What is blockchain and how does it work?
Cryptocurrency has major security issues.
Unlike fiat currency—the kind of money most people use every day—cryptocurrency isn’t regulated by a government, and it’s not insured by a banking system, so investors don’t have the same protections against things like theft and Ponzi schemes.
Blockchain technology helps solve this problem. While blockchain doesn’t keep cryptocurrency investors completely secure from losses and scams (opens in new tab), it does track and verify information about crypto transactions, including who has rightful ownership of a token.
What exactly is blockchain?
Blockchain is a virtual ledger that stores information about cryptocurrency (opens in new tab) transactions.
To break it down further, the “block” in blockchain refers to a unit of information that’s been added to the ledger. A single block can contain all kinds of information, but it typically includes the following details about cryptocurrency or NFT transactions:
- The sender and receiver
- The date and time of the transaction
- The amount and type of asset
Each block in the blockchain also has a unique identifier, called a “hash,” which is a long series of characters that acts like a digital pin or a fingerprint.
When a new block is created, it contains the previous block’s hash, therefore forming an end-to-end “chain” of traceable transactions.
Is blockchain the same as bitcoin?
Blockchain was invented to be used with Bitcoin, but they aren’t the same thing.
Bitcoin (opens in new tab) is a type of cryptocurrency, and it was the first crypto invented and is still the most widely circulated virtual coin.
Although blockchain was created to track Bitcoin transactions, the technology is now used by most cryptocurrencies, including Ethereum, Cardano and Litecoin, and it’s even used by some businesses to track non-digital transactions.
How secure is blockchain?
Blockchain provides security for cryptocurrency transactions, but it doesn’t always protect investors from loss. From flash loans to crypto payment scams and malware that steals account login credentials (opens in new tab), threats abound.
According to a report (opens in new tab) from blockchain data platform Chainalysis, $7.8 billion worth of cryptocurrency was stolen from individuals in 2021. Crypto security—or the lack thereof—has also made some big headlines in 2022:
- In May, celebrity NFT promoter Seth Green had more than $300,000 (opens in new tab) worth of NFTs stolen from his crypto wallet in a phishing scam.
- Investors lost tens of billions (opens in new tab) of dollars in a run on scheme stablecoins, luna and terraUSD, in May.
- Between April and July, three major flash loan schemes took place, the third of which cost Nirvana Finance $3.5 million (opens in new tab).
- In August, the creators of Forsage were charged with taking over $300 million (opens in new tab) from investors in a fraudulent crypto Ponzi scheme involving blockchain contracts.
How blockchain helps
What blockchain does effectively is create a record that’s highly accurate and nearly impossible to alter. Because of the transparency and credibility of blockchain records, U.S. law enforcement has repeatedly been able to use the ledgers to track criminals, and even return stolen digital assets to their rightful owners.
Each blockchain uses a slightly different process, but these are some of the ways blockchain ensures security:
Verifying information
Creating new blocks requires a significant amount of work.
The work is typically done by “miners,” or people who use specialized hardware (and a massive amount of computing power) to verify information based on a predetermined set of rules.
Before a new block can be added to the chain, it has to be validated by a majority of other users, or “nodes,” in the network. In January 2021, an estimated 83,000 nodes were in the Bitcoin network.
Protecting information
Once a new block is added to the chain, it’s extremely difficult to alter.
To effectively tamper with any single block in the chain, a bad actor would have to alter the hashes for multiple blocks. Then, most people in the blockchain network would have to accept the changes as valid. If the changes are not accepted, all successive blocks become invalid.
How can you keep your cryptocurrency secure?
Arguably, the biggest threat to crypto security is user error.
Many losses are not the result of blockchain hacks, but rather consumers practicing bad cybersecurity habits and failing to recognize scams.
Investors should follow these best practices to avoid losing money:
- Beware of “rug pulls.” Just because a cryptocurrency is listed on an exchange doesn’t mean it’s legitimate. Be wary of counterfeit, name-alike coins and only purchase cryptocurrencies that have undergone code audits.
- Protect your key. Private keys prove ownership of crypto. You can store your keys online, but keeping them offline in a “cold wallet,” such as a USB drive, written down or locked in a safe is more secure.
- Get insured. Check if a crypto exchange protects against criminal losses before making a purchase.
- Click wisely. Never click on a social media ad, or use a link from a post or private message to buy cryptocurrency.
Other good cybersecurity practices (opens in new tab) are important too. Like any other consumer, crypto investors should always use strong and unique account passwords, automatically install new updates on their devices, and limit their activities while using public WiFi.
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