What is Blockchain and how does it work
The blockchain is a new and innovative tool by which people and businesses can create, verify and implement transactions of any type without the need for an intermediary or a central authority. In its simplest form, it can be considered as a ledger that stores transactions in chronological order in one giant ledger. Transactions recorded in the blockchain can include the exchange of money, property, or anything that requires an enforceable contract or authorized access.
Many SMB owners think that blockchain is only used for the creation and exchange of cryptocurrencies like Bitcoin (BTC), but that is not the case. Below I will try to briefly describe blockchain technology and how it can influence the choices of SMEs. By the end of the article, you should have learned what blockchain is, how it works, which industries already use it currently, and which industries may use it in the future. To ensure the greatest possible clarity, I will prioritize simplicity over technical accuracy.
What is Blockchain and how does it work
At the basis of blockchain technology, there is the concept of “blocks”. Each transaction is recorded in “blocks” that belong to a long “chain”; these are then recorded and verified using cryptographic mathematical techniques, making it impossible to alter them later. As a result, as each subsequent transaction adds to the end of the chain, previous transactions become even more difficult to alter, further increasing security.
Many blockchains are decentralized, which means that several independent machines execute copies of the blockchain ledger at the same time. Each transaction is created and recorded in the chain and, at the same time, is transmitted to each of these decentralized copies of the ledger. These decentralized ledgers then record and doubly verify the transaction with the other ledgers. In principle, if at least 51% of the decentralized ledgers possess the same information, the transaction is considered verified and admitted as valid.
This comes in contrast to the centralized ledgers used by central authorities, such as the Central Bank or the Treasury. These centralized ledgers group transactions into a single record system controlled by a single entity. A bank statement is an example of a centralized ledger. With blockchain, however, copies of ledgers are distributed across a network of users, who independently record and verify transactions with each other.
The blockchain can be used to track and enforce most contracts that facilitate the exchange of ownership or have enforceable terms. It can manage the implementation of business contracts, streamline overall formal procedures, expedite the exchange of property (including currencies), verify identities and more.
This technology marries mathematics and computer science and is, in fact, a platform on which new applications can be built. Currently, it is mostly used as a decentralized ledger that records and verifies any transaction or relationship between two parts, but in the not too distant future it will become an integral part of most financial, economic and bureaucratic activities.
Simplifying as much as possible, the blockchain acts in 3 ways with each sequential transaction:
- Create transactions – First, the blockchain creates a transaction by recording it in all individual ledgers of the same blockchain.
- Verify Transactions – Once the transaction has been recorded in the blockchain, each individual ledger will independently verify that the transaction is valid. If one ledger’s information matches at least 51% of the others, it is reported as a successful transaction.
- Enforce Transactions – Based on the type of transaction, the blockchain can actually enforce the terms of the agreements. For example, if you bought goods/services net of terms, the blockchain can automatically send the money when it is due.
One of the most common types of transactions on the blockchain is known as “smart contracts”. Smart contracts are automated IT protocols that facilitate, verify and allow the negotiation and/or execution of a contract in the blockchain to be implemented. These smart contracts recorded as transactions in the blockchain generate a safe and secure way for any type of negotiation. They speed up and reduce transaction costs, contribute to the reduction of fraud and do not require intermediaries.
“Smart Contracts are a way to implement the blockchain value transfer of most contracts without having to resort to legal means to obtain precise performance. For example, if funds need to be sent on a precise day, they can be sent based on information encoded directly in the blockchain. As long as the transaction is agreed by both parties and verified by the decentralized ledger, the terms are applied – whatever they are – automatically.”
- Ivаn Brightly, Chief of Investments at Full Nоdе Cаріtаl.
The most famous smart contract at the moment is the one for cryptocurrency transactions, with which the largest international stock markets exchange currencies, securities and commodities, both real and derivatives, among themselves and between private investors.
The benefits of blockchain technology for SMEs
Since blockchain facilitates the transactions, speed, transparency, security and low cost of centralized blockchain ledgers, it is easy to say that this technology will greatly benefit SMEs. Most of the time it won’t even be noticed, as it will be operating “behind the scenes”, the only thing a small business can see is contracts and more efficient transaction processes, but once you compare operational costs and speed of execution with the past, it will be time of celebrations.
Here are 5 benefits of a blockchain for a small business:
- Transparency – Each transaction (or block) of the blockchain has: a unique ID; all the transactions included in the smart contract (they can be from 1 to more than 1,000) and a public key to identify the transaction. Public blockchains make all of this information open to the public. This means that there is complete transparency with public smart contracts.
Conversely, private blockchains can provide only some information, keeping the others private. For example, Bitcoin makes public all information about a transaction except the identity of the two parties. Other cryptocurrencies like Zcash (ZEC) give more anonymity and also keep transaction details private.
- Security – Once a transaction is recorded and verified in the blockchain, it cannot be altered. This is made possible by the mathematical cryptography used to record each transaction and by the fact that each transaction is stored in thousands of decentralized ledgers rather than a single master ledger. To alter a transaction, you would not only have to figure out how to do it once, but you would also need to alter 51% of the other ledgers in the network.
- Furthermore, since each subsequent block is added to the chain, it protects the previous blocks because to alter the previous transaction, all transactions that occurred after it would have to be altered in the first instance. For this reason, people talk about blocking a blockchain like a fly in amber; the amber becomes increasingly dense over time and protects the fly
inside. For example, the Trade Finance Market (TFM) has created Controlled Invoicing to reduce fraud. The company uses blockchain technology to make it easier for factoring company invoices to check whether previous invoices have been paid. This helps factoring companies reduce their risk, allowing them to offer their services to business owners at a lower cost.
- Real-Time Transactions – It takes approximately 20 seconds to 10 minutes for a blockchain transaction to be verified by the decentralized ledger network. This means that the blockchain can facilitate transactions in as little as 20 seconds. For example, you could send Ethereum from one cryptocurrency wallet to another in just under a minute. To be clear, an ACH
transaction takes more than a day.
These real-time transactions become a benefit when traditional ones require more time. For example, a real estate title transfer is currently being facilitated by a securities firm and can take anywhere from 30 to 45 days. With blockchain, a title transfer can happen as fast as it takes to verify the terms of the transaction.
- Lower Transaction Costs – Typically, when a small business uses blockchain, there are little or no transaction costs. This is because there is no intermediary or central authority. In addition, some decentralized ledger networks receive incentives to cede computing power to blockchains.
For example, “Bitcoin miners” are those people who allow the Bitcoin blockchain to act on their computers. In return, miners create Bitcoins by “mining” them. The amount of cryptocurrencies a miner earns depends on the computing power used. This means that when Bitcoins are sent from one wallet to another, the transaction costs are assigned to the computers that actually made that operation possible and not, as in the case of centralized payment instruments, assigned to a central body (VISA, bank, etc). Some merchant wallet accounts charge a monthly service fee for use. Plus, you can pay just under 1% on your transactions to get priority verification.
- No Intermediary – Since the blockchain is decentralized there is no intermediary or central authority such as the Central Bank or Treasury. Rather, distributed networks of ledgers work independently of each other to track, record, verify, and transact transactions on the blockchain. This results in a higher transaction speed and a reduction in the aforementioned transaction costs.
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