Financial Planning and Investment Advisor, Mercer Street has given me permission to republish this excellent introduction post to what is blockchain and its relationship to NFTs. I hope you find it useful. Tim
It’s impossible to exist on the internet and not hear about blockchain. You may not understand what a blockchain is or how they work, but you probably recognize that they are somehow connected to the worlds of cryptocurrency and NFTs.
What Is a Blockchain and How Does It Work?
Blockchains are kind of like that library card that you’d find in the back of a book in elementary school. You could see who had it last, how long they kept it, and you’d put your name in it when you checked it out.
To get a better understanding of blockchain, you’ll need a few vocabulary words.
Block: a data set containing information that is hashed (see definition of hash below) and linked to the previous block. The very first block is called the “genesis block.”
Data: the kind of information each block contains depends on the type of blockchain. Typically, a block record contains the number of coins or tokens created and spent, the wallet addresses of the sender and recipient, and a timestamp of when the block was created.
Hash: the hash is a unique digital identifier of the block, much like a fingerprint. If the information in the block were altered, the output from the hash function would change. This is why blockchains are immutable: once a record is created, it is virtually unalterable. Each block contains the hash of the one before it; this is what links the chain together.
P2P Network: this stands for peer-to-peer network. It’s the group of participants in a network who transact on the blockchain.
Nodes: are participants in a network that have a full or partial history of the blockchain (think of them as the ledger or record keepers). The more nodes there are in a network, the more likely it is that the blockchain is distributed and secure. Oftentimes, nodes validate and confirm the authenticity of new blocks via a process called mining.
Proof of work: is a type of consensus algorithm (https://www.investopedia.com/terms/p/proof-work.asp) used in mining that disincentivizes block tampering by rewarding network participants who update and maintain the ledger with cryptocurrency
Smart contract: an agreement that is based on computer code. If a specific event occurs or condition is met per the agreement, then the contract is executed and the resulting transaction is recorded on the blockchain.
Putting Everything Together
Now that you have the basic blockchain vocabulary, let’s walk through a chain with all its parts.
The first block is called the genesis block. It has its own hash and houses the data specific to that cryptocurrency type.
Once a new block is created/mined, it’s given its own hash. But before the new block is added to the chain, all the nodes on the P2P network have to approve it to confirm whether it’s legitimate. Once it’s confirmed, the new block is recorded on the blockchain, thus becoming the next block in the chain which is now cryptographically linked to the original genesis block.
Each block goes through the process above, though not all blockchains use the same consensus algorithm (e.g., the Bitcoin network uses proof of work, but some cryptocurrencies use proof of stake). These networks need an internet connection and energy to work.
Understanding Blockchain: What’s an NFT
While most blocks have some sort of digital representation in the way they’re described above, they’re not bought for their design. NFTs (Non-fungible Tokens), on the other hand, are blocks that are designed as artwork or collectibles. They function in the same block pattern for trading and are very popular.
You can buy and sell NFTs using smart contracts. Most people treat them as investments, as you would a priceless piece of art.
Getting Started in Blockchain Investing
One of the best things about blockchain is how secure it is. Blocks are tough to tamper with since there is proof of work time limits, and there is a decentralized network of participants following the rules (i.e., computer code), which keeps everything in check.
If you’re looking to invest in the crypto market but still need some help understanding blockchain for beginners, don’t worry! Our firm has a blockchain investment expert ready to work with you.
Neither Tim Thomas nor Timothy Thomas Limited is affiliated with Mercer Street.
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Tim Thomas holds no positions in the stocks, ETFs, mutual funds, forex, cryptocurrencies, or commodities mentioned.
Featured credit image: Pexels.