Additionally, when talking about cryptocurrencies and other digital assets, the fact that there are other applications for blockchain is often overlooked. Regardless of how important Bitcoin, Ethereum and Co. become in our daily lives, blockchain will likely play a key role outside of finance in the future. The context of this subject is therefore all the more relevant.
DLT and Blockchain: The Technology Behind Cryptocurrencies
Well-known cryptocurrencies as well as the non-fungible token (NFT) are based on the blockchain principle. It is a decentralized database that stores information in chronological order. Individual transactions are committed in the eponymous blocks. Since the blocks of data are linked to each other, it is called a blockchain. The term “Distributed Ledger Technology” (DLT) is also common for the entire consistent data structure, as the structure is similar to a continuous cash book. Unlike a cash book, transactions are not documented centrally, but in a network. It only works because each network user receives their own copy of a transaction which is automatically updated with other transactions in the network. However, this update only takes place after confirmation by the other network participants. In addition, the data stored in the blocks is encrypted and therefore anonymized.
In principle, everyone should be able to participate in so-called “public blockchains”, therefore a computer with sufficient performance characteristics is sufficient as a server. Each participant has the same rights and can read the information stored in the blocks, perform transactions and at the same time help to validate them. The integrity of the data in the blockchain is thus secured by each individual member of the network. Due to the constant comparison of updated copies, the blockchain is considered tamper-proof. In addition, the exclusively chronological extension of the data structure allows a clear assignment of individual transactions. The amount of data generated and the power required depends specifically on the consensus process of the selected blockchain architecture. Of course, the blockchain itself grows with each newly created block. For example, the Bitcoin blockchain was already 284 gigabytes in June 2022, and the Ethereum blockchain at the same time was around 850 gigabytes. In addition to these public variants, often used for cryptocurrencies, there are also private blockchains that only certain people have access to and mixed forms of both types. A central distinguishing feature is the unequal allocation of rights.
Crypto wallets and blockchain transactions
The following applies to cryptocurrencies: “Not your keys, not your coins”. In order to be able to access the cryptocurrency, private keys are therefore always necessary. Generally, it makes sense to store these passwords in a physical or virtual crypto wallet. With the help of these wallets, traders can receive coins and also make payments. The underlying principle is the same for almost all cryptocurrencies. For example, if a trader wants to buy Ethereum, he can turn to one of the available trading platforms. You can choose between crypto exchanges, crypto brokers or marketplaces, which traders can use to contact other traders or miners directly. Both parties need crypto wallets for the transaction. These can be in the form of a “hot wallet” or a “cold wallet”.
Hot wallets are also called online wallets because the user only has virtual access to them. Clients of crypto exchanges usually receive such a free wallet from the provider. Since the actual data is on the servers of the trading platform, users assign private key protection to the service provider. For this reason, many crypto exchanges require multi-factor authentication for the transaction. On the other hand, there are cold wallets, which are mostly modified hardware, like special USB sticks. Ethereum and other cryptocurrencies also rely on “smart contracts” for transaction. In addition to the private key, there is also an intelligent protocol, the smart contract, in which the conditions of the transaction are recorded. These self-executing digital contracts work according to the simple if-then scheme and trigger the specified action as soon as the precondition is met.
Proof-of-Work vs Proof-of-Stake: Mining Cryptocurrencies
The consensus process is of paramount importance for the creation of new units of a cryptocurrency. It describes the protocol after which the network decides whether or not to add a block to the blockchain. Two methods currently dominate the world of cryptocurrencies: Proof-of-Work (PoW) and Proof-of-Stake (PoS). Bitcoin is considered the most successful and well-known representative of the proof-of-work principle. The PoW consensus process, which has existed on paper since the 1990s, allows participants of a blockchain to “work”. Specifically, it is about solving cryptographic tasks using computing power (specified as hash rate). This procedure validates transactions. As a reward, participants receive a fixed share of currency for solving the puzzle. The whole process is also known as “mining” and requires special mining hardware. Motherboard chipsets with many PCI Express slots are preferred. The goal is the integration of many fast GPUs, with which ideally 25 megahashes/s are possible.
As prospecting does not allow any outside intervention, it is considered very safe. A weak point, however, is the immense power consumption. Ethereum has now moved to the proof-of-stake process, saving 99% of previous energy needs. Since PoS is share-based, the percentage of the network and an additional random factor determine the selection of validators.
Change through new technologies
Crypto-currencies are already establishing themselves in many countries as a daily alternative to state means of payment and it is therefore becoming increasingly possible to do without an intermediary when purchasing goods or services. In Asia, one of the goals of direct selling is to better distribute groceries. However, the potential of blockchain technology goes far beyond the creation of digital currencies. Sweden, for example, is already trying to process tamper-proof land register entries with blockchain. Smart contracts, in particular, could replace conventional contracts in many places in the future. The contracting parties would then have the possibility of avoiding the detour through banks and notaries, which would save time and money.