This Gate Learn educational article provides readers with a thorough understanding of the basic principles of blockchain technology that are extremely relevant to know in the current crypto landscape - what blockchain is, its utility, the meaning behind layers and rollups, blockchain comparisons and how different crypto ecosystems are being built.
In short, blockchain is a system that allows you to track the sending and receiving of some types of information over the internet in a decentralized, peerless manner. They are pieces of code generated online that carry connected information like blocks of data that form a chain – hence the name. Unlike other data tracking and transactional systems, blockchains have the potential of being completely decentralized. Meaning, they do not rely on organized central entities to verify the information but do so through their own programmable framework.
It is this system that allows the operation and transaction of cryptocurrencies. While cryptocurrencies always use decentralized blockchain technology, those under the umbrella of “digital assets” don’t necessarily do so. One example of that is Ripple (XRP), popularly called a cryptocurrency although it does not possess a decentralized blockchain framework - therefore, it is theoretically a digital asset and not crypto.
The concept of blockchain emerged in 2008 in the academic article “Bitcoin: a peer-to-peer electronic financial system,” authored by Satoshi Nakamoto (pseudonym of the alleged creator or creators of bitcoin). In this material, blockchain is defined as a network that timestamps transactions, placing them in a continuous chain, forming a record that cannot be changed without redoing all the work.
To understand the fundamentals of how blockchain works, think of a toy train whose tracks are spread all over the world. Not one, but several that form a global network. Each material transported goes inside a wagon, which is validated by computers around the world. If verified as authentic, the material is sealed with a complex code of letters and numbers and joins other cars.
To further increase security, each car carries its own code and the code of the previous car. So, if someone tries to break into a car, more than one code will have to be cracked. This train network has no owner, so all shipments are recorded in a book available for anyone to access. Although it is possible to see what was sent and when, it is not possible to know the names of the people behind those car carriers; their identities are represented in the form of cryptographic addresses - the so-called “digital wallets.”
Although the technology came about so that bitcoin could exist, the possibilities for use go far beyond cryptocurrencies.
Today, there are countless applications for blockchain in the world; they range from decentralized financial systems to identity verification, ticket sales, media entertainment and even legal registry verification in notary offices. While there are virtually no limits to where blockchain tech can be applied, the gist of its utility is simple: it provides a data verification and transaction method that can run on itself without the need of an overseeing authority.
From a capital perspective, these perks make a major difference for companies, who are seeing the decentralized features of blockchain technology as an opportunity to reduce security costs. From a practical standpoint, blockchain-based networks, due to lack of central oversight, can also make a company or organization’s system safer and generally easier to coordinate.
Blockchain networks have become so popular that they are even being used by entire nations. One example is the country of Estonia, which is using blockchain for a national framework of digital identity verification in an effort to reduce fraudulent activity, plus minimize security breaches and high costs of inefficient identity management systems.
While the fundamentals of blockchain can be explained as above, there are different levels to such networks when it comes to cryptocurrencies. While different cryptos may use different blockchains, it’s far more common for them to be placed under the same one - just under different internal structures. There are also the projects which exist solely to make the network more efficient.
In the crypto ecosystem, these are called Layer 1 blockchains, Layer 2 blockchains and Rollups. Learn more about each concept below.
Layer 1 blockchains are native blockchains that are inherent to a particular protocol and can provide updates to scale and change its baseline framework. It’s the base network of the project, instead of a crypto that utilizes the blockchain that was developed by a different organization, for instance. Since they are native and base-level blockchains, they are autonomous and do not rely on any other network. Layer-1 cryptos create, verify and transfer information on their own, while also creating updates that will become inherent to the system once deployed.
The two main examples of Layer 1 blockchains are Bitcoin and Ethereum. While Bitcoin has yet to branch out to other utilities beyond a store of value, Ethereum was solely responsible for the creation of countless Layer-2 verticals that would not exist without the Ethereum network. DeFi, NFTs, Metaverse-related projects and more are usually based on Ethereum and don’t exist by themselves. Avalanche is another example of a Layer 1 crypto project that gained popularity very recently, due to its novel frameworks that are entirely inherent to that ecosystem.
Speaking of Layer 2 verticals, Layer 2 cryptos are basically projects that are built on top of another blockchain - therefore, they cannot exist on their own. These projects offer solutions to scalability issues present in Layer 1 cryptocurrencies, while also creating their own crypto assets and advantages for users to utilize their Layer 2 network instead of going directly to the source - Layer 1’s.
Here are some examples: Bitcoin suffers from scalability issues when it comes to the speed of its transactions getting progressively slower as more people use the network. Therefore, Layer 2 project Bitcoin Lightning Network surfaced as a secondary framework solution to make the BTC blockchain faster and with room for more transactions.
Ethereum has many, many examples of Layer 2 projects. Polygon and Loopring are some of the most popular, allowing developers to easily build fast and promptly scalable decentralized apps (dApps) without much hassle - while also acting as bridges for faster and much cheaper transactions compared to ETH’s usual gas fees.
Rollups, which are dedicated exclusively to the Ethereum network, are scalable solutions responsible for “rolling” several packs of transactions together into a single one - thus making them much cheaper. Optimistic rollups are the most popular method, which presumes that all transactions present in the “roll” are true without verifying for themselves - since this was done by the Ethereum network previously. Zero knowledge rollups, or zk-rollups, actually verify the transactions by themselves.
Bitcoin and Ether cryptos, also entitled BTC and ETH, are by far the most popular cryptocurrencies in the world. They are also, consequently, the most popular blockchains utilized every day by millions of investors. But on top of their differences are some clear contrasts between the two that highlight how flexible blockchain frameworks can be, not isolated into a single label or structure of use.
For instance: on a surface level you may have noticed that, while Ethereum gave birth to DeFi and NFTs through the novel technology of smart contracts, Bitcoin doesn’t provide these services. As Ethereum exists in multiple chains and services, from dApps to Metaverses, Bitcoin seems kinda isolated in a league of its own as a transactional currency and deflationary store of value. But why is that the case?
The reality, as it turns out, is that Bitcoin actually is a smart contract platform - just not a very reliable one. Bitcoin has had the capability to deploy smart contracts from the very start of its network, while Ethereum is also able to perform simple transfer transactions beyond smart contracts. What makes Ethereum more appealing to those services comes down to two things; speed and accessibility.
Bitcoin’s network is able to conduct only 7 to 8 transactions per second, while the Ethereum network conducts roughly 30 transactions per second - still not fast compared to other newer Layer 1 projects, but it makes a large difference when it comes to smart contracts. The second reason comes with the programmability of such contracts, as Bitcoin uses its native “Bitcoin Script” language that is not user-friendly and very hard to manage. The Ethereum blockchain, on the other hand, was built on top of co-founder Vitalik Buterin’s original programming system called Solidity, which is extremely user-friendly for those with software development experience.
While blockchain is an innovative, disruptive technology changing the way we view private property, investments and financial inclusion, it does come with some flaws that have yet to be fixed over the past decade and a half of its existence. The main one is popularly known as the “impossible triangle”; basically, to have two major features is to compromise a third, regardless of what that is. These three pillars that cannot coexist are decentralization, security and scalability.
Here are the three main examples available in the market. Bitcoin is fully decentralized and the most secure blockchain ever made, but it suffers from major scalability issues as the network is extremely slow compared to newer ones and it has not been able to update itself to compete with other blockchains that now provide services and smart contracts that are easily deployable. Then there’s Ethereum, which does suffer from scalability issues but those are always improving and consistently leading to solid results - decentralization, on the other hand, is non-existent for major updates as they are all decided by the Ethereum Foundation and its leaders (such as Vitalik Buterin). Solana, both extremely fast and scalable, suffers from major security issues and has had its blockchain shut down several times over the past few years.
There might come a day when we are able to overcome the impossible triangle but, as for now, there’s always the need to compromise. Regardless of the issues faced by these systems, the only right path is forward. New blockchains and updates on current ones like Bitcoin and Ethereum are constantly being proposed and implemented, while crypto development accessibility only grows stronger as the topic of blockchain knowledge is no longer underground, but actual classes in thousands of universities throughout the globe. It’s no longer a matter of if, but when this dilemma will be solved.
Bitcoin gave birth to the entire concepts of blockchain and cryptocurrencies, leading the wave to a new era in financial assets. Seven years later came Ethereum, popularizing smart contracts on a level that resulted in entirely new branches of crypto being used, whose limits are still unknown.
Now, building on top of these two major leaders of the current global financial system, new ecosystems and digital cultures are being built and fed day-by-day within crypto communities. The market structure of cryptocurrencies is no longer unidimensional, relying on simple concepts such as “store of value” and “decentralization” for the common retail investor. They are entertainment, media, jobs, digital lives, property and much, much more - it’s a new world, filled with possibilities.
As new blockchains like Solana, Avalanche, Cardano, Polkadot and more are built, it’s clear to notice how respective investors interact and behave in different ways compared to Bitcoin and Ethereum, for example. Different crypto ecosystems are giving birth to digital spheres of influence that focus on the prospects and goals that better fit their interests and intentions.
The next decade of cryptocurrency development will be key in defining how large of an impact cryptocurrencies will have on the actual daily lives of not only your average investors, but your average computer and cellphone user. If the past 14 years, since Bitcoin’s conception is any indication, such an impact will be exponentially larger than what we currently have or can even begin to imagine.