Digging Deeper Into The Relationship Between Blockchain and Crypto

Masterworks
January 25, 2022

Cryptocurrencies like Bitcoin, Ethereum, and others have been generating high levels of interest for years, as has interest in blockchain, the technology that makes these digital assets possible. Here’s what you need to know about blockchain and how it’s related to cryptocurrency.

Better Financial Technology Through Programming

The blockchain – the underpinning database technology that makes cryptocurrency possible. Much has been said about this new programming paradigm, how its decentralized and open-source nature is already revolutionizing financial technology.

But what about the exact relationship between the blockchain and cryptocurrency is beyond the idea that blockchain is somehow the foundation of crypto? How does this “foundation” actually work?

The implementation of cryptocurrency through a blockchain is certainly complex, but the core concepts aren’t nearly as complicated as you might think. Here’s what you need to know about the blockchain and how it enables the use of cryptocurrency.

A Definition of the Blockchain

When you get right down to it, a blockchain is a unique type of digital database. Usually referred to as a “ledger,” a blockchain is designed to record large amounts of data over a long period of time.

Because of how they are constructed, blockchains offer several truly ingenious advantages, such as the data entered into a ledger being highly resistant to alterations or tampering. This is because the data contained in blockchains make use of heavy cryptographic encryption to keep this data secure.

This involves the creation of both a cryptographic hash and a timestamp so every block in the chain is linked to every block before and after it. Each of these blocks are then verified by every computer with access to the chain. Altering anything in the blockchain would require you to access every node and every block simultaneously, which is functionally impossible.

Yet blockchains are also incredibly transparent The data records of blockchain ledgers are, for the most part, open to any computer granted access to the chain (also known as a “node”) to view. The decentralized nature of blockchain ledgers means that instead of a single controlling entity that decides who and when people are allowed to access the database, blockchains are ruled and maintained by consensus using a peer-to-peer network. Any alterations to the blockchain, such as adding new data, require all peers on the network to agree to these alterations.

Because of the security and transparency that the blockchain provides, these ledgers are ideally suited for financial bookkeeping. Blockchains can create and maintain excellent financial records for whatever currency that blockchain records. This includes how much currency is in circulation, where and when each unit was created, who owns the currency, and any and all transactions made with the coins.

Additionally, identity protection in the blockchain is high.  The only “personal” data included the username associated with the digital address number listed with every transaction. Unless someone has a legal right to access that information, such as chain owners, companies, and law enforcement, the identities of blockchain users are secure.

Blockchain Technology Applications – Cryptocurrency, NFTs, and More

Because blockchain ledgers allow for transparent, decentralized data transmission, offer little chance for tampering, and are open source and publicly referenced, they are ideal for several technology applications.

The biggest and most famous use case of blockchain is for the creation and maintenance of digital assets. There are cryptocurrencies such as Bitcoin, Ethereum, and countless others; there are also NFTs, or non-fungible tokens, that have been used increasingly to assign ownership rights to reproductible digital files outside of cryptocurrency, such as photos, videos, and audio.

But the blockchain is much more than cryptocurrency. NFTs also use the blockchain as a database to provide a record of ownership rights. In fact, there are a few traditional banking institutions that are researching how to leverage this ledger technology for their own applications.

These banks are more concerned with using cryptocurrency as a taxable asset instead of a currency, as cryptocurrencies aren’t linked to fiat currencies. However, the underlying technology can be used to replace existing databases with blockchain ledgers to keep track of withdrawals and deposits and offer serious benefits when it comes to updated recordkeeping in a global financial system, beneficial because it doesn’t require trust.

Cryptocurrency: the Original Technological Use for the Blockchain

Yet even as the use of blockchain ledgers in traditional financial markets and for non-currency matters like digital NFT ownership records continue to develop, the most understood use case for the blockchain remains the idea of cryptocurrency. There are quite literally hundreds of different cryptocurrencies with their own individual blockchains.

Cryptocurrency is a type of digital financial asset that can be used to make purchases wherever it’s accepted as a valid currency, just like you would with the dollar, euro, yen, or any other type of “official” currency. However, one main difference is that cryptocurrency values can and do fluctuate dramatically – Bitcoin, as an example, is currently valued at over $42,000 per coin.

Another important difference is that these assets are 100% digital. They don’t “exist” in any sort of physical form. You can’t go to an ATM and withdraw Bitcoin for you to carry around like you could with dollars from your checking account. There are no cryptocurrencies that are recognized as a nationally administered currency, which means you couldn’t store these in a traditional bank account.

This might appear to be counterintuitive, as the use of cryptocurrency means you can only use them for electronic transactions. However, with the digital financial technologies of today, it’s become increasingly possible to not need to have any physical cash on you to make purchases at brick-and-mortar stores thanks to debit and credit cards or even smartphone payment systems that don’t even require a physical card.

How Digital Currencies Are Created

The blockchain ledger of a specific digital currency keeps track of its disposition. The blockchain keeps a record of whenever these assets enter or leave your digital personal cryptocurrency wallet, where those assets went, and where they come from, all in the form of data that can be easily examined but not-so-easily altered.

Yet since these cryptocurrencies aren’t printed or minted like fiat currency, the way these currencies are created is unique – and is also related directly to the way its blockchain works. The blockchain contains all information about a cryptocurrency, including code that limits the production to a maximum number of coins in circulation. Blockchains create the scarcity needed for digital currencies to function through this mechanism.

These crypto coins are created through a process that’s referred to as “mining.” A new unit of currency is “mined” by devoting computing power to solving complex mathematical equations that require time and energy, accomplished by standalone computers that are tasked with doing these calculations.

Cryptocurrency miners receive currency as a reward for completing these calculations in “blocks” of verified transactions in a process called “proof of work.” This activity is recorded in the blockchain. The blockchain then keeps track of who “earned” the currency, as well as how much of the currency remains to be mined.

Typically, the difficulty of the calculations needed to earn a unit of this currency become increasingly higher, requiring more and more effort to mine as the total supply dwindles. In very long-lived blockchains, such as Bitcoin, the difficulty associated with mining new coins is extreme.

In fact, with the amount of electricity needed to mine new Bitcoin quickly becoming untenable, many miners are looking for ways to harness renewable power to avoid contributing to the burning of fossil fuels to generate electricity.

The Future of Blockchain and Cryptocurrency

Blockchain technology has come a very long way since its initial conceptualization. While early blockchains were concerned only with keeping track of cryptocurrency assets, modern blockchain ledgers can do so much more than just that.

There’s no telling where these technologies will go in the future, but there’s one thing certain: the technology behind the blockchain, and the rationale behind using a decentralized, transparent, and tamper-resistant database technology for all sorts of digital applications, is not going away any time soon. Investing in NFTs, for example, is a clear use case of how blockchain technology can aid individuals interested in investing capital in something other than a digital currency. Yet investing in the ownership rights associated with fine art isn’t just relegated to the world of NFTs; Masterworks is a unique community dedicated to investing in contemporary art. To learn more, visit Masterworks.io today.


Masterworks
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