able to break into a cryptocurrency wallet. The only stories of hacks of individual digital wallets have been due to social engineering or getting hold of files, documents, pictures, or paper that has the passphrase on it.

Trust

Blockchain creates trust between different entities where normally trust is either non-existent or unproven. It allows people or entities who otherwise wouldn't be able to engage in a transaction a way to trust each other. For example, you want to sell your car to someone, but you are worried their check won't clear the bank. Because of the speed of the settlement of the transaction and the public visibility of the blockchain, accounts, and transactions, you could accept payment as a cryptocurrency transaction and trust that the funds are yours seconds or minutes later. The enablement of trust is one blockchain's most cited benefits.

Permissionless

This simply means that an individual or business doesn't need permission from anyone to participate in transactions or even mining on the blockchain. If you want to send or receive cryptocurrency on the blockchain it is as simple as opening your own wallet or account and giving someone the public address of your account or purchasing cryptocurrency and adding it to your account and then sending cryptocurrency to another person's public address. Whereas it might take you an hour or maybe more to go to a bank and open an account, you can open your own cryptocurrency account or wallet in minutes and begin transacting right away. Also, if you wanted to begin mining Bitcoin, or some other cryptocurrency, it would be as simple as creating your own account, purchasing the appropriate equipment (from a typical personal computer to specialized mining hardware), and installing the free and open-source hardware. No one needs to give anyone permission to mine cryptocurrencies.

Reduced costs

With the traditional financial system there are various costs incurred by individuals and businesses. For individuals, you might have to pay a monthly fee for a checking account at a bank, pay for money orders or cashiers checks, pay for a book of blank checks, pay overdraft fees, returned check fees, and fees for wire transfers. For businesses, they pay merchant fees for processing checks and credit card transactions, and the fees can be quite high. With blockchain and cryptocurrencies, many of the fees are eliminated and all are at least reduced for the most part (Ethereum transaction costs are an outlier at this time until the Ethereum blockchain is upgraded later this year).

If you want to send $1,000 to someone in another country, with the traditional banking system you would need to send a wire transfer, which could cost $25-$35 dollars and it would take a day or two to clear. With blockchains and cryptocurrencies you could send that same amount of money, or more, for as little as fractions of a penny (though it could easily be a multiple dollars depending on the particular cryptocurrency and how busy the network is) and have it settle in minutes instead of a day or two.

If you run a business and want to accept payments, with a credit card you pay an average of around 3% in credit card processing fees. With blockchains and cryptocurrencies, you would actually incur no fees at all to accept a direct payment from a customer to your public address. In turn sending those funds to another address or getting it converted to a fiat currency (like the U.S. Dollar) would be another story, but even then the fees could be much lower. A business might pay a small fee (fractions of a penny to a few dollars) to transfer funds to an exchange or custodian, and then maybe a 0.175% to 1% fee (depending on the exchange or custodian or the account type) to exchange for the fiat currency or another cryptocurrency. Those additional fees could of course be completely avoided if the business kept the cryptocurrency instead of exchanging for fiat and conducted its business dealing using cryptocurrency. The end result could be hundreds to millions of dollars in savings for businesses.