Updated August 2, 2022

Built on Blockchain: What is Blockchain & How Does it Work?

Most of the cryptocurrencies that exist today—including the big two of Bitcoin and Ethereum—are built on a technology known as blockchain. Simply put, blockchain is the infrastructure that makes cryptocurrencies possible. It’s what allows for the transfer of value between parties without third-party middlemen like banks or credit card companies. 

In other words, it’s powerful, industry-disrupting stuff. 

If you are considering investing in cryptocurrencies or other digital assets, then you are, in part, investing in the different use cases that blockchain provides. With this in mind, it’s important to understand what blockchain is, how it works, how it powers cryptocurrencies, and the potential that exists for blockchain to transform other industries outside of the world of finance. 

We answer these, and other questions, below so that you will be better equipped to make an informed decision about whether and how to invest in cryptocurrencies. 

What is blockchain and how does it work?

A blockchain is a distributed, immutable, and transparent ledger or database that contains information, most commonly transaction history. 

Unlike traditional databases, which are stored in one central location such as a file or server, a blockchain is shared amongst multiple nodes of a computer network. This is what makes a blockchain distributed. These nodes are connected to each other in a peer-to-peer fashion. 

When a transaction is made on the network, each node is responsible for independently verifying it. This ensures that the transaction does not conflict with any previous transaction recorded on the network. 

Periodically, these transactions are recorded to the blockchain. This happens when enough transactions have occurred to generate a new “block,” which is then chained to the blockchain in chronological order. 

When a block is generated, all of the information contained within the block must be verified by the entire network for a second time to ensure that the records match. Once the block has been added to the blockchain, it becomes extremely difficult (theoretically impossible) to alter the information contained within it. This is what makes a blockchain immutable.

With all of this in mind, a blockchain contains a record of every single transaction that has ever occurred on the network. This record can be accessed by any node on the network at any time (which, as discussed above, is a key part of how transactions are verified). This is what makes a blockchain transparent.

Taken together, a blockchain’s distributed, immutable, and transparent nature work to instill trust and security in the system. This trust is, ultimately, the key that allows blockchain—and with it, the cryptocurrencies built on top of it—to flourish, as it replaces the trust previously held by middlemen such as banks and credit card companies.

Is blockchain always decentralized?

All blockchains are inherently distributed because of the way in which the ledger exists independently across multiple nodes in a network. This distribution is what provides the blockchain with its security and immutability.

Importantly, however, not all blockchains are decentralized. Centralized blockchains can and do exist.

Decentralized Blockchains

With a decentralized blockchain, it’s possible for anyone to participate in the blockchain by making a transaction or by verifying transactions. Because it is decentralized, this means that no single person, organization, or entity can control or corrupt the network. 

Decentralized blockchains come with certain vulnerabilities due to their open nature. To address these vulnerabilities, most truly decentralized blockchains are secured with cryptography and some form of consensus system such as proof of work (PoW) or proof of stake (PoS). 

Bitcoin’s network is an example of a decentralized blockchain.

Centralized Blockchains

With a centralized blockchain, on the other hand, only select individuals can participate with the network. By design, the identity of these participants is known. 

The Ripple network is an example of a cryptocurrency blockchain that is more centralized than decentralized. Centralized blockchains can also potentially be leveraged within private organizations, for purposes unrelated to cryptocurrency.

Blockchain and Cryptocurrency

Now that we understand how blockchain works, it’s easier to understand why it is such a necessary part of most cryptocurrencies. Simply put, in the world of crypto, a blockchain serves as a record of every transaction that has ever occurred on a given cryptocurrency’s network. This has the following effects, which are essential to establishing a functioning cryptocurrency:

  • Eliminates the issue of double spending: One of the primary concerns of cryptocurrency’s opponents is the idea that a coin or token may potentially be spent more than once. Called “double spending,” this possibility would make it impossible for large-scale adoption of cryptocurrency to exist. Blockchain technology, by nature, makes it very difficult for double spending to occur, as it would require the ledger be altered.

  • Protects the integrity of the network: Because blockchain is distributed, the database containing the list of transactions that has taken place on the network exists in multiple locations. This, again, makes it very difficult for the record to be retroactively adjusted or changed, and protects the overall integrity of the network.

  • Generates trust in a decentralized system: Both of the points mentioned above work to create trust in the system, which is very important for a nascent technology like cryptocurrency. Without this trust, the value proposition behind cryptocurrency vanishes, and most people would not use it. 

Importantly, the word “transaction” doesn’t just mean buying or selling something. Blockchain makes many other things possible in the world of crypto, including smart contracts, decentralized applications, and more. 

The Future of Blockchain

Though blockchain was originally designed with cryptocurrency in mind, the technology can be applied to many other applications as well. That’s because the same benefits that blockchain offers cryptocurrency—immutability, transparency, security, trust—can be applied anywhere that data is collected and leveraged. 

In the future, it’s possible that blockchain may be leveraged by and disrupt a wide variety of industries, many of which have only just begun to explore blockchain’s potential. 

A few industries ripe for blockchain integration include:

Supply Chain & Logistics

A supply chain is the network that exists between suppliers, manufacturers, and distributors. It’s the web that takes something all the way from raw material to finished product in the hands of a consumer. While that definition may sound simple, supply chains are anything but; they can be incredibly complex, requiring a significant amount of data and management to ensure that everything operates the way it is meant to operate. 

According to the Harvard Business Review, “blockchain can greatly improve supply chains by enabling faster and more cost-efficient delivery of products, enhancing products’ traceability, improving coordination between partners, and aiding access to financing.”

This is because a blockchain can help businesses record valuable information relevant to their supply chains, such as:

  • Dates

  • Prices

  • Location of origin

  • Product quality

  • Certifications

  • Etc.

This data can be leveraged in a wide variety of ways. It could, for example, be used to trace produce all the way back to the farm that originally produced them—regardless of how many stops they may have made along the way. In the event of an E.coli outbreak at a particular farm or distribution center, the company can use this data to determine which product (at which stores) may be subject to a recall, and which would be otherwise healthy to consume.

Walmart was an early pioneer of leveraging blockchain in this way, all the way back in 2018, when they began tracking leafy greens (prone to E.coli outbreaks) with blockchain technology.

Healthcare

The healthcare industry is one of the most highly regulated industries in the United States and around the world, making it a prime example of an industry that can leverage the inherent trust and transparency made possible through blockchain technology. 

In particular, there are two potential use cases for blockchain in the healthcare industry that are receiving a lot of attention—so much so that the US Department of Health and Human Services (HHS) released a report detailing these potential applications.

The first use case is related to supply chain management above, specifically in regard to the shipment of highly regulated products—such as pharmaceuticals, vaccines, biological products, medical devices, surgical equipment, and more. Because these products are used to support human health, it’s critical that they can be easily authenticated, and that their origin can be traced. Blockchain makes this possible in much the same way as tracking leafy greens.

The second use case is related to a patient’s electronic health records (EHR), which are again highly regulated and protected by HIPAA. Because this data is so sensitive, healthcare service providers (hospitals, clinics, physicians, pharmacies, etc.) have had to build highly secure systems that protect patient privacy. Unfortunately, this also makes it difficult for the patient and their doctors to access their records from across multiple systems, which often leads to an incomplete picture of patient medical history.

It’s been theorized that a blockchain-based medical record system can be “linked into existing medical record software and act as an overarching, single view of a patient’s record without placing patient data on the blockchain.”

Voting

In order for democracy to exist, citizens must have trust in the election process—perhaps most importantly, in the voting process. In the absence of trust, doubts can arise and draw into question the validity of election results, as voters worry about voting fraud, tampering, and low voter turnouts. Blockchain may offer a path forward in addressing these concerns.

As discussed above, records contained within a blockchain are immutable. This means that they are essentially tamper proof. If blockchain was to be leveraged for widespread voting, it could then, at least in theory, serve to eliminate fears of fraud and vote tampering.

Because blockchain-enabled voting can theoretically take place anywhere there is an internet connection, it’s possible that individuals may one day be able to vote on their computer or smartphone through a secure application. This may dramatically increase voter turnout, particularly among those who are elderly or disabled, work during election hours, have a lack of transportation, or who otherwise find it difficult to physically visit a polling station.

While blockchain-enabled voting has yet to be rolled out en masse, it has been piloted a number of times in recent years—for example, by West Virginia in the 2018 midterm elections, and by the city of Denver in its 2019 municipal elections.

Some election experts have cast doubt on blockchain-based voting not due to the underlying technology, but the fact that it requires connection to the internet (which brings its own security challenges). For blockchain-enabled voting to truly take off, these security challenges must be addressed. 

Investing in Blockchain

At the end of the day, blockchain is a technology. As such, it’s not something that can be invested in directly. That being said, investors that are excited about the opportunity that blockchain represents may still invest in it indirectly in a number of ways. These include:

  • Investing in companies that enable blockchain

  • Investing in companies that leverage blockchain to improve their products and services

  • Investing in companies that develop blockchain-based products and services

  • Directly purchasing and holding cryptocurrencies which exist on a blockchain, such as Bitcoin and Ethereum

Here at Allio, we believe that cryptocurrency has exciting potential to help build the infrastructure of tomorrow’s technological and financial ecosystem but currently as an asset, doesn’t have the regime in place to drive its price up. Bitcoin, due to its limited supply could come into high demand if the global financial system ever experienced hyperinflation. Rather than have our clients purchase a wallet or trade on a messy exchange with hidden fees to purchase coins, we prefer to seek this upside via the use of an ETF which includes the added benefit of not being directly exposed to the speculative underlying asset. That said, they are still volatile and investors should only purchase them if they’re willing to lose that entire portion of their portfolio. For that reason, we offer our clients the choice for whether they’d prefer to have crypto exposure, alongside traditional asset classes—like stocks, bonds, commodities, and real estate— for a truly diversified macro investment strategy.

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