Blockchain technology is one of the most innovative and disruptive concepts in recent times. However, it is sometimes difficult to understand.
What is a blockchain? What differentiates it from cryptocurrencies? How does the blockchain work? What are its advantages? How does a node in the network work? Don’t worry because we have put together this complete guide to what blockchain technology is and how it works.
What is Blockchain?
First of all, it’s important to define exactly what a blockchain is. Blockchain is a new technology that records information in a database shared among a network of users, a network known as peer-to-peer. This information is usually linked to financial transactions such as the buying and selling of various financial assets.
In a way, a blockchain works like a ledger. However, what sets it apart from other databases and storage systems is that data is not stored in a single space. Instead, it is copied and distributed through the network of computer systems that are part of it.
As the system is decentralized, there is no single administrator or manager that has control over the entire blockchain. All its participants can have access to the accounting ledger and make the corresponding updates. They cannot make alterations, let alone delete data that has already been entered without leaving any trace. This system, referred to as distributed ledger technology, makes the blockchain completely resistant to interference and manipulation.
How Blockchain Technology Works
The idea of blockchain technology looks simple, but how is it executed?
As the name suggests, blockchains are made up of so-called “blocks”, which form the basis of a blockchain network. These blocks are data structures that record information related to financial transactions between nodes (participants) as they are generated. Each record can contain information about a seller and buyer, the time and conditions of the transaction, among other data.
Once a block is complete, the data is encrypted. As a block goes through a process known as “hashing,” it transforms the data recorded in the blocks into a unique string of characteristics called a “hash.” This function makes it virtually impossible to reconstruct the encrypted data from the hash, which means that it is impossible to change transaction records without being detected.
A fully formed block is connected to the previous block, creating a long chain of transaction data—hence the name “blockchain.” Each block correspondingly possesses the hash of the previous block, which ensures that the sequence of blocks is not mixed and does not break.
What is a Consensus Mechanism?
A consensus mechanism allows users or machines to coordinate in a distributed environment. It guarantees that all participants accept a single source of truth, even if some agents do not achieve their goal. It ensures that all nodes in the network have the exact copy of the ledger, which contains a record of all transactions. Consensus mechanisms are indispensable for the blockchain because there is no single authority to verify transactions and maintain the full integrity of the network.
With tens of thousands of nodes storing a copy of the blockchain data, some difficulties can quickly arise, such as data consistency and rogue nodes. To guarantee the integrity of the blockchain, several consensus mechanisms regulate how the nodes in the network reach an agreement. Let’s take a look at the main ones below.
Types of Consensus Mechanisms
What is Proof of Work (PoW)?
Proof of Work (PoW) is a consensus mechanism employed in many blockchain networks to confirm transactions and preserve the integrity of the blockchain. It is the consensus mechanism used by Bitcoin.
In this type of mechanism, miners compete to solve a mathematical problem to add the next block to the network. In the process, which is called mining, the first miner to solve the problem wins a reward in cryptocurrencies.
The miners must use high-powered computers to solve mathematical problems to mine new coins and protect the network. It is for this reason that the mining process requires significant amounts of computing power and, consequently, electrical power.
What is Proof of Stake?
Proof of Stake (PoS) is a consensus method developed to solve some of the problems of Proof of Work (PoW). In a PoS method, instead of miners competing to solve mathematical problems to validate transactions and add new blocks, validators are chosen based on the number of cryptocurrencies they have staked in the network.
To participate in the consensus process, validators have a specific amount of cryptocurrencies as collateral or stake. They are then randomly chosen to create new blocks and validate transactions by their stake size. Validators receive rewards from transaction fees for creating new blocks and as motivation to act to improve the network.
Benefits of the Blockchain
Decentralization
The decentralized nature of blockchain means there is no single point of control or failure, making it more secure and proof against attacks or data breaches.
Transparency
Transactions on a blockchain are transparent to all participants, allowing for easier tracking and verification and ensuring accuracy.
Immutability
Once a transaction is registered on a blockchain, it cannot be modified or deleted. This creates a permanent historical record of all transactions. Anyone with access to the blockchain network can verify this record. This is a considerable difference from traditional systems, where transactions are reversible.
Efficiency
The blockchain facilitates agile and efficient transactions because it does not need intermediaries like banks.
Lower fees
By cutting out intermediaries and automating procedures, blockchain can decrease transaction costs and improve the operational efficiency of certain business operations.
Quality without trust
Blockchain technology allows transparent transactions to be verified and validated by the network participants themselves without the need for imposed intermediaries.
What Are The Different Classes Of Blockchain Networks?
Public Blockchain
A public blockchain is a decentralized network that is available to anyone who wants to participate in it. These networks are usually open source, transparent, and permissionless, i.e. anyone can access and use them. Bitcoin and Ethereum are two models of public blockchains.
Private Blockchain
As the name suggests, a private blockchain is a blockchain network that is not open to the public. Private blockchains are generally controlled by a single entity, for example, a company, and are employed for internal objectives and use cases.
Private blockchains operate in environments with permissions and rules that regulate who can see and write to the blockchain. They are not considered decentralized systems because they establish a clear hierarchy of control. However, they can be distributed thanks to the fact that many nodes maintain a copy of the chain on their machines.
Consortium blockchain
A consortium blockchain is a mix of public and private blockchain types. In a consortium blockchain, numerous organizations join together to form a shared network that is jointly managed and governed. These networks can be opened or closed, depending on the requirements of the consortium members.
Rather than being an open system in which everyone can validate blocks or a closed system in which only one entity designates block producers, a consortium chain involves a group of parties acting as validators, and all have equal weight.
The rules of the system are variable: the transparency of the chain can be limited to validators, be accessible to authorized persons, or be visible to all. If the validators reach a consensus, changes can be implemented smoothly. In terms of how Blockchain functions, if a certain threshold of these parties behaves honestly, the system will not have any problems.
What is Blockchain Used For?
While blockchain technology is still in its early stages, there are already use cases in many diverse industries. Some of the most popular existing applications of blockchain technology are:
Cryptocurrencies
Blockchain technology was designed to support the creation of cryptocurrencies, which use the blockchain as a secure, decentralized ledger to record transactions.
Digital identity
Blockchain can be used to generate secure, foolproof digital identities, which in turn serve to verify personal information and other sensitive data. This may become increasingly important as personal information and assets move online.
Voting
Blockchain technology can create a protected and transparent voting system capable of eliminating election fraud and ensuring the integrity of the voting process by providing a decentralized, tamper-proof record of all votes cast.
Store chain management
Blockchain technology can record all transactions within the supply chain. Each transaction can be registered as a block on the blockchain. In this way, an immutable and transparent record of the entire supply chain process is generated.
Smart contracts
Smart contracts are self-executing agreements that can be structured to perform automatically when certain conditions are met. Blockchain technology makes it possible to develop and implement smart contracts securely and decentralized. Smart contracts have one of their most promising uses in decentralized applications (dApps) and organizations (DAOs).
Conclusion
Blockchain technology delivers a secure and transparent way of recording transactions and storing data. It has the capacity to revolutionize industries by bringing a unique level of trust and security to the world at a digital level.
Whether enabling peer-to-peer transactions, generating new forms of digital assets or enabling decentralized applications, blockchain technology opens up a world of opportunities. Over the next few years, as this technology continues to develop and spread, more novel and transformative use cases will presumably emerge.
