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What is a blockchain?

Blockchains are decentralized lists of records consisting of individual blocks linked using cryptography. Similarly to the term blockchain, the term “distributed ledger technology” (DLT) is also commonly used. In these distributed records, information of any kind can be documented as transactions that are tamper-proof, transparent, and cannot be altered. In practice, blockchains are used, for example, as the basis for digital payment methods such as bitcoin or as transaction protocols for smart contracts.

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01

A definition of blockchain

In IT, blockchain refers to decentralized lists of records (blocks) in which data transactions are stored in a unique, tamper-proof, unalterable, and transparent manner. Transactions are recorded on individual blocks that are linked to one another using cryptography. Blockchain systems generally do not use central servers but are distributed among all participating systems. This structure is intended to ensure that all parties involved can use the system on a level playing field. No company, state, or authority has more authorizations than individual users. Tampering is only conceivable if one party succeeds in taking over more than 50 percent of all connected systems in the network. Transactions in the blockchain network are verified and logged internally. In this way, values can be transferred directly and securely with no need for an intermediary. These properties make blockchain solutions particularly suitable in scenarios where the transfer of information must be guaranteed to be secure beyond doubt and tamper-proof. Common applications include cryptocurrencies, smart contracts, and supply chain tracking systems.

02

How does a blockchain work?

Example of the bitcoin blockchain: As a distributed database, the blockchain consists of data blocks linked using cryptography that contain the information of the transactions carried out in the network. Every node in the blockchain network can make as well as view transactions. In turn, a certain number of transactions are summarized and recorded on each block. At the same time, each block uses a hash to link to the preceding block and its transaction history. The blocks are verified by miners. These are blockchain nodes that provide computing power in order to use the brute force method to calculate a predefined hash for each block. This verification method is called proof of work. Symbolically, miners act as the bookkeepers in the blockchain, confirming the legitimacy of transactions in the network. When a new block is completed, the information is passed on to all the nodes in the blockchain network and saved on the local copy of the blockchain. Any subsequent alteration of the data is not possible as even minimal changes would have a major impact on the hashes that the individual blocks use to link to each other.

03

How do blockchain transactions work?

Client software is required to actively participate in a blockchain network, which in the case of cryptocurrencies such as bitcoin is referred to as a wallet. The software uses asymmetric encryption based on a private key and a public key – the latter serves as the address for transactions. The private key is secret and is used to sign transactions to ensure their authenticity. As an alternative to software-based wallets, hardware wallets can also be used for blockchains. These devices are specially designed to manage the private keys of users as securely as possible. Unlike software wallets on smartphones or PCs, there is no direct connection to the internet, which eliminates a critical attack vector. The devices sign transactions locally and output the signed transaction when connected to a PC for further processing. This means that the private keys never leave secure storage. This rules out the possibility of sensitive data being read by malware, which means that hardware wallets can theoretically be safely used even on compromised systems.

04

How secure is blockchain?

The blockchain itself was designed for the tamper-proof and transparently traceable exchange of information. The technological basis for this is provided by cryptographic processes that, thanks to high encryption standards, are also intended to ensure the security of the blockchain. However, the use of complex encryption methods by no means guarantees across-the-board IT security. As the German Federal Office for Information Security (BSI) points out in its blockchain guide, it is not possible to make concrete (especially quantitative) statements about the level of security for the large number of blockchain applications. Only when companies have gained sufficient experience with the technology can an informed assessment of cybersecurity ensue. Moreover, blockchain is only suitable for processing confidential data to a limited extent, as the technological concept primarily pursues data transparency. Encrypted content that cannot be viewed by the entire blockchain network is difficult to verify. Special zero-knowledge protocols are required here, which in practice are complex to implement and very resource-intensive.

The BSI sees additional challenges in IT security in key management. If, for example, the public keys have to be specifically assigned to a person, this requires additional processes for checking and verifying identity. A public key infrastructure, for example, is suitable for this purpose, taking over the technical and organizational work involved. However, such a concept again requires the use of trusted third parties in the form of a certificate authority, which also involves a centralized entity.

05

What are the advantages of blockchain?

Compared to classic databases or cloud architectures, blockchain-based solutions offer a number of advantages. The most important attributes of the technology include:

Availability & reliability:

Blockchain solutions have a number of advantages over centralized systems. The architectural structure alone ensures a high level of reliability. Whereas conventional databases are operated on central servers, which in turn clients access to query and process the data, management of the data is shared in a blockchain network. If a technical failure occurs at one node, the data is still available across all other instances. In contrast, server problems in centralized architectures usually cause limited availability, depending on the degree of redundancy.

Secure transfer of values:

Transactions in the blockchain are technologically verified and recorded. This means that transfers of values and data can be transparently traced and recorded in a tamper-proof manner for all entities involved in the network.

No intermediaries:

All transactions in the network are peer-to-peer (P2P) with no need for intermediaries such as banks, notaries, or governments. By dispensing with trust-building intermediaries, business processes can be highly automated, resulting in savings of both time and money. Therefore, blockchain technology has great potential in logistics for automated supply chains and the like.

06

What are the drawbacks of blockchain?

Blockchain is also not free of disadvantages and problematic properties, especially since many blockchain solutions are still struggling with teething problems. The biggest shortcomings of blockchain technology are:

Resource requirements:

The proof-of-work concept, in particular, requires vast amounts of computing resources and power. For example, the average power consumption of a single bitcoin transaction in 2020 was 741 kilowatt hours. By comparison: The same amount of energy can be used to make nearly 500,000 Visa transactions (source: Statista). In addition, the cumulative storage requirements of branched blockchain databases are many times higher than those of centralized server systems.

Slow:

The high technological overhead for cryptographically verifying transactions makes blockchain solutions comparatively slow. By direct comparison, centralized cloud architectures work faster and can handle far more transactions.

Lack of practical feasibility:

Even though the high potential of blockchain-based solutions is undisputed, the technology is still in its infancy. There is a lack of standardization and clarity. The BSI, for example, criticizes the confusing abundance of available solutions, which makes it difficult to select a specific product with any certainty. Practical implementations are only available for a few companies and industries, and connecting legacy systems poses problems. Moreover, IT specialists with the requisite blockchain skills are in short supply in the competitive labor market.

07

Where blockchain is used?

Numerous blockchain-based solutions leverage the characteristics of decentralized data processing. Blockchain solutions unlock the greatest potential when they build directly on the positive attributes of the technology. Among the best-known applications are:

Cryptocurrencies

The most prominent example of blockchain is the bitcoin cryptocurrency, which is regularly featured in the headlines with wild price fluctuations. Due to extreme volatility, bitcoin and most other blockchain tokens are unsuitable for normal payment transactions. Much more, cryptocurrencies currently serve as speculative investments for risk-taking investors.

Smart contracts

Beyond cryptocurrencies, blockchain is currently being used in logistics for the automated tracking of supply chains and the processing of customs and tax formalities via smart contracts. Initial pilot projects by international shipping companies and seaports have already been underway for several years. Using blockchain can make the required trade documentation more transparent, faster, and more cost-efficient. Documents are transmitted, validated, and approved electronically and automatically between the individual trading partners and the responsible customs authorities.

E-health

The digital corona vaccination certificate also relies on blockchain. The solution is designed to enable citizens to electronically share their vaccination status for things such as attending events or for checking in at hotels. The vaccination data and personal details such as name, address, and ID number are encrypted and stored on a total of five blockchains. For citizens, however, only the associated QR code is relevant, which is used to compare the data. The code can be printed out or used in a software-based wallet on a smartphone.

08

What you need to know about blockchain

Blockchains are decentralized structured databases composed of cryptographically linked blocks. Information is stored transparently and tamper-proof in blockchain databases, making the technology particularly suitable for the traceable transfer of values, such as in the form of cryptocurrencies or within smart contracts. The advantage of blockchain-based solutions in applications is that an authenticating entity is no longer required to secure the transaction. Instead, the exchange takes place in the blockchain peer-to-peer from one entity to another. Compared to centralized databases, blockchain solutions are slower and require significantly more resources – due to the high technical overhead involved in verifying the data.

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