Blockchain explained: how does it work
Fast and accurate information is essential for efficient business operations. Blockchain technology is an answer to instant, shared, and fully transparent data stored in an immutable ledger. In this article, we’ll look at what the Blockchain is, how it works and how this technology can benefit businesses.
What is Blockchain?
Blockchain is a shared and immutable ledger used to record transactions and track tangible or intangible assets across a network. Blockchain technology can be used to track and trade almost any asset, reducing risk and lowering costs for all stakeholders.
Key elements of a blockchain
- Distributed ledger technology
All network participants have access to the immutable record of transactions in the ledger. This ledger supports a shared view of all transactions to avoid duplication, typical for traditional business networks.
- Immutable records
Transactions added to a shared ledger cannot be reversed once confirmed. If a transaction record contains an error, a new transaction must be added to undo the error, creating two records.
- Smart contracts
Blockchain technology uses “smart contracts” executed automatically based on predetermined rules to speed up transactions. For example, smart contracts can be integrated into the company’s business and programmed to define and execute the terms of a corporate bond transfer.
At its core, a blockchain is simply a database for recording transactions — a database distributed across multiple computers on a network. Blockchains store data in fixed structures, with each block containing multiple parts. The main parts of a block are:
- Its header that contains metadata, including a unique block reference number, a link back to the previous block, and the time the block was created;
- Its content, a verified list of digital assets and instructions, particularly the transaction performed, its amount, and the parties’ addresses.
Since you can access the previous blocks, you can keep a complete history of all assets and instructions executed since the very first block. The more users join a system and verify transactions, the harder it becomes for bad actors to overwhelm the system. Therefore, as the network grows, it becomes more secure and robust.
A brief history of Blockchain
The early years of blockchain technology [1991–2008]
Blockchain grew out of the thoughts of two computer scientists, Stuart Haber and W. Scott Stornetta, who first introduced the idea in 1991. Initially, they worked on a cryptographically secured chain of blocks where no one could falsify documents’ timestamps.
In 1992, they improved their system by adding Merkle trees to increase efficiency and allow the collection of more documents in a single block. 2008 is a key year in the history of Blockchain, as it was the year that the technology’s potential first became apparent through the work of Satoshi Nakamoto. It is believed that Nakamoto could be a person or a group of people who worked on Bitcoin, the first application of blockchain technology. He has been referred to as the mastermind behind the Blockchain.
In 2008, Nakamoto conceived of the first Blockchain and developed the technology, which has become a globally distributed ledger for applications beyond cryptocurrencies. In 2009, Satoshi Nakamoto published the first whitepaper on the technology. The document explained how the technology could strengthen digital trust due to its decentralization.
Since Satoshi Nakamoto left the scene and handed over the development of Bitcoin to other core developers, the digital ledger technology has evolved and led to new applications that now construct the Blockchain.
The Emergence of Bitcoin [2008–2013]
Although the terms “Bitcoin” and “blockchain” are often used interchangeably, they are not synonymous: Blockchain is the underlying technology behind most applications, of which cryptocurrencies are an example.
In 2008, Bitcoin was introduced as the first application of blockchain technology. The mysterious Satoshi Nakamoto described it as a peer-to-peer electronic currency in a white paper. Satoshi Nakamoto created the first data block, called the Genesis block, from which other interconnected blocks were mined and added to a chain. As a result, one of the largest chains of blocks containing various information and transactions was created.
Development of Ethereum and Smart Contracts [2013–2015]
As a developer who contributed to the Bitcoin codebase early on, Vitalik Buterin was one of many programmers who fretted about Bitcoin’s limitations. Buterin began working on a blockchain platform that could perform multiple functions. Ethereum was launched in 2013 as a new public blockchain platform with additional features compared to Bitcoin.
Vitalik Buterin expanded the functionality of Ethereum by giving people the ability to record things and contracts. This makes Ethereum more than just a cryptocurrency, as it allows developers to build apps on the platform.
Ethereum, which was launched in 2015, has become one of the largest applications of blockchain technology. The platform has also managed to attract a large developer community, which has created a real ecosystem for the platform.
Applications on the Blockchain [2018 — present]
Blockchain technology has evolved in recent years thanks to new projects that attempt to solve some of the problems with Bitcoin and Ethereum. One interesting approach leverages the power of blockchain technology.
Since 2020, developers have created more and more decentralized applications (Dapps). However, speed and scalability are needed to achieve global adoption. Although Ethereum has dominated the Dapp market for the past two years, the huge gas costs and slow transaction speeds of the Ethereum network have shown that alternative solutions are needed.
For example, Solana has become the market-leading blockchain platform. Solana is the fastest Blockchain and the fastest-growing ecosystem for cryptocurrencies. It is the only Blockchain truly capable of filling the high-frequency trading and payment processing niche in the long term. Solana’s innovations, such as Layer 2 rollups, could make Blockchain faster and more efficient than it is now.
As the technology has evolved, some companies have begun to use Blockchain internally to improve their operational efficiency. Microsoft and other companies have led the way in exploring applications of blockchain technology, resulting in what are known as private, hybrid, and federated blockchains.
How Blockchain works
1. Each transaction is recorded as a “block” of data.
Transactions show the movement of an asset from one party to another, which can be a physical product or intellectual property. The block of data can record various information, including who, what, when, where, how much, and even the condition of a temperature-sensitive product.
2. A new block is linked to the next and the previous blocks.
Data blocks are added to a chain when an asset moves from one location to another or changes ownership. The blocks confirm the exact time and order of transactions and are securely linked to prevent a block from being changed or inserted between two existing blocks.
3. Transactions are grouped into blocks that form a linear chain; this chain is called the Blockchain.
This blockchain system eliminates the possibility of tampering by a malicious actor and creates a secure ledger of transactions. The addition of each new block strengthens the whole network. This makes the blockchain tamper-proof and, therefore, more trustworthy and provides the critical strength of immutability.
Let’s see an example
1. Suppose Bob owes Alice money for lunch. He installs a bitcoin wallet app on his smartphone to create a crypto wallet. A wallet is like a bank account, and an app is like a mobile banking app.
2. He needs to know his private key and her public key to pay her. Bob gets the public key from Alice by scanning a QR code from her phone or having her text him the payment address.
3. An app notifies bitcoin miners around the world of a pending transaction. The miners check that Bob has enough Bitcoin in his account to make the payment.
4. In a given time, many transactions take place on the network. Each transaction is combined into a block and then verified. A block contains a unique number, creation time, and a reference to the previous block. New blocks are added to the Blockchain so that miners can verify that the transactions they contain are genuine. The verification is done by performing complex cryptographic calculations.
5. When a miner has solved the complex cryptographic problem, it communicates this discovery to the rest of the network. Blocks are linked together to create a series known as the Blockchain. The winner of each block is rewarded with crypto, and a new block is added to the Blockchain.
6. Within minutes of initiating the transaction, Bob receives the first confirmation that the transfer has been made. Shortly after that, all transactions on the block are fulfilled, and Alice receives crypto.
Types of blockchain networks
Blockchain networks may be built in a variety of ways. It can be public, private, permissioned, or built by a consortium.
- Public Blockchain
A public blockchain is a type of distributed ledger that anyone can access and participate in. Disadvantages include high computing power required, low transaction privacy, and weak security. These are important considerations for the business use of Blockchain.
- Private Blockchain
Private blockchain networks operate in the same way as public blockchains. However, a private blockchain network is controlled by a centralized group and may be run internally by industry or organization. An organization is responsible for the network and decides who can participate, executes a consensus protocol, and manages the shared ledger. A private blockchain can be deployed behind an enterprise firewall.
- Permissioned or Hybrid Blockchain
Companies that want to set up a private blockchain usually choose to set up a permissioned network. In this way, not everyone can participate in the network, and certain transactions are impossible. All participants must receive an invitation or permission to participate.
- Consortium blockchain
Multiple organizations can share the responsibility of managing a blockchain. Consortium blockchains are ideal for organizations that need to keep the identities of their participants private but also want to have shared responsibility for the chain. These pre-selected organizations are the only ones allowed to submit transactions to the ledger or view the data.
What are the differences between public and private blockchains?
Blockchains are similar to other types of databases in that they can be public or private. The Bitcoin network is public because anyone with the appropriate Bitcoin software installed can read or write data from the ledger. On the other hand, private blockchains are networks in which participants are known ahead of time and can add new information to the ledger. Participants may be from the same organization or different organizations within an industry. Informal agreements or formal contracts
may govern their relationships.
Public blockchains need additional mechanisms to arbitrate disputes and protect the integrity of the data. This adds complexity because there is no central authority to pass judgment in a decentralized network. For example, in the Bitcoin blockchain, newly created transactions cannot be added to the Blockchain until a participant in the network solves a complex mathematical problem. This is known as “mining.” Mining validates transactions by spending
computing power on a mathematical puzzle to find a solution that verifies a transaction.
What elements are common to all blockchains?
- Blockchain technology makes it possible to execute transactions without centralized authorities or trusted middlemen. The Blockchain is a shared and continuously reconciled database of transactions. It does not need to be stored in a specific location. The unique blockchain data structure automatically updates every time new transactions are added. This means the system is highly secure.
- The Blockchain uses a peer-to-peer network to reach consensus: Peers in a peer-to-peer network use their computers to authenticate and verify the timestamps on new blocks. New blocks are not added to the blockchain ledger until computers using the relevant software agree that they are valid.
- When you use a blockchain, the people’s identities in the transaction can be tracked, but not their real identities. A blockchain is a database that records activity between anonymous users: each transaction is recorded in a digital ledger that, with some reverse engineering, can be traced back to the person or machine.
- Blockchains make it difficult to alter historical records: Although data can be read and added, information that already exists in a blockchain cannot be changed unless the rules embedded in the protocol allow such changes — for example, that more than 50 percent of the network must agree to a change.
- A blockchain is useful for tracking and verifying information — transactions are timestamped.
- A blockchain is programmable — a network of interacting computers that automatically exchange data. The instructions embedded in the blocks can be simple or complex and allow transactions or other actions only when certain conditions are met.
Benefits of Blockchain
Many companies waste time and effort on duplicate records and third-party validations. Systems of record are vulnerable to fraud and cyberattacks. Limited transparency slows down data verification. And with the advent of the IoT, transaction volumes have exploded. All of this slows business weighs on the bottom line — and means we need a better way. That’s where Blockchain comes in.
- Greater trust
By using Blockchain, a member of a members-only network can be confident that the information they receive is accurate and timely and that their confidential data is only shared with other network members to whom they have explicitly granted access.
- Greater security
All validated transactions are permanent in the Blockchain, as they are recorded on every computer in the decentralized network. Transactions that have been validated can’t be changed. All members of the network must vote on the accuracy of the data.
- Greater efficiency
Distributed ledger that can be accessed across a network of computers eliminates the need for companies to reconcile records. And by using smart contracts — or sets of rules stored on a blockchain — companies can streamline processes for payments and transactions.
Is Blockchain Secure?
Blockchain technology provides decentralized security and trust in several ways. First, new blocks are always stored in a linear, chronological way and appended to the “end” of the Blockchain. The contents of a new block on the Blockchain are extremely difficult to modify once they have been added, barring a consensus from the greater community. Hash codes and timestamps link blocks. A hash code is a series of numbers and letters generated by a mathematical function representing digital information. When this information is processed in any way, the hash code also changes.
Let us imagine that a hacker running a node on a blockchain network wants to alter the ledger and steal cryptocurrency from the entire network. Altering his unique copy of the single-cell would result in a cellular mutation that is incompatible with the copies of the others. If the other copies of the chain were matched with those on other computers, they would find the hacker’s version and reject it as illegitimate.
A hacker would have to simultaneously control and modify 51% of the Blockchain copies to maintain control of the system. Such an attack would require a great deal of money and resources. In addition, all blocks would have to be recreated, as their timestamps and hash codes would become invalid.
Given the size of some cryptocurrency networks and their rapid growth, scaling such networks to an even larger size will likely prove to be economically infeasible. It would be extremely expensive and might not even be successful. Even if a fork were to be launched, it is unlikely to succeed due to the combined computing power of the network members, who could potentially create a new version of the chain
independently. In this way, the network was designed to provide an economic incentive to participate rather than attack it.
Blockchain technology has a bright future as governments and companies invest in it to drive innovation and applications.
Gartner Trend Insights predicts that by 2022, at least one company built on Blockchain will be worth more than $10 billion. Due to the digital transformation of Blockchain, the research firm expects the total value of companies to grow to more than $176 billion by 2025 and exceed $3.1 trillion by 2030.
Blockchain technology exploded in popularity over the past decade, and entrepreneurs are using it to build various business applications. The technology will help automate most tasks performed by professionals in all sectors. It is already being used in banking and cloud computing and is also likely to find use in basic things like search engines on the Internet.
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