Blockchain Definition: You have to know

With its potential to reduce fraud, speed up and secure transactions and exchanges, and assist in risk management inside the interconnected global financial system, blockchain technology is a promising financial innovation.

In order to do this, Blockchain employs sophisticated cryptography that is supposedly impenetrable to hacking, hence strengthening the transaction ecosystem's integrity. In 2022, there are approximately 10,000 active blockchain-based cryptocurrencies and hundreds of non-cryptocurrency blockchains.

Financial transactions and trades can be tracked using the blockchain technology. Investors would be well advised to learn about how blockchain is transforming the system and how to get and regulate exposure to this development as our global financial system becomes more connected in our age of digital revolution.

What is Blockchain?

Decentralized databases are known as blockchains, and they are shared among network nodes in a decentralized manner. When it comes to data storage, a blockchain is akin to a digital database. Blockchains are well known for their critical role in keeping a secure and decentralized record of transactions in cryptocurrencies like Bitcoin. 

A blockchain divides data into blocks, each of which contains a collection of information. Contents about transactions is included in each block, along with a cryptographic hash of the previous block's data (generally represented as a Merkle tree). All subsequent data is compiled into a new block, which is subsequently added to the chain once it is complete.

As the name suggests, a blockchain organizes data in the form of blocks, which are linked together to form a chain. Using this data structure in a decentralized fashion provides a time line that cannot be reversed. Once a block is filled, it is added to the timeline permanently. There are timestamps attached to each block as it is added to the chain.

This ground-breaking technology secures information exchanges as they take place. The goal of blockchain is to make transactions less expensive, more efficient, and faster. Financial services is one market where the blockchain has obvious advantages, as organizations compete to cut transaction costs and friction.

The technology has a wide range of applications that can be integrated into a variety of businesses, giving investors a wide range of options. To begin with, it is one of the technological foundations of cryptocurrencies such as Bitcoin. An introduction to the Bitcoin digital currency by Satoshi Nakamoto referred to it as "an entirely peer-to-peer electronic cash system with no trusted third party" in a research paper describing the currency's development. Because it distributes its operations across a network of computers, Blockchain enables cryptocurrencies like Bitcoin and others to operate without the need for a centralized authority.

What Is a Blockchain Platform?

A blockchain platform can be used by users and developers to extend the functionality of an existing blockchain infrastructure. A cryptocurrency called ether is native to Ethereum (ETH). However, the Ethereum blockchain also enables for the construction of smart contracts, programmable tokens, and non-fungible tokens (NFTs), which are utilized in initial coin offerings (ICOs). Nodes in Ethereum's network safeguard all of this code, which is built on top of Ethereum's foundation.

Blockchain's Financial Services Benefits

Financial services can be made more transparent, less sensitive to fraud and more affordable for consumers thanks to blockchain technology.

The level of openness is rising. As transactions are recorded on a public ledger, blockchain has the potential to improve transparency in the financial sector. Transparency can uncover illegal practices such as fraud, allowing financial institutions to address issues and reduce risk in the process. Of course, the records in the Bitcoin blockchain (and most other blockchains) are encoded. Because of this, decryption and identification of the record's owner are impossible for anybody else (using a public-private key pair). Thus, blockchain users are able to remain anonymous while keeping full transparency of their actions.

Increasing security. Scammers thrive in the digital world because people are spending more time online. Blockchain technology may provide some comfort in this regard. When compared to blockchain-based transactions, traditional bank payments and money transfers are both slower and less traceable.

Data can be intercepted as it travels via multiple financial intermediaries, increasing the likelihood of fraud. This oversight hole can be filled by the cryptographic protocols of the blockchain, which ensure the security of data sent between members.

"Clear audit trails can be difficult to obtain in traditional banking at times," says Ben Samaroo, co-founder and CEO of WonderFi, a decentralized financial platform. "Due to negligent or malevolent actions, this has resulted in significant losses in the past. If blockchain technology is used to monitor hazards and manage them more effectively, this risk can be considerably reduced."

In fintech companies and other organizations that work with large amounts of data, blockchain is necessary for data integrity.

"The blockchain network has no single point of failure since everything is dispersed," says Marie Tatibouet, chief marketing officer at Gate Technology, a Chinese cryptocurrency exchange.

This feature, according to Tatibouet, boosts the network's resilience and protects it from attack.

Cost-cutting. Blockchain allows consumers to benefit from decreased costs connected with traditional financial services as investors migrate away from financial advisors to avoid higher fees. It is common practice for businesses that accept credit card payments to pay a small fee to the banks and companies who process the transactions.

Financial technology companies have become an important part of the financial services industry, allowing investors to open digital adviser accounts and make their own financial decisions. Fintech's link with blockchain will surely strengthen as fintech's importance in global finance grows.

Blockchain can be used by suppliers to track the origins of the materials they procure in the supply chains, like in the IBM Food Trust example. In addition to verifying the authenticity of their own products, companies would be able to verify the legitimacy of common labels like "Organic" and "Local," and "Fair Trade."

Investors will get more bang for their buck, which make them balance  financial service automation and costs. "To get a greater market share, the first companies to deploy this new technology will be able to streamline internal procedures and offer lower-cost financial services," Samaroo says.

Drawbacks of Blockchains

While blockchain can save customers money on transaction costs, it is not a free technology. For example, the bitcoin network's PoW algorithm, which is used to validate transactions, demands a lot of computing power. In the actual world, the electricity generated by the bitcoin network's millions of computers is comparable to what Norway and Ukraine consume annually. 

Illegal Activity. By using the Tor Browser and making illicit purchases in Bitcoin or other cryptocurrencies, users can buy and sell illegal things without being tracked on the black web.

Blockchain and Financial Institutions Face Risks

One key danger hurting the bottom line is the potential blockchain has for financial institutions: Transaction fees, which might be reduced or eliminated with blockchain technology, are how traditional financial institutions generate money.

To accomplish money transfers, consumers must rely on banks or other third parties.

However, blockchain adoption could eliminate fees and other costs connected with these services by bypassing third parties such as banks. As a result, banks may encounter volume and transaction-based income issues.

According to Thomas Shohfi, assistant professor in the Lally School of Management at Rensselaer Polytechnic Institute in Troy, New York, blockchain reduces the importance of proprietary financial infrastructure since it serves as a verification mechanism that is "not concentrated in the power of one institution."

Furthermore, blockchain innovation is moving at such a rapid pace that regulation has yet to catch up. As a result, possible policies affecting blockchain can be considered as a further impediment to blockchain adoption in financial services.

"Existing regulation presents a substantial barrier to blockchain adoption," Tatibouet argues, "since regulators will prioritize existing incumbents over challengers."

Regulators are weighing the benefits and drawbacks of blockchain technology to see if it is appropriate for financial institutions and what the implications are for businesses and consumers.

"So far, this rigidity has hampered innovation," adds Tatibouet. "However, this view is changing as governments and other public organizations see the benefits of contemporary technology."

What Is the Distinction Between a Private and a Public Blockchain?

A public blockchain, also known as an open or permissionless blockchain, is one in which anybody can join and construct a node without restriction. These blockchains must be safeguarded using encryption and a consensus technique like proof of work (PoW) due to their open nature.

A private blockchain, on the other hand, necessitates the approval of each node prior to joining. It is unnecessary to have as many levels of security in place because nodes are assumed to be trustworthy.

Blockchain Investments

There are a few options for investors who wish to get involved with blockchain as it transforms the financial services industry. One option is to invest in companies that use blockchain technology in their operations.

"Financial firms or technology firms that see blockchain as a disruptive technology and wish to be specialists in it can sell their services to clients," adds Shohfi.

International Business Machines Corp. (ticker: IBM), which is focusing on the development of blockchain technologies, is one such company. Businesses can also use IBM's services to incorporate blockchain for efficiency, scalability, and growth.

Another option for investors is to buy cryptocurrency-related stocks that are solely focused on blockchain investments. MicroStrategy Inc. (MSTR) is a good example of this. The software solutions firm has over 105,000 bitcoins in its portfolio, which is worth more than $5 billion.

Square Inc. (SQ) is another corporation with a significant Bitcoin investment and a strong belief in the blockchain network. The payment services firm recently announced the launch of a decentralized financial platform aimed at Bitcoin applications.

These stocks and their potential are attracting the attention of investors. MicroStrategy has increased by roughly 80% year to date, whereas Square has increased by 23% year to date. This compares to the S&P 500's year-to-date return of around 20%. Investing in these publicly traded companies allows you to broaden your blockchain exposure while avoiding the volatility and speculation that other cryptocurrencies bring.

Exchange-traded funds may be a preferable alternative for investors wishing to further hedge their risk against Bitcoin speculation and volatility. The Amplify Transformational Data Sharing ETF (BLOK) exposes investors to companies that are well-positioned to benefit from the advancement of blockchain technology. The fund has returned 150 percent since its launch in 2018, making it a viable investment option.