The Basics of Blockchain Technology, Explained in Plain English

Historically, no asset has been a greater source of wealth creation than the stock market. Throughout its history, stocks have returned an average of 7% per year, inclusive of dividend reinvestment, and when adjusted for inflation. For the average long-term investor, this works out to a roughly doubling in value about once a decade.

Then cryptocurrencies came along and turned this traditional source of wealth creation on its head. When 2017 began, the aggregate value of all digital currencies combined equaled just $17.7 billion. However, as recently as this past weekend, the combined market cap of the nearly 1,400 investable cryptocurrencies was almost $836 billion. That better than 4,500% increase in value is something that the stock market would take multiple decades to accomplish.

Yet, truth be told, most folks don’t understand the basics of cryptocurrencies, or the blockchain technology that underlies them. Recently, we broke down what cryptocurrencies are in the easiest way possible. Today, we’re going to explain, in plain English, what blockchain technology is all about.

Blockchain is the digital and decentralized ledger that records all transactions. Every time someone buys digital coins on a decentralized exchange, sells coins, transfers coins, or buys a good or service with virtual coins, a ledger records that transaction, often in an encrypted fashion, to protect it from cybercriminals. These transactions are also recorded and processed without a third-party provider, which is usually a bank.

The main reason we even have this cryptocurrency and blockchain revolution is as a result of the perceived shortcomings of the traditional banking system. What shortcomings, you ask? For example, when transferring money to overseas markets, a payment could be delayed for days while a bank verifies it. Many would argue that financial institutions shouldn’t tie up cross-border payments and funds for such an extensive amount of time.

Likewise, banks almost always serve as an intermediary of currency transactions, thus taking their cut in the process. Blockchain developers want the ability to process payments without a need for this middleman.

So, what does blockchain technology bring to the table that current payment networks don’t? For starters, and as noted, it’s decentralized. That’s a fancy way of saying that there’s no central hub where transaction data is stored. Instead, servers and hard drives all over the world hold bits and pieces of these blocks of data. This is done for two purposes. First, it ensures that no one party can gain control over a cryptocurrency and blockchain. Also, it keeps cybercriminals from being able to hold a digital currency “hostage” should they gain access to transaction data.

Second, removing the middleman from the equation and working around the traditional banking system should allow for smaller transaction fees. What’s unclear is if lower fees would mean cheaper fees for the consumer, or just bigger profits for businesses deploying blockchain technology.

Third, and maybe most important, blockchain offers the potential to process transactions considerably faster. Whereas banks are often closed on the weekend, and operate during traditional hours, validation of transactions on a blockchain occur 24 hours a day, seven days a week. Some blockchain developers have suggested that their networks can validate transactions in a few seconds, or perhaps instantly. That would be a big improvement over the current wait time for cross-border payments. 

However, blockchain isn’t perfect, and it does have some clear drawbacks.

One obvious hurdle is the adoption of the technology. To deploy blockchain, financial institutions would essentially have to abandon their current networks and start anew. Trying to integrate the current payment networks with blockchain could prove exceptionally challenging — to the point where some businesses don’t even bother trying to do so.