Blockchain is to cryptocurrency what the internet is to email, a system on top of which applications and programs can be built. It is a distributed digital ledger containing a chain of blocks that stores data of any kind such as records of information about cryptocurrency transactions. As new data is added to the network, a new ‘block’ is created and attached to the ‘chain’.
To better understand blockchain technology, it is important to know what problem it was designed to solve. Take a step back to learn more about what blockchain is, its processes and its applications in this article.
What is blockchain
Blockchain is a decentralised ledger maintained by all users across a network that solves the problems of centralisation such as vulnerable security and having a single point of failure. It was first used to power cryptocurrencies but is now used across industries to improve security and transparency.
To create, verify and update records, the blockchain needs four elements namely, cryptography, consensus mechanism and a punishment and reward system. Find out more about each of them in detail below:
For a blockchain to work, there must be a network of computers also known as nodes that are equal in privilege and are open to anyone and everyone. These nodes spread across different locations communicate, share information with each other and store all data uploaded on the blockchain remotely.
This is the communication system that secures the transfer of data in a hostile environment. It allows the receiver to verify and prove the authenticity of the sender’s messages even when others try to change them.
This is why cryptography is required because anyone can participate in the network including those who cannot be trusted and this ensures that only verified data comes through all the time.
Before a new block can be added to the ledger, a majority of nodes must validate and confirm the data. Once they reach a consensus, the block is verified and added to the chain. This system of validation and verification is called ‘consensus mechanism’ and it guarantees that all nodes on a blockchain are synchronised and their transactions are legitimate. For a cryptocurrency, they might involve ensuring that new transactions in a block were not fraudulent, or that coins had not been spent more than once.
This final element is based on game theory to make sure that it’s in people’s best interest to follow the rules. To glue all the elements together, a reward is given to people who follow the rules, help maintain the records and add the blocks of data. A token or coin is given every time a consensus is reached and a new block is added to the chain.
Why blockchain is needed
Most companies store data today in centralised servers. This creates a single point of failure and once the main server is down, all operations will cease. Blockchain prevents this by being a system that can reach decisions without a central authority. Aside from being used in various applications to secure data and verify the legitimacy of transactions, it eliminates the need for third-party control and helps secure anonymous transactions.
The concept of decentralised money
Before cryptocurrencies, money was solely issued and controlled by the government and the only way to use it digitally was through middlemen. Bitcoin changed all that by providing a decentralised form of currency that individuals could trade directly without the need for third parties.
Each Bitcoin transaction is validated and confirmed by the entire Bitcoin network. This is possible because of the blockchain where there is no single point of failure which makes the system virtually impossible to shut down, manipulate or control.
The blockchain process
The blockchain process is similar to maintaining a ledger with many pages of records. Each page begins with a summary of the page before it. If changes are made in the previous pages, the summary on the current page also needs to be changed.
Every instance of a transaction creates a page or block and is chained together as part of the blockchain process. For a more detailed explanation, continue reading below:
A transaction is made
When one party signs a transaction they use their private keys using wallet software. The transaction data is broadcast to the network and to the recipient’s wallet which will ask validating nodes to verify the transaction.
Data is recorded to a block
Nodes then ‘update the ledger’ and record data which includes the sending and receiving addresses, the amount sent and an encrypted hash of the individual’s digital signature.
The finished block is sent to the network
Because it is decentralised, the finalised block gets distributed throughout the network for validation from other nodes of the network that must come to a consensus on the state of the ledger. Once all nodes have reached consensus on the data’s validity, mining nodes compete to verify and include it in a new block.
All nodes verify the block
Mining nodes run software that does cycles of computer work toward solving complex math problems required to verify the current block. When one node solves the block, it is awarded the fees and the predetermined new coins. The transaction data is then included in a block which will then be uploaded to the chain.
Block is added to the chain
The completed block receives a unique timestamp and identifying code called a ‘hash’. The block also records the hash of the previous block which connects the two together and forms the chain.
Transaction is complete
The updates on the blockchain are shared with nodes of the network. The integrity of the ledger is then confirmed by the matching hashes. On the sender’s and receiver’s ends, they will see an updated balance in their wallets.
The future is bright with blockchain
The bulk of hard work done on blockchain technology is already in place. All one needs to do is use it to develop a software solution on top of it. If used properly, blockchains will always be open to everyone, there will be no borders, no censors and third parties to transactions and the network will remain neutral and stable.