What is Blockchain and why is it the most secure way to exchange tokens?
Blockchain technology has come out in a big way this year with cryptocurrencies touching a market cap of over $180 billion.
Even through the technology has been around for a few years, and its key elements for even longer, today everyone wants to know what is “blockchain” and why is it the most secure way to exchange tokens.
In order to understand blockchain technology, we need to take a look at how we traditionally transfer data or information on the internet.P
How the internet traditionally handles information?
Whenever you visit a website, you are basically requesting information that is available on a server or a cluster of servers. Be it Google, Amazon, Yahoo or Wikipedia — all the data that you receive or send is stored on a server owned or managed by these companies using databases.
While this system works well, it can suffer from a single point of failure, and more importantly, can facilitate censorship because the information is being controlled by particular entities or organizations.
Blockchain technology creates distributed databases
Blockchain technology changes the existing system by creating trustless, distributed ledgers or databases that are not stored in any single location and are not under any single entity’s control. A network is set up with multiple nodes, all of which maintain a record which is constantly updated and a state of consensus is maintained.
This is basically a trustless system because no single entity, node or server is responsible for the database.
You can compare this to your use of services like PayPal where you trust the company to act as an intermediary between payments and transactions. We use services like that because of the trust problem — we need them to verify whether someone is who they are claiming to be and whether they have enough money in their account to make a transaction.
Blockchain technology solves this problem on two levels — authentication and authorization — and removes the need for any other trusted party to be involved.
Its true nature as a decentralized system to record and distribute information is what makes blockchain technology so exciting.
How does the blockchain technology work?
Blockchain technology has three main elements that are connected in a way to achieve a trustless, distributed ledger.
- Private Key Cryptography
- Peer-to-Peer Network
- Platform Incentivizing Participation
When these three elements come together, you don’t need a trusted party for a digital transaction to be executed and recorded.
As mentioned earlier, a major challenge that blockchain technology resolves is that of digital trust. We need middlemen to act as trusted parties because we don’t know “who is who” on the internet.
There are two parts to solving the trust issue — one is that of authentication and the second is that of authorization.
Authentication is all about proving ownership of a digital asset or information (without ownership there can be no transaction). Blockchain technology employs private key cryptography to solve this. Whoever owns the private keys owns the tokens on that particular block. These are encrypted keys and are to be kept securely, just like keys to your house or your safe.
However, simply proving who you are is not enough for trust. You need to prove that you can also do what you claim to do. This means that when I share my intent to transfer a certain amount of tokens, my claim should be verifiable for you to trust that I can do what I am saying I will.
This problem is solved by the distributed network which records each transaction and the number of tokens on each block. Since every transaction has to undergo verification and the records are stored on nodes around the world, there is no chance of fraud.
A simple example can help explain this concept further
Let’s say you and I intend to enter into a transaction where I give you twenty tomatoes in exchange for ten potatoes.
My tomatoes and your potatoes are stored in a glass box where everyone can see them, and each glass box has one half of a complete sticker with a code on it, and we have the other half, completing the sequence.
By showing each other the half stickers we can prove that we own the boxes and hence the tomatoes and potatoes in them (provided the sticker cannot be duplicated or forged — that’s where cryptography comes in).
The coded sticker solves the authentication problem — we both can verify each other’s ownership.
Now comes the distributed ledger part and in our example that is done by a group of people in the town who are all looking at the glass boxes every now and then to count the number of tomatoes and potatoes.
They write the numbers down in their notebooks and have a complete record of what is in the boxes. Even if one tomato leaves my box, it will be visible to them and they will all update their records, or at least the majority will.
In this case, when I say I have twenty tomatoes, you don’t have to believe me. You can simply verify the number by asking any of the people in the town maintaining their notebooks.
When we finally make the transaction, the same people note down the number of tomatoes and potatoes leaving our respective boxes and the records are updated, ready for the next transactions and so on.
This would be a trustless system where we don’t have to know each other to enter a transaction and everything is recorded in a distributed database.
All this is great, but one burning question remains unanswered.
Why would so many people devote their time and resources to recording our tomatoes and potatoes?
This is solved by the protocol that incentivizes participation — which in the case of blockchain technology are mining rewards. In our example, this would be a rule which stipulates that the town folk keeping a record of our tomatoes and potatoes also get a tomato and a potato every time we make a transaction.
Why is blockchain the most secure way to exchange tokens?
By now we hope you understand how blockchain technology works. After all this, answering why blockchain is the most secure way to exchange tokens is very easy.
Blockchain technology removes the need for any kind of trust in transactions and relies on a decentralized ledger which registers information in real time.
The biggest risks in financial or any other kind of transactions are fraud, duplication, forgery, mistakes and errors.
All these are addressed by blockchain technology. There is no chance of fraud because record keeping is not centralized and records cannot be tampered with even if you use super computers.
Duplication and errors are not possible either because the data has to be verified by a majority of the network nodes and a consensus has to be reached. This means invalid blocks are discarded and the blockchain maintains the correct version of information.
All in all, trusting a blockchain is more secure than trusting your bank or any other entity — including some of the biggest brands and companies in the world. The technology can have wide-scale applications in various data record and distribution systems and this is just the beginning of what many believe will be a crypto-led revolution.
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