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  • What is a Blockchain?

    5 August 2022

    Alexander Wilson

    A blockchain may also be referred to as a ‘distributed ledger’. In short, a blockchain is a record or ledger of transactions retained by a network of computers. Each computer has a complete record of all of the transactions (some more recent technologies split the records between different ‘shards’ but the principle remains the same).

    So, as an example, every node on the Bitcoin network has a complete record of every transaction that has ever taken place on that network. All of them. Every single one.

    The importance of the data being shared in this way, is that it is very difficult to fool the system. If you wanted to deceive the system into thinking that you were a Bitcoin billionaire, you would have to persuade at least 51% of the nodes that this was true, which would mean creating a false transactional history on a very large number of ‘nodes’.

    The networks or blockchains are further secured by consensus mechanisms to make it even harder to successfully operate a “51% attack”.

    What is a Blockchain video

    What is a Consensus Mechanism?

    The consensus mechanisms used by blockchains exist to ensure that individuals may only add transactional records to the blockchain with the consensus of others in the network.

    To add transactions to the blockchain on the Bitcoin network (and other networks using the same model), a ridiculously complex cryptographic puzzle must be solved (‘Proof-of-Work’), so (in theory), the electricity required to rewrite Bitcoin’s history would cost more than it would be worth to do. (This is the process of mining, for which node operators are rewarded amounts of BTC.

    Effectively, node operators ‘compete’ to earn the right to add the next ‘block’ of transactions to the network. Other nodes are able to verify that this has been done successfully and so consensus is achieved and the data are added to the blockchain.

    The miners expend energy (electricity) in the hope of receiving BTC in return.

    Other networks are turning toward less costly means of securing against attack. The Ethereum network, for example, will shortly transition to ‘Proof-of-Stake’. This means that to have the right to be the person allowed to record transactions on the blockchain, you would have to hold (and keep on holding) a certain amount of ETH. Again, buying enough ETH to take over the system should be more expensive than the potential benefit.

    Like ‘mining’, this process provides rewards, though ‘staking’ in this way looks a lot more like interest yield on a bank deposit (i.e., ETH 2.0 is rewarded for ‘staking’ ETH 2.0).

    Whether you are just getting started or have been investing in cryptocurrency for several years, our team of tax specialists can provide bespoke advice to support you to achieve your objectives in a tax-efficient manner.  Please contact us.

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