In this article: “What is Blockchain technology and how does it work?” we will cover some major questions and ideas to give you a clear understanding of blockchain and how does it work.
What Is Blockchain?
Blockchain technology is a relatively new concept, first developed by Satoshi Nakamoto in 2008. Originally designed as a method of reliably verifying transactions for Satoshi’s cryptocurrency – Bitcoin. Since then, however, it has evolved and is now being used worldwide. But how does it work and why has it become so central to technological development so quickly? Let’s start by taking a look at the basics.
How does Blockchain work?
Blockchain technology is also known as Distributed Ledger Technology (DLT). Essentially, it is an online record of transactions that have taken place. DTL also act as a record of any data. Now, in the case of regular record keeping, your record is stored in one place – a piece of paper, or perhaps a spreadsheet. If you make a backup, it is a record of that paper or spreadsheet at that particular moment in time. However, if you change the original, the backup is then out of date until you replace it with a new one.
Blockchain, however, does not work like that. With blockchain, your record is duplicated many times over, with the duplicate record stored on vast numbers of computers, known as nodes. When you want to add to a record, every single iteration of that record is updated across all nodes. This is extremely effective, as it means that there is no danger that a single, centralized record can be hacked, resulting in the corruption, unauthorized manipulation or loss of data. Connected nodes use algorithms to verify transactions or new data records, and these are then added to a list of other verified data as a block – part of the larger blockchain.
What is the Blockchain concept?
The original blockchain concept was based on a consensus mechanism called Proof of Work. The principle of proof of work is that for a transaction to be verified and placed on the blockchain, complicated mathematical problems must first be solved, which require a lot of computing power and use algorithms.
In cryptocurrency, this is known as mining. People who use their computers to perform these calculations – the miners – receive rewards in the form of new currency. This is the mechanism that keeps a blockchain running and the one that makes it so reliable. As a proof of work is difficult to produce but easy to verify, it makes it worthless and almost impossible to fake or manipulate. And because these computations are automatic, this creates an environment that doesn’t rely on one party trusting another – a trustless environment.
Proof of work and proof of stake
Since the first blockchain was created based on proof of work, several new consensuses have been created. Ethereum, for example, runs on a consensus called proof of stake. In this case, the creator of a new block is chosen based on its own wealth – its stake.
The result is the same; ongoing, trustless maintenance of the ledger. However, miners are rewarded in transaction fees rather than new currency and the huge amount of computational power and energy required to process transactions is greatly reduced, as no proof of work is required. It is the energy consumption issue that caused Vitalik Buterin to create Ethereum based on proof of stake. Currently, Bitcoin transactions alone consume as much energy as entire countries and this is unsustainable as well as unethical.
What is a Blockchain wallet?
In cryptocurrency, a blockchain wallet, or digital wallet, is a place where you store your public and private keys. The codes that prove that your currency is yours. The simplest way to describe a wallet is a place where you store your money. However, this is in fact not true; the wallet simply consists of these two codes.
A wallet for your cryptocurrency
You can get a wallet for your Bitcoin, Ethereum or other cryptocurrencies. Wallets are set as a form of an app, a downloadable bit of software, a USB stick or even store your information on a piece of paper. Your public key is like your sort code and account number – this is how people know where to send cryptocurrency.
It isn’t tied to your identity; it’s just a string of numbers and letters. Your private key is only known to you; this is what you must use if you want to use the cryptocurrency you have received. You only need to enter it as a way to verify that you are the owner of funds, to start the transaction process that ends up with a block being produced.
Main benefits of Blockchain
Decentralized is the main benefit of the blockchain. This means that there is no third party that is responsible for record keeping and transactions. The problem with centralization is that the authority figure could manipulate or lose data – or collapse entirely. This was the case with many banks during the global financial crisis of 2007/8. With blockchain, records are public and unchangeable, meaning that security is much better.
Another major advantage of blockchain is that the process of verification is far quicker than in the traditional banking system. SWIFT transactions, for example, can take a couple of days across international borders. Country border, national holidays or a physical administration can not restrict the blockchain. Therefore, the transaction verification process is easy and has no wait time.
Who is the owner of the Blockchain?
The key thing to remember is that nobody owns blockchain. A company can create its own blockchain, but as soon as they do, and nodes join as verifiers, it becomes decentralized. There is no central, controlling entity and all records are public. Indeed, while Satoshi Nakamoto created the first blockchain as we know it, the concept existed prior to the birth of Bitcoin. Therefore, no one really owns the blockchain.