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How Does Blockchain Work?

Given the rise of cryptocurrencies in recent times you have most probably heard about blockchain before. And if you have followed the banking, investing, and other financial sectors over the past few years, you must also have heard about it. Most people only associate blockchain technology with Bitcoin technology, when in reality it can do more. 

Here is everything you need to know about blockchain technology

What is blockchain? 

A blockchain is a type of database with a set of information stored electronically. Also known as a distributed ledger technology, blockchain makes it impossible to alter or hack the system. It ensures the history of any digital assets remains intact and secure through decentralisation and cryptographic hashing.

The simplest way to understand blockchain is using an analogy of Google docs. One party creates a document which they share with the others instead of copying or transferring. This creates a decentralised system where anyone has the ability to modify or edit the document. However, all the changes are recorded for transparency. 

While blockchain is a little complicated it works the same way as Google docs. It operates as a digital ledger of transactions shared across all the computers in a blockchain. Every block contains a given number of transactions, and for every transaction, the information is updated on the participant’s ledger. 

The decentralised data with various active participants is called a Distributed Ledger Technology (DLT). Blockchain is an example of DLT with its transactions recorded using a cryptographic signature called a hash. A change in any single block in the blockchain would be visible for all the participants. As such, anyone looking to tamper with a blockchain must change all the blocks. This takes time and also does not go unnoticed by the participants. 

Even though blockchain seems like new technology, it is a combination of various proven technologies. It involves private key cryptography, a peer-to-peer network, and a computing program. All these combine to create digital transactions that don’t need a trusted third party for control or approval. 

 

How does blockchain work?

Blockchain has become a popular technology in the world today. Various businesses are introducing its use in their various operations. But how does blockchain work to make it useful for various applications? Also, is it a significant change that will revolutionise businesses or only a simple addition?

As already mentioned, blockchain is an integration of three technologies; cryptographic keys, a peer-to-peer network, and a means of computing. To understand how blockchain works you need to know the role of each technology on the system.

  • Cryptographic keys 

The cryptographic keys have two keys; public and private. It is these keys that work when creating successful transactions between two parties. Every party has both private and public keys they use in creating a secure digital identity reference. This identity works like a digital signature that is useful in authorising and controlling transactions. 

The digital signature also provides ownership rights. However, there is more to secure digital transactions than ownership. 

  • Distributed network 

While ownership through the cryptographic keys allows you to launch or accept transactions, there is a need for authorisation of the transaction. That is where the distributed network comes in.

The distributed network is a large group of individuals who authorise digital signatures to reach a consensus on the transactions and other blockchain concerns. The authorisation involves mathematical verification to connect the various parties involved in the transaction. 

The distributed network ensures the security of the network. It also provides the platform for the cryptographic keys to perform various digital interactions. 

  • Protocol 

The major concern for most people is how to attract the users in the distributed network to authorise the transactions involving the cryptographic keys. 

For the public blockchain, the incentive to join the network is through mining. It means that one uses their computer to participate in validating transactions then get rewarded in return. For example, in Bitcoin mining, various computers work on the network to avoid double-spending and other invalid transactions.

How does Bitcoin blockchain work that makes it an ideal use case? The Bitcoin network keeps a record of all transactions on a public ledger. The participating computers solve various mathematical puzzles to approve transactions. All the participating computers must approve the solution before it can be published on the ledger and become part of the block. Every new block has a timestamp and contains various digital data and messages. 

With various blockchains available, every blockchain can use a different verification process. For example, the Bitcoin blockchain works differently from that of the other cryptocurrencies like Ethereum. 

For information on how does blockchain verification work for different entities: Every blockchain can create its own validity metrics, verification process, rules, and incentives for successful verification. It is for this reason that various businesses can implement blockchain technology irrespective of the industry and services offered.  

 

Principles of the blockchain technology 

As a type of distributed database, blockchain works through various principles. These include;

 

  • Decentralisation 

Blockchain technology has no single controlling authority. Instead, various computers are involved in managing the networks. The Bitcoin blockchain is the best example of how decentralisation in blockchain works. 

For Bitcoin, several computers in different geographical locations are involved in mining to approve transactions and secure the network. It then keeps all the data in a ledger that is accessible to all the computers in the network. It is the various computers working together that explain how does blockchain mining works. 

In case a computer has an error, it can rely on the data from the other computers. As such, no single computer can alter information stored in the database. Any change in information must be verified by all the other computers. 

While Bitcoin stores transactions details, the information varies depending on use. Some blockchains store legal contracts, product inventory, state identifications, and many more. 

  • Transparency 

The decentralised nature of blockchain means unlimited access to information on the database either using a node or the blockchain explorers. The platform updates all information as transactions occur in real-time. This allows you to track any transaction if you wish to.

Without a single control authority you might wonder, how does blockchain security work? Once a transaction is recorded on the blockchain it is irreversible. The timestamp on the blocks is matched such that they have to fit for any changes to be recorded. In the same way, you cannot fake a block. Before a block is included on the blockchain, all the participating nodes must approve it. 

Even though the various nodes work independently, they have to compare results with other nodes for approval. As such it takes longer to reach a consensus. This delay has seen blockchain networks become quite slow. Already there are various advancements to improve blockchain speeds. An example of such development is cryptocurrencies developing segwit that reduces the information stored to allow space for more transactions in a single block. 

 

How is Blockchain technology used?

Blockchain has become a popular technology for various businesses. It is particularly beneficial for smart contracts. This involves defining rules and penalties for various agreements like in any other contract. However, for smart contracts, the obligations apply automatically.

Some of the possible applications of blockchain technology are in;

  • Decentralised finance 

One of the most successful uses of blockchain technology so far has been decentralised finances (DeFi). This is where participants use a decentralised platform to access traditional financial services. They can borrow loans, lend money, and access other credit facilities on decentralised platforms. 

  • Supply chains 

 Supply chain management can use blockchain technology to track the various inventories. It can be used to track materials, ingredients, and other products to prove their source and other related information. 

  • Insurance claims 

Smart contracts allow the insurance company to establish a set of criteria to analyse the various claims. It also helps the insured submit claims for an automatic payout as long as they meet the set criteria. 

  • Internet of Things (IoT)

Blockchain technology is proving to be a useful technology in the IoT. The IoT can rely on its security as a guard against hackers. It can also be employed against data tampering and misleading information emanating from rogue devices. 

 

Blockchain technology limitations and vulnerabilities 

While blockchain technology is functional for most businesses, it also has various issues and limitations that compromise how it works. One of such issues is the complexity. As a new technology, it comes with various new vocabularies and aspects that might take some time to master.

The success of blockchain technology depends on the number of users. The system is not immune to “bad actors” which might compromise any network. For the best security, the network has to be robust and with widely distributed nodes. 

The slow transaction speeds are another concern for blockchain technology. For example, compared to VISA that facilitates thousands of transactions per second, Bitcoin can only manage a handful. The speeds get even lower when demand rises leading to higher transaction costs. 

Lastly, there is always the politics of blockchain technology. While it is currently decentralised, there is the possibility that a single organisation might capture the technology. Any large-scale control would mess up decentralisation. 

FAQs 

 

What is distributed ledger technology? 

Distributed ledger technology is a supporting factor of blockchain technology. Blockchain technology does not rely on a single computer for transactions authorisation, instead, it relies on distributed ledger technology to incorporate various nodes to maintain digital records. The distributed ledger works together with cryptographic keys and the protocol. 

 

What is a private blockchain? 

While blockchains were made as open-source and for public efforts, corporations are realising their importance. These institutions are developing private blockchains to use for the various operations that involve handling sensitive data. Most of the private blockchains are used in the financial sector but are likely to grow as blockchain technology expands. 

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