Definition, Explanation, Pros & Cons

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• Blockchain is a decentralized, digital database that stores transactions and other forms of data.
• Key blockchain features include immutable records, distributed ledger security, and smart contracts.
• Blockchain has many other uses outside of cryptocurrencies.

It’s almost impossible to say “cryptocurrency” without mentioning blockchain technology. A blockchain is a digital, public ledger that securely stores segments of data through a self-managing, peer-to-peer (P2P) network of computers. And some of its key components include irreversible records (i.e., unchangeable blocks of data), decentralized transactions, and smart contracts.

Decentralized digital assets like crypto and stablecoins use blockchain technology for buying and selling assets. Centralized banking digital currencies (CBDCs) are centralized currencies and don’t use a blockchain.

Here’s how blockchains work — along with a closer look at their pros, cons, and potential applications.

What is a blockchain?

A blockchain is a digital database that stores “blocks” of data in chronological order. These blocks are linked together on what’s known as the “chain,” and unlike traditional databases that utilize a third party or intermediary, a blockchain is completely decentralized.

This means that no third parties can monitor or interfere with transactions. The blockchain system is basically self-regulating, thanks to a P2P computer network of nodes (i.e., individual computers) that verify all new data and distribute cross-network copies of the blockchain to keep it secure.

“Blockchains are made of, well, blocks,” explains Lorien Gabel, co-founder and CEO of Figment.io. “Each block contains a timestamp, transaction data, and a mathematical function from the previous block. Computers that mine blocks or run validating nodes that sign blocks will include that mathematical function — called a cryptographic hash — from the previous block into the current block to form a chain.”

How a blockchain works

Cryptocurrencies would essentially be nonexistent without a blockchain. This technology relies on a distributed ledger that keeps a record of all past, present, and future data (e.g., transactions or accounts). 

“A blockchain is commonly used to build a distributed ledger,” says Gabel. Ledgers, he added, track accounting transactions and accounts — we can think of it as a database that stores information. “Distributed ledgers don’t have to be on a blockchain to be considered ‘distributed,’ they just have to be shared with other computers on the network.”

But several other features separate blockchain technology from traditional databases controlled by financial institutions. These include immutable, or unchanging, records and smart contracts.

Irreversible transactions

Each transaction that the nodes add to the blockchain is permanent. So once the computer network verifies the data and adds it as a new block, that record is permanent. And this serves much more important purposes beyond simply keeping the system running.

“Transactions are irreversible, permanently recorded, and available for everyone to see. It’s challenging and complicated for any one actor to change or falsify data recorded on a ledger,” explains Gabel. 

In order to change the data on the ledger and have the modified chain become the majority chain, someone would have to both alter their duplicate of the ledger while adjusting at least 51% of other users’ copies of the database. Therefore, the immutable records component makes it extremely difficult to hack the system.

Smart contracts

“[A smart contract] is a self-executing contract with the terms of the agreement directly written into lines of code on the blockchain,” Gabel explains. This allows them to execute once the terms are met. 

But as for the blockchain process, here’s how it works: Whenever a new transaction takes place (e.g., a bitcoin or ether buy order), that data is sent to a network of computers (nodes) that solve math equations to validate the transaction. 

If the transaction is rejected, it won’t show up on the blockchain. But if it’s confirmed, the nodes will add the data as a new block on the ledger, chaining it to the prior blocks (and the ones that follow) to maintain the chain’s security. Once this step is done the transaction is complete.

What is a blockchain used for?

Cryptocurrency is likely the first thought many people have when it comes to blockchain, but this technology has many other uses:

• Banking and finance: Blockchain has many uses for money transfers, especially for fiat currencies (e.g., USD, EUR, or JPY) that individuals typically exchange through financial institutions like banks or payment services. 
• Cryptocurrency: This is perhaps one of the most well-known uses of blockchain technology. The blockchain stores data for all cryptocurrency exchanges.
• Healthcare: Blockchain has several applications within the medical industry. It can be used to secure medical records, healthcare data, and other related electronic records.
• Records of property: Whether it be property deeds or other assets, this technology can additionally validate property transactions between two parties.
• Voting: Though not currently in effect, the idea of using blockchain to improve the voting process has become a topic of discussion. Arguments in favor urge that it could prevent voter fraud and offer a simpler way of counting votes. Those against it insist that such a system could pose national security concerns.