What is a ‘Blockchain’?
Blockchain is a Decentralised Ledger Technology (DLT), originally created to launch the first Peer-to-Peer Electronic Cash System: Bitcoin.
A blockchain, at its most basic form, constitutes a system that keeps a list of records using cryptography. In this system, various parties enter information that is progressively kept and protected by cryptography, which makes it resistant to modification and thus immutable. This information is then saved on a distributed ledger, which means it does not exist in a single cloud or storage unit, but simultaneously on several ones.
These distributed characteristics make blockchains secure, to a great extent, by design. Blockchains also avoid the typical dangers of centralised information, since they can be accessed publicly and require a consensus by the whole network to make any additions to future blocks.
The blockchain’s security and decentralisation-oriented approach make it an ideal network to host consensus algorithms, which issue rewards to users for performing set tasks. For example, the Bitcoin network rewards users for progressively protecting and securing the Bitcoin network through encryption.
Are all Decentralised Ledger Technologies (DLTs) blockchains?
While all blockchains are DLTs, not all DLTs are blockchains! A blockchain is merely a way to create a decentralised ledger, using blocks as a base for this system. There are many other ways to create a decentralised database without necessarily utilising blocks, which allows DLTs to use different (if any at all) consensus algorithms than blockchains. DLTs are, therefore, more prevalent within organisations, since they provide all the security advantages of blockchains without the escalation or consensus algorithm concerns. An example of this is the Directed Acyclic Graph (DAG) which features a system with interconnected nodes without blocks.
What makes blockchains so special? Why do I keep hearing about them?
Since a blockchain rewards those that contribute to their intended purpose, the structures of power fluctuate seamlessly within them, benefiting those that provide the most value to the network. This creates the possibility of creating markets to organically organise communities, disrupt existing industries, and decentralise power structures, eliminating many sources of conflict.
Because of this, many believe that blockchains could represent the most significant technological advance since the creation of the Internet, especially when combined with other tech trends like AI and IoT. Since the primary application of this technology, cryptocurrency, has managed to advance and grow organically despite regulatory concerns and scepticism, the upward trend is expected to continue.
Blockchains could signify a revolution in multiple aspects of daily life where networks are involved. Therefore, markets, social media, finance, governments, and many other networks are all subject to be transformed. Many individuals and companies have realised this, and are dedicating time and effort to build and grow decentralised, blockchain-based solutions for everyday problems, creating an attractive niche for tech investors to allocate resources to back these projects.
What do STO, IEO, and ICO, mean?
There are many different models that blockchain companies use to raise funds for their development. These models vary in different ways and are often abbreviated, which can be confusing to those entering the space for the first time. Some of the most common ones are:
- ICOs: An Initial Coin Offering (ICO) is the cryptocurrency equivalent of an Initial Public Offering (IPO), that takes place when a company’s shares are first offered publicly. In an ICO, investors usually fund a company’s development in exchange for tokens, which can be traded openly in the cryptocurrency market. This model, formerly the most popular one in the blockchain space, is still largely unregulated and has presented irregularities (such as fraud) in the past, making investors wary and leading to the development of other crowdsourcing strategies. Tokens offered on ICOs are usually considered utility tokens by regulators and tend to have a function within a blockchain ecosystem.
- STOs: A Security Token Offering (STOs) is a more secure, and usually more susceptible to regulation funding method that consists in offering tokenised securities in exchange for capital. Following the controversy behind many fraudulent ICOs, STOs were developed to provide investors with a safer way to participate in crowdfunding projects. Investing in STOs is typically done by purchasing tokens backed by assets (whether these are equities, shared income, or others), as opposed to tokens with a value determined by the free market. STOs are regulated in the US, the EU, Australia, Canada, and many other Western nations, which means that companies performing STOs can be legally prosecuted in case of misbehaviour.
- IEOs: Another response to generalised distrust in the ICO model, Initial Exchange Offerings were created to mitigate risks for investors by holding the token offerings on trusted platforms. In this model, a company usually holds its token offering on an exchange’s platform, which assures investors that tokens will be immediately liquid and available to be traded for other cryptocurrencies or sold for a national currency. To perform an IEO, a company usually has to meet the criteria designed by the exchange they want to list on, which can include legal, code, and financial audits, as well as background checks. In the IEO model, all parties have incentives to conduct due diligence and protect investors’ interests.
It’s important to remember that the models quoted above are not the only funding strategies used by blockchain projects, and that our descriptions are meant to be simplifications and not exhaustive explanations. When investing in blockchain projects, users are expected to know the intricacies of each model, as well as to make sure that they understand the details behind the project’s funding rounds.
What happens after people invest in a blockchain project?
What happens after you invest in a blockchain project depends on the stage or phase on which you entered:
- If you invested as a part of a crowdfunding round (such as an ICO, STO, IEO, etc.), you’ll typically receive your tokens after the funding for the project is completed, or receive a reimbursement in case that the project cannot reach its funding goals. This process depends on the specific criteria of the project: Some may choose to lock tokens away during their developmental stage to prevent users from immediately selling large amounts of them in the free market, affecting their price and therefore the returns of other investors. Whether this is the case or not, if your investment is completed, your tokens will eventually be sent to a crypto wallet (see next question) of your choice.
- If you invested on an existing crypto project with tokens that are actively trading, you’ll typically receive them in a crypto wallet of your choice, or, if you purchased them through an exchange, in a wallet created within its platform. In the latter case, it’s essential that you immediately take steps towards reallocating your funds to a secure wallet of your own.
What is a crypto wallet?
There is a misconception (mostly due to the terminology surrounding cryptocurrencies) that crypto wallets store cryptocurrencies inside them, like a wallet in your pocket. However, cryptocurrencies do not exist inside wallets or move around like regular money. Instead, they exist within the blockchain, and a cryptocurrency transaction is basically a third party assigning the ownership of the keys to access them to you, through your private wallet.
This difference makes it important that you understand wallets, how they work, and how to use them to store your cryptocurrencies securely.
A crypto wallet can be developed by a private company, by individuals on the Internet through open-source code, by a cryptocurrency issuer as an official product, or by an exchange to use within its platform. They can also support multiple or just a single (crypto) currency. Since a wallet holds the keys to your coins, and therefore your money, you must abstain from storing your currency on wallets that aren’t yours (like exchange wallets), and make sure that you’re the sole owner of your private keys. It’s also highly recommended that you store your cryptocurrency on an offline device, which is known as cold storage.
The different types of crypto wallets are:
- Paper wallets: The simplest kind of wallet. A paper wallet only requires you to generate it online, print your private keys (often along with a QR code that you can later use to transact more easily), and a safe place to store it. You can then use your private keys to access your coins.
- Online wallets: An online wallet is both the easiest to use and the least secure solution. While your coins are stored in the cloud (either in an exchange wallet or on a third-party server), and these wallets often present well-designed, user-friendly platforms, they are very vulnerable to attacks and fraud. However, transacting in online wallets is often more agile.
- Software wallets: Software wallets can be mobile or desktop-based, and they allow you to transact with and store your coins in a single device. You can then set this device offline for maximum security. Hacking and viruses are the greatest threats to these wallets, as well as theft.
- Hardware wallets: The safest solution, hardware wallets store your funds in an offline device with built-in security, which can then be plugged into any computer with an Internet connection to transact. Users handling large sums of money are often encouraged to use these solutions, since the cost of lost funds can be much higher than the cost of purchasing the wallet. Hardware wallet users can also generate a ‘seed’ phrase to restore their access in case their device gets lost.
Apart from using cold storage wallets, what else can I do to keep my cryptocurrencies safe?
- Backup your wallet: This is not an option for online storage users, but most wallets can be backed up, as well as protected, combining different solutions.
- Update your software: Make sure you always have the latest version of the software of your desktop, mobile, or hardware wallet installed, and that you understand what every change entails.
- Have good cyber hygiene: Always use long and complicated passwords. Don’t install any suspicious or potentially malicious software. Keep an eye out for scams and thieves. In general, users tend to forget that everything that happens online is connected to the entire world. However, you can always protect yourself by being careful and maintaining good cybersecurity practices.
Which businesses are currently using blockchains?
Many big names in diverse industries have already adopted the use of blockchain solutions. In fact, six out of Forbes’ Top 50 FinTech companies for 2020 are in some way involved with blockchain. Other big names using or adopting blockchain for particular processes are Amazon, Walmart, Facebook (famously developing Libra, a cryptocurrency project that raised the question of whether Facebook tries to imitate central banks), ING, Mastercard, Microsoft, and Nestle.
What is ‘Decentralised Finance’ (DeFi)?
Decentralised Finance, or DeFi, is the effort to create fully decentralised financial services, such as lending, exchanging, derivatives, and others, even betting, on the blockchain.
Decentralised Finance heavily relies on blockchain applications (particularly those based in Ethereum) to exist, since smart-contracts, code on the blockchain open for anyone to examine, power these services. The smart-contracts, code in the blockchain that is open for anyone to see, operates within the dApp (Decentralised App) platform autonomously running financial services based on algorithms. Services such as lending, for example, pay interest to lenders by automatically adjusting their yields to match the number of borrowers.
The leading DeFi applications are, in order, Maker, Compound, and Synthetix. Estimates indicate that Maker currently holds over 60% market dominance. Of the total $1.18 Billion in value locked in DeFi, around 90% is locked in lending apps. DeFi is still subject to the crypto market’s volatility.
Can blockchains be attacked?
Blockchains offer improved security as opposed to centralised systems precisely because they are decentralised. Since within a blockchain the ledger that keeps track of all transactions is not stored in a single place but distributed among many nodes (i.e. computers running the network), an attacker needs to tamper at least 51% of these nodes to be successful. In large enough systems (like the Bitcoin blockchain) this is practically impossible, making an attack highly unlikely. Therefore, one could consider the number of nodes in a blockchain a good representation of its security.