Many people have been hearing their friends, the news media, and especially younger generations talking about buzzwords like Bitcoin or cryptocurrency or blockchain. You might think those are some things from the latest science fiction movie, but the terminology doesn’t get much better from there, with names like DragonCoin, Gifto, and Bread. These and more are all included in what might be called the 'blockchain revolution'.
People hearing about Bitcoin and these other terms for the first time might be scratching their heads. Well, good news, there’s plenty of people out there asking the same questions.
This article should serve as a beginner’s guide to help you understand how blockchain technology really works, and how coins, like Bitcoin, are using it to their advantage.
What is it? Blockchain explained.
Like the name indicates, a blockchain is simply a chain of blocks, and each contains a set of information and data. This information recording technique was originally intended for timestamping digital documents to minimize the possibility of tampering or backdating. However, the technology protocol didn’t gain much traction until Satoshi Nakamoto created the digital currency Bitcoin using blockchain.
The blockchain is a ledger that is openly distributed and accessible to anyone. Once a bit of data has been recorded and added to the blockchain, it’s incredibly difficult to change it. That makes the blockchain immutable, like the timestamps, in order to keep them from being tampered or backdated.
So what the blockchain intends to do for a digital currency like Bitcoin, is provide an openly accessible, trustworthy history of transactional information of payments. That way whenever money (in this case Bitcoin) payments change hands to a new cryptocurrency wallet, the new account balances are securely added to the blockchain ledger. Anyone that wants to can obtain the ledger and participate in the network, removing the central point of control.
What is contained in the blocks?
Each block that is added to the chain has three fundamental pieces of information: the data, its own hash, and the hash of the previous block.
For example, the data can contain information about the sender, receiver and amount of coins transacted. The block’s hash is comparable to a fingerprint, making it a unique identifier for the block’s data contents. Once the block has been created and added to the chain, its hash has already been calculated, so changing any of the data inside the block would cause a different hash, making the change easily noticeable by the network.
Including the hash of the previous block is what effectively creates the chain of blocks we know as the blockchain. It’s also what provides the security aspect of blockchain technology. For example, changing the hash of block #5 in the chain will make all blocks afterward invalid, because they no longer have a valid hash from the previous block. Block #5 effectively breaks the link.
How are new blocks created?
In the case of Bitcoin, the blockchain uses a method called Proof-of-Work (PoW) to create new blocks. PoW is a technique that slows down the creation of new blocks over time as the chain gets longer. What happens is the difficulty of mathematical computations to solve for the new hash is increased to keep the network from basically printing money.
With Bitcoin, it takes about 10 minutes to calculate the required proof of work and add a new block to the chain. This also adds to the anti-tampering efforts, because in order to alter one block you will need to recalculate the proof of work for the rest of the blocks on the chain. The required time for that task makes it infeasible for the current processing power of computers.
How are blockchains distributed?
The typical example of a transactional ledger for currencies is a bank ledger. However, with a bank ledger, only the bank has the authority to record transactions and credit or debit the account of their user. Account holders have no way to write on the ledger, and it’s completely owned by the bank.
With blockchain, instead of using a central authority, like a bank, to manage the ledger of information, blockchain relies on a peer-to-peer network where everyone is allowed to join. When someone joins the network, they download a full copy of the blockchain with the public ledger, which is used to verify that all data is still accurate.
What happens when someone creates a new block?
When someone on the network submits a new transaction, it’s bundled with a number of other transactions waiting on the network to be confirmed. All of the network nodes jump to work on verifying the transactions, and if they succeed, the network might choose them to sign and add the block to the chain. The Bitcoin network rewards these nodes that create a block with 50 Bitcoin, thus creating the so-called mining system on blockchain networks.
When a new block is created, it is then sent to everyone on the network. Each user, or node, verifies the block to make sure it hasn’t been tampered with. If everything adds up, each node adds the block to their own blockchain. This creates a consensus among the nodes when they agree about the validity of new blocks.
So what does this mean for financial transactions?
The reason people are so excited about the potential for Bitcoin and blockchain applications is that it could drastically change the way transactions happen online. Using blockchain technology can mean that someone in New York can send money to their friend in Africa in a very short amount of time at minimal cost.
This system created by blockchain threatens the traditional financial system currently in place. In order to send money across a national border, banks or other payment processors need to be involved, verifying the transaction and its legitimacy, checking the money for regulatory purposes, and recording the transaction on their internal ledgers.
With blockchain, there is no need for the central points of authority. The decentralized nature of the blockchain network is arguably much better for the overall security and trustworthiness of the system. In the classic scenario, the entity processing the transaction can act as a single point of failure. In a blockchain network, removing one node from the system doesn’t have much impact at all. There is no single point of failure.
How are blockchains evolving?
On top of securely recording and storing sets of data, blockchains are constantly evolving to record virtually anything of value. Smart contracts are one of the recent developments in blockchain technology. Smart contracts are simple programs that are stored on the blockchain and can be used to automatically exchange digital assets based on specified conditions. For example, parameters can be set on smart contracts to execute on a time lapse, like an escrow service.
With all the hype around Bitcoin and cryptocurrencies, it’s important for people, especially those looking to invest in the blockchain, to actually understand blockchain technology and how it works. The protocol designed by Satoshi Nakamoto for Bitcoin was elegant and revolutionary. Since then, various other blockchain projects have spurred up, some leveraging the software from Bitcoin and others creating their own.
There is incredible potential for blockchain technology and blockchain data to disrupt a multitude of industries. Blockchain use cases are seemingly infinite. There are many examples of how the secure and trustworthy ledger can bring advantages:
- Tamper-proof digital identity
- Anonymous, secure voting system
- Distributed data storage services
- Transactional currency
- Faster processing times
- Reliable gambling services
- Supply chain integration
Blockchain technology is exciting, and the possibilities for blockchain adoption are endless.