These 4 Concepts Will Help You Understand Blockchains
For those looking to evaluate the value of blockchain technology to their business, there are four key concepts to understand.
Over the last year, media coverage of and general public interest in cryptocurrencies, blockchains and NFTs has ramped up significantly. As of March 22, the global market cap of all cryptocurrencies stands above $1.9 trillion, and El Salvador now recognizes bitcoin as legal tender. Blockchain, the technology underpinning these developments, has seen growth in institutional adoption, with 20% of enterprises already using or planning to use the technology in their operations. Venture capital funding continues to pour into the space, clocking in at more than $25 billion in 2021 alone.
Amidst all the hype, it is important to understand what blockchain is, and why, outside of market dynamics and speculation, the technology stands to be so transformative. Explanations can often be highly technical, which is not particularly useful for decision-makers evaluating the technology and exploring its applicability to their businesses.
For those looking to evaluate the value of blockchain technology to their business, there are four key concepts to understand: connectivity, decentralization, immutability and automation. By understanding these concepts, businesses can come to an informed understanding of the power blockchain technology presents.
What are blockchains useful for?
Before diving into the four key concepts, what are blockchains, and what can businesses use them for?
At its most basic level, a blockchain is a digital ledger maintained by a decentralized network of computers. Each computer in the network runs the same software, stores the same information, tracks when information changes and validates those changes. Blockchains are also a platform for executing programs called smart contracts — pieces of code that automatically execute according to conditional software logic such as, “if x is true, then execute y.”
Developers are leveraging smart contracts and blockchain technology to build a new generation of decentralized applications. For instance, fueled by retail investors’ interest in access to cryptocurrencies, decentralized finance (DeFi) offers complex financial products, like lending and borrowing platforms and derivatives protocols, all without requiring intermediaries like banks. With DeFi, individuals retain complete control over their finances. DeFi is the fastest-growing blockchain sector, growing more than 12x from $18.7 billion to $254.94 billion in 2021. Beyond DeFi, blockchain has the potential to transform debt, equity and carbon markets.
Meanwhile, decentralized insurance products are creating efficiencies and tapping into underserved markets. According to Deloitte, blockchain technology can save property and casualty insurers more than $200 billion a year while improving automation, transparency and audit trails. Low overhead costs have also allowed blockchain-native coverage providers like Arbol to cater to less-covered sectors, such as small and micro-farms, which are often deemed too niche or risky for legacy insurance providers.
By connecting to IoT sensors, blockchains enable comprehensive supply chain tracking, increasing transparency and promoting on-time delivery. Organizations can also use private blockchains to achieve scalable automation for highly sensitive internal data.
These use cases are only the beginning of what’s possible with blockchains. Business leaders in these industries and others can take advantage of blockchains’ superior security, reliability and transparency guarantees to unlock new revenue streams in their area of operation. Below are the four key concepts you need to know to better understand how blockchains deliver on these features and how they apply in business contexts.
1. External connectivity enables new applications
Making blockchains useful, or creating any of the advanced applications listed above, requires access to external data. However, one of the most important aspects to remember about blockchains is that they are not, by nature, connected to anything outside of themselves. Blockchains are purpose-built this way for higher levels of security, but a closed blockchain system is like a computer without the Internet — interesting and useful, but not nearly as much as it would be with internet connectivity.
Introducing external data can compromise a blockchain’s security. While blockchains themselves are highly secure, linking a smart contract to external data introduces a new attack vector, meaning that a malicious actor does not have to overcome a blockchain’s security architecture to exploit smart contracts; they only need to manipulate the data source, triggering the smart contract in a way that favors them.
Oracle networks, however, securely connect blockchains to real-world data, which in turn enables the advanced applications users demand. Instead of obtaining information from a single source — say, the price of ether (the Ethereum blockchain’s native cryptocurrency) in USD — decentralized oracle networks like Chainlink aggregate multiple different sources to smooth out errors and guard against manipulation. When smart contract developers source data through an oracle network, malicious actors cannot exploit the system by manipulating a single data source. They must simultaneously target as many data sources (whether it be five, ten or even more) as the smart contract requires as input to execute a command, which is extremely unrealistic as networks become more decentralized.
Without an oracle network, developers might as well not use a blockchain for use cases that involve interacting with the real world, since there is no guarantee that the data triggering smart contracts is accurate. While they are not an inherent feature of blockchains, oracle networks are essential in driving the wider adoption of blockchain technology. The realization of blockchain’s full potential is contingent upon the successful development of a new generation of applications powered by oracle networks.
2. Decentralization ensures uptime and security
As mentioned above, a blockchain network is made up of hundreds, or even thousands of nodes, each of which carries an identical copy of all the information ever recorded on-chain. Blockchain architecture is decentralized — no single, centralized identity is responsible for record-keeping or controlling the system. This design has multiple benefits. For one thing, redundancy helps guarantee uptime. If one node goes down, there are plenty of other nodes with identical information to keep operations running. Additionally, malicious actors cannot compromise a blockchain by attacking one node. They need to successfully control the majority of the network, which is extremely expensive and resource-intensive, posing a significant challenge to even sophisticated attackers while automatically weeding out low-effort exploit attempts.
3. Immutability promotes transparency and accountability
Blockchains are also immutable, meaning that once something is added to the blockchain, it cannot be edited retroactively or deleted. Changes to existing information are recorded through the addition of new data blocks that show the edits that were made. Even if data does change, every participant in the network has a record of the information’s initial state.
This setup creates a trustless system. The people running individual nodes don’t need to trust each other, because the true state of information is available to all participants, with high barriers to manipulation. The realization of trustless value exchange through Bitcoin was transformative, because for the first time in history, complete strangers could reliably exchange value without an intermediary, like a bank, absorbing some of the funds and creating inefficiencies. With all participants operating on the same information, there is no way for one party to manipulate transactions or renege on a contract. With all information and changes visible on-chain, the system offers unparalleled oversight. For instance, companies looking for greater supply chain traceability can use a blockchain to examine a product’s full lifecycle, using IoT sensors to deliver information on location, date, quality, certifications and more on-chain.
4. Smart contracts power automation
Blockchain-based applications, or decentralized applications (dApps), are essentially collections of smart contracts. Developers turn to dApps for the same guarantees afforded by blockchains, including heightened security, immutability and decentralization. Ethereum was the first blockchain to offer widely accessible smart contract functionality, enabling the development of dApps. Without smart contracts, blockchains are generally only useful for minting and moving tokens around.
Once externally connected, smart contracts can be used to automate business processes by serving as highly reliable, secure forms of digital agreement. This is where real efficiencies and cost savings start to occur. Take, for instance, the example of rainfall insurance: An individual agent no longer needs to verify that qualifying conditions have been met to approve a payout. Rather, funds are held in escrow within a smart contract, and when IoT sensors indicate that an area received insufficient rainfall over a pre-established time horizon, a farmer is paid automatically. Because the contract is linked to real-world data sourced directly from the region and verified by an organization like the National Oceanic and Atmospheric Administration, the insurer does not need to fear that funds have been inappropriately allocated. This system simultaneously limits insurance fraud, ensures faster payouts for farmers and expands market opportunities for providers who can bring down costs using automated policies.
Where do we go from here?
While most business decision-makers do not need to understand all of blockchain’s technical properties, an understanding of these four core elements can help organizations determine how blockchain technology can best serve them. There are significant automation and cost-saving benefits to be realized by moving business functions to the blockchain, and leading organizations are already making the switch.
As more and more organizations look to incorporate blockchain technology, they can also take advantage of middleware solutions like Chainlink to ease the transition. Chainlink enables businesses to connect legacy backend systems as well as external data to blockchains. With these capabilities, organizations can not only connect to the off-chain data they need to develop advanced applications, but seamlessly leverage blockchains’ decentralization, immutability and automation capabilities in concert with their existing systems.
By understanding the core tenets of blockchain technology and considering their approach to integrating their existing processes with the smart contract economy, business leaders can position their companies to capture the full benefits of the value presented by Web3.
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