How To Trade Bitcoin In 2024 – Forbes Advisor Australia
This guide explains how Bitcoin trading works, which factors influence Bitcoin's price the most, and the role of technical and fundamental analysis in forming ...
blockchain
At its core, Bitcoin trading refers to the act of buying and selling Bitcoin in an attempt to capitalise on its price fluctuations. Unlike traditional fiat currencies which are anchored by governmental and institutional policies, Bitcoin operates on a decentralised network known as <anchor>blockchain</anchor>. Its price is driven by myriad factors including demand, adoption rates, regulatory news, and broader market sentiments.
What is a Blockchain? – Forbes Advisor Australia
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# What Is A Blockchain?

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Published: May 4, 2023, 4:30pm

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Editorial note: Forbes Advisor Australia may earn revenue from this story in the manner disclosed here. Read our advice disclaimer here.

## Table of Contents

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Blockchain is the innovative database technology that’s at the heart of nearly all cryptocurrencies. By distributing identical copies of a database across an entire network, blockchain makes it very difficult to hack or cheat the system. While cryptocurrency is the most popular use for blockchain at present, the technology offers the potential to serve a very wide range of applications.

## What Is A Blockchain?

At its core, blockchain is a distributed digital ledger that stores data of any kind. A blockchain can record information about cryptocurrency transactions and ownership of Non Fungible Tokens (NFTs).

While any conventional database can store this sort of information, blockchain is unique in that it’s decentralised. Rather than being maintained in one location by a centralised administrator—think of an Excel spreadsheet or a bank database—many identical copies of a blockchain database are held on multiple computers spread out across a network.

These individual computers are referred to as nodes.

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## How Blockchain Works

With blockchain, the digital ledger is described as a “chain” made up of individual “blocks” of data. As fresh data is periodically added to the network, a new “block” is created and attached to the “chain.”

This involves all nodes updating their version of the blockchain ledger to remain identical.

How these new blocks are created is key to why blockchain is highly secure. A majority of nodes must verify and confirm the legitimacy of the new data before a new block is added to the ledger. For a cryptocurrency, they might ensure that new transactions in a block were not fraudulent or that coins had not been spent more than once.

This differs from a standalone database or spreadsheet, where one person can make changes without oversight.

“Once there is consensus, the block is added to the chain and the underlying transactions are recorded in the distributed ledger,” says C. Neil Gray, partner in the fintech practice areas at US-based Duane Morris LLP. “Blocks are securely linked together, forming a secure digital chain from the beginning of the ledger to the present.”

In a blockchain network, transactions are secured through cryptography, which involves solving complex mathematical problems to verify and process each transaction. However, the process of validating transactions and adding new blocks to the chain consumes significant computational resources and energy. This process is known as “proof-of-work,” which is a consensus algorithm that requires nodes to perform complex computations.

“As a reward for their efforts in validating changes to the shared data, nodes are typically rewarded with new amounts of the blockchain’s native currency, such as new Bitcoin on the bitcoin blockchain,” says Sarah Shtylman, fintech and blockchain counsel with Perkins Coie.

An alternative to proof-of-work is “proof-of-stake,” which is a more energy-efficient consensus algorithm. This algorithm selects nodes to validate transactions and create new blocks based on their holdings or stake in the cryptocurrency, rather than requiring them to perform complex computations.

Ethereum, a prominent blockchain platform, has successfully transitioned from a proof-of-work to a proof-of-stake system, now known as Ethereum 2.0. This major shift has enhanced the network’s scalability, security, and energy efficiency, solidifying Ethereum’s position as a leading blockchain solution.

While proof-of-work has been the traditional consensus algorithm used in many blockchain networks, the move towards proof-of-stake is seen as a more sustainable and environmentally-friendly option.

## Transaction Process

The process of a blockchain transaction begins when someone requests a transaction involving cryptocurrency, contracts, records, or other information. The transaction is then broadcast to all the participating computers in the specific blockchain network, which are called nodes. All transactions are published to the memory pool, where they are considered ‘pending,’ and gas fees are paid by users to compensate for the computing energy required to process and validate transactions on the blockchain.

Next, miners verify the transaction by checking it against some validation rules set by the creators of the specific blockchain network. Once the transaction is validated, it is stored in a block and sealed with a lock known as a hash.

The newly created block is added to the existing blockchain. Other computers in the network validate the lock on the block to ensure that it is correct. Once validated, the transaction is complete, and it becomes part of the blockchain. Once a transaction is recorded on the blockchain, it cannot be altered in any way.

## Public Vs Private Blockchains

There are two types of blockchains – public and private. A public blockchain is open to everyone, meaning that anyone can read, write or audit the data on the blockchain. One of the key advantages of public blockchains is that they are very difficult to alter, as no single authority controls the nodes. This makes public blockchains ideal for decentralised applications and peer-to-peer financial transactions, where trust and security are paramount.

On the other hand, private blockchains are controlled by an organisation or group. Only those invited to the system have access to the data and can read, write, or audit the blockchain. Unlike public blockchains, a single entity has the authority to go back and alter the blockchain if necessary. This private blockchain process is similar to an in-house data storage system, but with the added benefits of distributed nodes for increased security.

While public blockchains prioritise transparency and decentralisation, private blockchains prioritise control and exclusivity. Each type of blockchain has its own set of advantages and disadvantages and is suited for different use cases.

## How Is Blockchain Used?

Blockchain technology is used for many different purposes from providing financial services to administering voting systems.

### Cryptocurrency

The most common use of blockchain today is as the backbone of cryptocurrencies, like Bitcoin or Ethereum. When Australians buy, exchange or spend cryptocurrency, the transactions are recorded on a blockchain. The more people use cryptocurrency, the more widespread blockchain could become.

“Because cryptocurrencies are volatile, they are not yet used much to purchase goods and services. But that is changing as PayPal, Square and other money service businesses make digital asset services broadly available to vendors and retail customers,” notes Patrick Daugherty, senior partner of international law firm Foley & Lardner and lead of the firm’s blockchain task force.

### Banking

Beyond cryptocurrency, blockchain is being used to process transactions in fiat currency, such as pounds, Australian dollars and euros. This could be faster than sending money through a bank or other financial institution as the transactions can be verified more quickly and processed outside regular business hours.

Central Bank Digital Currencies (CBDCs) are another emerging application of blockchain technology in the banking sector. CBDCs are digital versions of a country’s fiat currency issued and controlled by the central bank. They aim to provide a more efficient, secure, and transparent way to conduct transactions and maintain a stable form of currency. Several countries are exploring or developing their own CBDCs, such as China’s digital yuan and the potential digital AUD.

However, there are concerns that CBDCs may give central banks excessive control over people’s money, potentially leading to surveillance and restrictions on financial activities. Critics argue that this level of control could infringe on individual privacy and financial freedom, and there is a need for clear regulations to balance the benefits of CBDCs with the protection of personal liberties.

### Asset Transfers

Blockchain can also be used to record and transfer the ownership of different assets. This is currently popular with digital assets such as NFTs, representing ownership of digital art and videos.

However, blockchain could also be used to process the ownership of real-life assets, such as the deeds to property and vehicles. The two sides of a party would first use the blockchain to verify that one owns the property and the other has the money to buy. Then they could complete and record the sale on the blockchain.

Using this process, they could transfer the property’s deeds without manually submitting paperwork to update land registration records—it would be instantaneously updated in the blockchain.

### Smart Contracts

Another blockchain innovation is self-executing contracts commonly called “smart contracts.” These digital contracts are enacted automatically once conditions are met. For instance, a payment for an item might be released instantly once the buyer and seller have met all specified parameters for a deal.

“We see great potential in the area of smart contracts, using blockchain technology and coded instructions to automate legal contracts,” says Gray. “A properly coded smart legal contract on a distributed ledger can minimise, or preferably eliminate, the need for outside third parties to verify performance.”

### Supply Chain Monitoring

Supply chains involve massive amounts of information, especially as goods go from one part of the world to the other. With traditional data storage methods, it can be hard to trace the source of problems, such as which vendor poor-quality goods came from.

Storing this information on blockchain would make it easier to go back and monitor the supply chain, such as with IBM’s Food Trust, which uses blockchain technology to track food from its harvest to its consumption.

### Voting

Experts are also looking into ways to apply blockchain to prevent fraud in voting. In theory, blockchain voting would allow people to submit votes that couldn’t be tampered with as well as would remove the need to have people manually collect and verify paper ballots.

## Advantages of Blockchain

### Higher Accuracy of Transactions

Because a blockchain transaction must be verified by multiple nodes, this can reduce error. If one node has a mistake in the database, the others would see that it’s different and catch the error.

In contrast, in a traditional database, if an individual makes a mistake, it may be more likely to go through. In addition, every asset is individually identified and tracked on the blockchain ledger, so there is no chance of double spending it (like a person overdrawing their bank account, thereby spending money twice).

### No Need for Intermediaries

Using blockchain, two parties in a transaction can confirm and complete something without working through a third party. This saves time and the cost of paying for an intermediary, a bank for example.

“It has the ability to bring greater efficiency to all digital commerce, to increase financial empowerment to the unbanked or underbanked populations of the world and to power a new generation of internet applications as a result,” says Shtylman.

### Extra Security

Theoretically, a decentralised network, like blockchain, makes it nearly impossible for someone to make fraudulent transactions.

To enter in forged transactions, they would need to hack every node and change every ledger. While this isn’t necessarily impossible, many cryptocurrency blockchain systems use ‘proof-of-stake’ or ‘proof-of-work’ transaction verification methods that make it difficult, as well as not in participants’ best interests, to add fraudulent transactions.

### More Efficient Transfers

Since blockchains operate 24/7, people can make more efficient financial and asset transfers, especially internationally. They don’t need to wait days for a bank or a government agency to manually confirm everything.

## Disadvantages of Blockchain

### Limit on Transactions per Second

Given that blockchain depends on a larger network to approve transactions, there’s a limit to how quickly it can move. For example, Bitcoin can only process 4.6 transactions per second versus 1,700 per second with Visa. In addition, increasing numbers of transactions can create network speed issues. Until this improves, scalability is a challenge.

### High Energy Costs

The energy consumption of blockchain networks varies depending on their consensus mechanisms. Proof-of-Work (PoW) blockchains, such as Bitcoin, require significant amounts of electricity for their mining process, as nodes compete to solve complex mathematical problems to validate transactions.

This high energy consumption not only makes PoW blockchain-based transactions more expensive, but it also creates a large carbon burden for the environment if the energy is sourced from fossil fuels. However, in some areas that favour development of renewable energy sources, Bitcoin mining has driven the creation of new renewable energy sources as a cheaper and cleaner alternative energy source.

Other consensus mechanisms, such as Proof-of-Stake (PoS), are much more energy-efficient. Ethereum, for instance, has transitioned from a PoW to a PoS model, significantly reducing its energy consumption by over 99%. This shift highlights a growing trend within the blockchain industry to adopt more environmentally friendly and sustainable consensus mechanisms.

It’s important to note that not all blockchain networks are associated with high energy costs, and the industry is actively working to address these concerns by developing and implementing more energy-efficient solutions, like the PoS model.

### Risk of Asset Loss

Some digital assets are secured using a cryptographic key, like cryptocurrency in a blockchain wallet. You need to carefully guard this key.

“If the owner of a digital asset loses the private cryptographic key that gives them access to their asset, currently there is no way to recover it – the asset is gone permanently,” says Gray. Because the system is decentralised, you can’t call a central authority, like your bank, to ask to regain access.

### Potential for Illegal Activity

Blockchain’s decentralisation adds more privacy and confidentiality, which unfortunately makes it appealing to criminals. It’s harder to track illicit transactions on blockchain than through bank transactions that are tied to a name.

In fact, the Australian Competition and Consumer Commission (ACCC) has issued warnings about Australians being caught up in crypto scams.

## How to Invest in Blockchain

You can’t invest in blockchain itself since it’s merely a system for storing and processing transactions. However, you can invest in assets and companies using this technology.

“The easiest way is to purchase cryptocurrencies, like Bitcoin, Ethereum and other tokens that run on a blockchain,” says Gray.

Another option is to invest in blockchain companies using this technology. For example, the US-based Santander Bank is experimenting with blockchain-based financial products. If you were interested in gaining exposure to blockchain technology in your portfolio, you might buy its stock.

For a more diversified approach, you could buy into an exchange-traded fund that invests in blockchain assets and companies. There are thousands of Exchange Traded Funds (ETFs) that offer Aussie investors exposure to overseas stocks.

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## Bottom Line

Despite its promise, blockchain remains something of a niche technology. Gray sees the potential for blockchain being used in more situations but it depends on future government policies. “It remains to be seen when and if regulators will take action. One thing is evident—the goal will be to protect markets and investors,” he says.

Shtylman likens blockchain to the early stages of the internet. “It took about 15 years of having the internet before we saw the first version of Google and over 20 for Facebook. It’s hard to predict where blockchain technology will be in another 10 or 15 years, but much like the internet, it will significantly transform the ways we transact and interact with each other in the future.”

Hurdles remain, especially with the transaction limits and energy costs, but for Australians who do their due diligence and see the potential of the technology, blockchain-based investments may be worth considering.

This article is not an endorsement of any particular cryptocurrency, broker or exchange nor does it constitute a recommendation of cryptocurrency or blockchain more broadly.

## Frequently Asked Questions (FAQs)

### What is a blockchain wallet?

A blockchain wallet is like a digital bank account for cryptocurrencies. It allows users to store, trade, and manage their cryptocurrencies securely on the internet. These wallets can be accessed through computers or smartphones and require a unique identifier and password to ensure the user’s security.

### Where is a blockchain located?

A blockchain’s location depends on its type: decentralised or centralised. Decentralised blockchains, like those used for most cryptocurrencies, are distributed across numerous computers or systems, called nodes, within the network. Each node holds an identical copy of the blockchain database, and as new data or transactions are added, new “blocks” are created, extending the chain. For many larger blockchains, like Bitcoin and Ethereum, these nodes are distributed worldwide.

Centralised blockchains, on the other hand, are controlled by a single organisation or entity, which maintains the database and can make changes as needed. This centralised structure is more similar to traditional databases, but it may still be distributed across multiple nodes for enhanced security. The type of blockchain used depends on the specific application and desired level of control and security.

### What is blockchain in simple words?

Blockchain is a digital ledger of transactions that is stored on a network of computers (nodes) rather than on a central server. Each transaction is recorded in a “block,” which is then added to a “chain” of other blocks. This creates a permanent and unalterable record of all transactions on the blockchain, which can be accessed and verified by anyone on the network.

### What is an example of a blockchain?

One example of a blockchain is Bitcoin, which is a decentralised digital currency that operates on a public blockchain. Ethereum is another example of a blockchain platform that is used to develop decentralised applications and execute smart contracts.

### Is blockchain a cryptocurrency?

No, blockchain is not a cryptocurrency. Cryptocurrency is a digital asset that operates on a blockchain, but blockchain technology can be used for a variety of other applications beyond cryptocurrency, such as supply chain management, voting systems, and identity verification.

### How many blockchains are there?

There are many blockchains in existence, with new ones being developed all the time. Some are public, like Bitcoin and Ethereum, while others are private and used by businesses or organisations for specific purposes. It’s difficult to say exactly how many blockchains there are, as the number is constantly changing and evolving. As of 2023, there are more than 23,000 cryptocurrencies based on blockchain and an increasing number of private blockchains being used by companies worldwide.

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David is a financial writer based out of Delaware. He specializes in making investing, insurance and retirement planning understandable. Before writing full-time, David worked as a financial advisor and passed the CFP exam.

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