Digital security is an essential issue for anyone with an online footprint. Whether it’s a company website, valuable trade secrets, or personal banking data on a laptop, digital information on an unprotected network or server can be vulnerable. As a result, we protect ourselves with virus programs, identity theft protection, and dozens of passwords to our various accounts and apps.
Blockchain technology is also a form of digital security used to protect information. But unlike banks and institutions, a blockchain doesn’t have a central authority monitoring data and processing transactions. Instead, a blockchain bypasses a centralized system and allows the community to verify itself. To properly understand crypto investing, it’s vital to learn the science behind blockchain technology and how different networks reach consensus on transactions.
A blockchain defined simply is just a digital ledger with unalterable records of transactions and data. Each ‘block’ contains information about how and when the transaction occurred, along with a unique code connecting it to the previous block (known as a hash). These blocks form a chain of uneditable data, hence the name blockchain. The first blockchain iteration came with the development of Bitcoin, but cryptocurrency blockchains are far from the only example of the technology.
People, businesses, and governments can use blockchain technology to secure a wide array of assets and information. For example, cryptocurrencies use blockchain to record and verify transactions to prevent the double-spending of tokens. Businesses can use blockchains to quickly and securely transmit private data. Even artists and content creators use blockchain to track sales and verify the authenticity of their work. As the adoption of decentralized digital ledgers expands, more and more use cases are coming to the forefront.
So how does a blockchain work? The answer depends on the type of blockchain. All blockchains serve as digital ledgers of unalterable transaction data, but networks can vary in how they agree on which data to verify. For example, who confirms the transactions when different Bitcoins change hands? Let’s compare two types of cryptocurrency blockchains: Bitcoin’s Proof-of-Work (PoW) and Ethereum 2.0’s Proof-of-Stake.
Bitcoin uses a consensus algorithm called Proof-of-Work to secure its transaction data by rewarding miners for quick and reliable verification. Bitcoin miners use high-powered computers to solve equations to be the first to verify a new block. Once the new block is verified and added to the chain, the miner receives Bitcoin tokens as compensation. The more extensive the network, the more secure it becomes. However, PoW has been criticized for its excessive energy consumption and difficulty in project scaling.
The Ethereum network will soon move to a Proof-of-Stake (PoS) consensus algorithm, which attempts to solve PoW’s energy use and scalability problems. Unlike the Bitcoin network, which uses miners with massive computer power to verify transactions, PoS systems require miners to accumulate tokens instead. These tokens are staked to the network, and transaction ‘validators’ are randomly selected based on the size of their stake and the length of time they’ve been verifying transactions. The chosen validator then earns a reward for proper verification. PoS uses less energy than PoW but also has been critiqued for giving too much sway to the richest stakes.