What is blockchain and how does it work?

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Linking the nodes to make a distributed ledger.

© Vadim Shechkov—iStock/Getty Images

Blockchain may be among the buzziest technologies to disrupt the world of finance, tied to the rise of cryptocurrency, but it’s refashioning perhaps the most archaic of all financial tech: the ledger. Yes, the system that originated from the clay tablets ancient Mesopotamians used thousands of years ago to record transactions and balances.

This latest iteration, however, has bells and whistles that make the ledger capable of overturning the entire financial environment that once brought it into existence. How’s that for an upgrade?

Blockchain is a digital ledger database whose recorded contents are encrypted into a sequence of blocks and distributed throughout a network of participating computers (nodes).

It’s really that simple. So, what’s with all the buzz? It sounds like a slightly upgraded, shareable spreadsheet with tracked changes, right?

Blockchain’s functionalities may seem plain and straightforward. But given its tweaks to the old ledger tech, it now sports a few features that would be considered impossible in the soon-to-be old world of today.

Blockchain is:

In short, blockchain has the potential to revolutionize almost every digital operation we know today, from sending payments and issuing contracts to undergirding complex industrial and government operations.

Something this large in scale is likely to present a wide range of opportunities—but also plenty of risks—for users and investors alike.

The critical aspect that separates blockchain from all other ledgers and databases is that it’s designed to distribute and record information on a peer-to-peer basis that, once completed, is unchangeable and incorruptible.

Immutable verification is one of blockchain’s key features. All data contents are “set in stone,” so to speak, but digitally. And blockchain networks accomplish this goal using strict consensus verification procedures. So, how does it work?

Once a block is added to the blockchain, all nodes (participating computers) update their copy of the blockchain. This is what makes the blockchain a secure system. Any changes to the contents of a single block have to be recorded in a new block, making it nearly impossible to rewrite a block’s history.

If a hacker tried to tamper with an existing block, then they would have to change all copies of that block on all participating computers in the network. That’s virtually impossible—the number of participating computers across the globe can number in the high thousands. Unless every single node in the network agrees with a change to a block, the change is discarded.

There are many potential benefits that come with the adoption of blockchain technology. Here are three to consider:

Blockchain can drastically reduce or nearly eliminate data tampering. Blockchain can significantly increase data security. This is why the technology is often called a “trustless network.” It means you don’t have to trust anyone to be certain that a given exchange or transaction is accurate and accurately recorded.

Blockchain can make transactions more transparent and traceable. Because it’s a distributed ledger, all participating computers on a network have access to the same database (the blockchain itself). This increases transparency and access, and the hash history makes every exchange and transaction traceable.

Blockchain can eliminate the need for centralized third parties. An automated network that allows for peer-to-peer transactions does away with the need for intermediaries. That may include the elimination of third-party service fees and any lag time caused by paper-based or human-driven processes.

Any industry that can use a peer-to-peer transaction system with an immutable ledger can benefit from blockchain technology. It’s easy to imagine how expansive blockchain applications can be.

The cryptocurrency industry made blockchain something of a household term; decentralized and traditional finance may soon follow crypto’s cue. Other fields that may adopt blockchain technologies include non-fungible token (NFT) markets, supply chain and logistics, energy, health care, e-commerce, media, voting systems, and government and public sector operations. A key to innovation may be smart contracts—blockchain-based computer programs or transaction protocols that function as digital contracts—and the decentralized applications (dApps) that use them.

Again, we’re still at the beginning stages of blockchain development. Although its potential use cases are many and various, it’s important to remember that wide-scale adoption hasn’t quite begun.

Every unique technology comes with its own unique set of risks. Blockchain is no exception.

Although the blockchain itself may not be hackable—remember, it’s an immutable ledger—the systems surrounding the blockchain can be hacked.

The simplest example is that of a bad actor obtaining passwords and credentials to access digital assets. Unsecured and exposed goods can be stolen.

A more sophisticated risk is that of a 51% attack. In cryptocurrency applications, this means a single entity could gain control of more than 50% of all cryptocurrency mining or staking. Once in control, the entity may not be able to alter previous blocks on the chain, but it can alter future blocks. For instance, it may be able to prevent or reverse transactions, possibly even double-spending any cryptocurrency pending a slot in the block.

For large networks like Bitcoin and Ethereum, a 51% attack may be too difficult and too costly to attempt. But for smaller networks, it may be possible.

Probably the most direct and regulated way to invest in blockchain tech is by investing in stocks of publicly traded companies that are developing blockchain networks.

You can also gain indirect exposure by investing in companies involved in decentralized finance, financial technology (FinTech), metaverse technologies, cryptocurrency exchanges, or hardware designed for crypto, blockchain, or decentralized finance (DeFi) purposes.

Your other options are to purchase digital assets such as cryptocurrencies or NFTs. Note that the crypto world is largely unregulated, so scams and fraudulent activity are frequently reported. Plus, cryptocurrencies and their underlying investments are highly volatile (i.e., prices tend to swing violently).

Blockchain is an emerging technology that has the potential to disrupt and revolutionize the way we conduct business, make commercial transactions, enforce legal contracts, and even enact government policy. Its impact on today’s world can be likened to the advent of the Internet back in the 1990s.

Like the early tech boom, the blockchain movement is generating plenty of innovations. They may all be unique, but they won’t all succeed or gain mass adoption. Blockchain presents investors with exciting new opportunities, but it also comes with a number of risks. Proceed with caution.