Tue. Oct 4th, 2022
how does the blockchain work?

A blockchain is a growing list of records, called blocks, cryptographically linked together. Each block contains a cryptographic hash of the previous block, a timestamp and the transaction data (usually represented as a Merkle tree). The timestamp proves that the transaction data existed at the time the block was published and is included in its hash.

As each block contains information from the previous block, a chain is formed in which the next block reinforces the previous block. Blockchains are resistant to data changes because, once written, the data in a particular block cannot be changed a posteriori without changing all subsequent blocks.

Blockchains typically operate in peer-to-peer networks and are used as a publicly distributed ledger in which nodes collectively communicate and verify new blocks according to a protocol. Although blockchain records are not immutable due to the possibility of forking, blockchains are internally secure and can be considered as an example of a distributed computing system with a high degree of Byzantine fault tolerance.

Based on the work of Stuart Haber, W. Scott Stornetta and Dave Baier, blockchain was popularised in 2008 by a person (or group of people) named Satoshi Nakamoto as a public ledger for transactions in the Bitcoin cryptocurrency. The identity of Satoshi Nakamoto remains unknown to this day. The introduction of the blockchain in Bitcoin made it the first digital currency to solve the problem of multiple consumption without the need for a trusted institution or a central server.

Bitcoin’s design influenced other applications and the blockchain, a publicly available and readable cryptocurrency. Blockchains are considered payment gateways. Private blockchains have also been proposed for commercial use, but Computerworld calls the sale of such privatised blockchains without a proper security model “snake oil”. However, others argue that, if designed carefully, licensed blockchains can be more decentralised than unlicensed blockchains and therefore more secure.

What is a blockchain?

A blockchain is a system of recording information that makes it difficult or impossible to alter, hack or manipulate. A blockchain is essentially a digital ledger of transactions that are replicated and distributed across a network of blockchain computer systems.

A blockchain is a decentralised database shared by nodes in a computer network. As a database, a blockchain stores information electronically and digitally. The blockchain is best known for its key role in cryptocurrency systems such as Bitcoin, which provides a secure, decentralised record of transactions. The innovation of blockchain lies in ensuring the fidelity and security of data records and creating trust without the need for a trusted third party.

One of the main differences between traditional databases and blockchain is the way data is structured. A blockchain gathers information into aggregates called blocks. A block has a fixed capacity and, when it is full, it is closed and connected to previously filled blocks to form a data chain called a blockchain. Any new information following this newly added block is collected in a newly created block, which is also added to the chain as it is added.

While databases typically structure data in the form of tables, blockchains, as the name suggests, structure data in the form of blockchains (chunks). This data structure, when implemented in a decentralised manner, essentially creates an irreversible timeline of data. When a block is inserted, it becomes part of this timeline. Each block on the chain is assigned a timestamp that is accurate at the time it is added to the chain.

Key points

  • A blockchain is a shared database that differs from a traditional database in that it stores data in blocks and uses cryptography to connect the blocks together.
  • When new data arrives, it is inserted into a new block. When a block is filled with data, it is chained to the previous block, placing the data in chronological order.
  • Blockchains can store many different types of information, but are most often used as a ledger for transactions.
  • In the case of Bitcoin, the blockchain is used in a decentralised way, which means that no specific individual or group of individuals has control over it, but that all users have collective control over it.
  • Decentralised blockchains are immutable and any data entered cannot be reversed. In the case of Bitcoin, this means that transactions are permanently recorded and can be seen by anyone.

How does a blockchain work?

The purpose of a blockchain is to allow digital information to be recorded and distributed, but it cannot be altered. Blockchain is therefore the basis for an immutable ledger: a record of transactions that cannot be altered, deleted or destroyed. For this reason, blockchain is also known as distributed ledger technology (DLT).

The blockchain concept was first introduced as a research project in 1991 and first became widely commercialised in 2009 in the form of Bitcoin. Since then, the use of blockchain has expanded with the creation of various cryptocurrencies, decentralised financial applications (DeFi), non-transferable tokens (NFT) and smart contracts.

Decentralisation of blockchain

Imagine a company with a server farm of 10,000 computers that maintains a database with all its customer account information. That company owns a warehouse building with all those computers under one roof, and has complete control over each of them and all the information they contain. However, it is a single point of failure. What happens if there is a power outage in this place? What happens if the network connection is interrupted? What if it fries? What if the bad guys destroy everything with a single keystroke? In any of these cases, data can be lost or corrupted.

With blockchain, the data stored in this database can be distributed across multiple network nodes in different locations. This not only creates redundancy, but also ensures the fidelity of the stored data. If someone tries to change a record in one instance of the database, the other nodes will not be modified, which prevents an intruder from doing so.

If a user forges a record of a Bitcoin transaction, all other nodes are compared with each other, making it easier to identify the node with the incorrect information. This system helps to create an accurate and transparent sequence of events. In this way, no node in the network can modify the information stored in the network.

As a result, information and history (e.g. cryptocurrencies) becomes irreversible. Such a record could be a list of transactions (e.g. of cryptocurrencies), but it is also possible for a blockchain to store all kinds of information, such as legal contracts, government identifiers, company inventories, etc.

To validate a new record or entry on the blockchain, a large amount of computing power in the decentralised network needs to agree. To avoid malicious transaction verification and double-spending, the blockchain is protected by consensus mechanisms such as Proof of Work (PoW) and Proof of Stake (PoS). These mechanisms allow agreements to be reached without the need for a responsible node.
Transparency

Because the Bitcoin blockchain is decentralised, all transactions are transparent to individual nodes and the blockchain driver, allowing anyone to see what is happening in real time. Each node has its own copy of the chain, which is updated as new blocks are confirmed or added. This means you can follow the movement of Bitcoin wherever you are.

For example, in the past exchanges have been hacked and people who had stored their bitcoins on the exchange lost everything. The hackers may have been completely anonymous, but the bitcoins they obtained were easily traceable. If the bitcoins stolen in these hacks are transferred or spent anywhere, they will be visible.

Of course, the records stored on the Bitcoin blockchain are encrypted (as are most blockchains). This means that only the owner of a record can decrypt it to reveal his or her identity (using a public/private key pair). This allows blockchain users to remain anonymous while maintaining transparency.

Is blockchain secure?

Blockchain technology provides decentralised security and trust in several ways. Firstly, new blocks are always stored linearly and chronologically. This means that they are always added to the “end” of the blockchain. Once a block has been added to the end of the blockchain, it is very difficult to retroactively change the content of that block, unless there is a consensus of the majority of the network.

This is because each block contains, in addition to its own hash, the hash of the previous block and the aforementioned timestamp. A hash code is created by a mathematical function that converts numerical information into a sequence of numbers or letters. If this information is altered in any way, the hash code will also be altered.

Suppose a hacker, who also runs a node in the blockchain network, wants to steal someone else’s cryptocurrency by changing the blockchain. If he modifies his single copy, it will no longer match those of the others. When the others compare their copies, they will see that this copy stands out, and the hacked version of the chain will be discarded as illegal.

For such a hack to succeed, the hacker would have to control and change more than 51% of the copies of the blockchain at the same time, so that his new copy would be the majority copy, resulting in a cohesive chain. Such an attack would require an enormous amount of money and resources, as each block would have to be recreated anew, with different timestamps and hash codes.

Given the size of many cryptocurrency networks and their rate of growth, the cost of achieving such a feat could be enormous. Not only would the cost be enormous, but it could also be wasteful. This behaviour should not go unnoticed by network members as they see this radical change in the blockchain. Network members then join the new, unaffected version of the blockchain.

As a result, the value of the compromised tokens is drastically reduced, rendering the attack useless, as the attacker gains control of useless assets. The same can happen if an attacker attacks a new Bitcoin fork. It was created to provide an economic incentive and not to attack a participating network.

Bitcoin and the Blockchain

Blockchain technology was invented in 1991 by Stuart Haber and W. Scott Stornetta, two researchers who wanted to create a system in which the timestamps on files could not be manipulated. However, the first real use of blockchain came almost 20 years later, with the launch of Bitcoin in January 2009.

Bitcoin’s protocol is based on the blockchain. In a study describing this digital currency, Satoshi Nakamoto, the creator of Bitcoin, describes it as “a new electronic money system that is completely peer-to-peer and has no trusted third party “2.

It is important to understand here that, although Bitcoin uses the blockchain only as a means to record a transparent ledger, in theory the blockchain can always record any number of data. As mentioned above, this could be transactions, votes in elections, inventories of goods, government IDs, housing documents, and so on.

Tens of thousands of projects are currently trying to implement blockchain in various ways to benefit society, not only to record transactions, but also as a means to securely vote in democratic elections, for example. The immutability of blockchain means that fraudulent voting can be more sophisticated. For example, a voting system could work by issuing a single cryptocurrency or token to every citizen in the country.

Each candidate would be assigned a specific wallet address, and voters would send their tokens or cryptocurrencies to the address of the candidate they wish to vote for. The transparency and traceability of blockchain eliminates the need for manual vote counting and the possibility of malicious manipulation of physical votes.

Blockchain and banking

It has been said that blockchain has the power to disrupt the financial industry, in particular payments and banking functions. However, banking and decentralised blockchain are two very different things.

To understand the difference between banking and the blockchain, let’s compare the banking system with the implementation of the Bitcoin blockchain.

How does a blockchain work?

It is already known that the blocks of the Bitcoin blockchain store data on Bitcoin transactions. Currently, there are more than 10,000 cryptocurrency systems running on the blockchain. However, it has become clear that blockchains are also a reliable way to store data about other types of transactions.

Companies that have adopted blockchain include Walmart, Pfizer, AIG, Siemens and Unilever. IBM, for example, has created a blockchain called Food Trust to track the journey of food to its location.

Why do we want to do this? The food industry has experienced countless outbreaks of E. coli, Salmonella and Listeria, as well as toxic substances accidentally introduced into the food supply. Until now, it has taken weeks to find the origin and cause of an outbreak in people’s diets. By using blockchain, brands can trace food from its origin to each stop and delivery.

If a contaminated food product is found, the source can be traced at every stop. Not only that, but now these companies can see everything they might come into contact with, allowing them to detect problems more quickly and save lives. This is just one example of the practical application of blockchain, but there are many other ways in which it is being used.

Banking and finance

Perhaps no sector would benefit more from the introduction of blockchain into its operations than the banking sector. Financial institutions are typically open five days a week. This means that if you deposit a cheque at 18:00 on a Friday, you will have to wait until Monday morning for the money to arrive in your account. Even if you deposit during business hours, it can take one to three days for your transaction to be confirmed due to the sheer volume of transactions banks process. The blockchain, on the other hand, never sleeps.

By integrating blockchain with banks, consumers can have their transactions processed in as little as 10 minutes, which is essentially the time it takes to add a block to the blockchain, regardless of holidays, time of day or week. Blockchain also allows banks to exchange funds between institutions more quickly and securely.

Equity trades, for example, can take up to three days (or longer for international trades) to settle and clear, during which time the funds and shares are frozen.

Given the amount of money involved, even a few days’ transfer represents a significant cost and risk for the bank. Similarly, Capgemini, a French consultancy, estimates that blockchain-based applications could save consumers up to $16 billion a year in banking and insurance costs.4

Coins

The blockchain is the basis of cryptocurrencies such as Bitcoin. The US dollar is controlled by the Federal Reserve. Under this central control, user data and currency are technically subject to the wishes of banks and governments. If a user’s bank is hacked, the user’s personal data is at risk. If your bank fails, or if you live in a country with an unstable government, the value of your currency could be at risk. In 2008, several failed banks were bailed out, partly with taxpayers’ money. It was this fear that led to the invention and development of Bitcoin in the first place.

The blockchain allows Bitcoin and other cryptocurrencies to be traded without the involvement of a central authority, decentralising their operation through a computer network. This not only reduces risk, but also eliminates many processing and transaction fees. It also makes the currency more stable for residents of countries with unstable currencies and financial infrastructures, as it increases the number of applications and broadens the network of people and institutions with whom it can be traded both domestically and internationally.

Using a cryptocurrency wallet to open a savings account or as a means of payment is especially important for those without a national identity. Some countries may be ravaged by war or lack the national infrastructure to enable identification. Citizens of these countries may not have access to savings or brokerage accounts and therefore may not be able to keep their assets safe.

Health

Healthcare organisations can use blockchain to securely store patients’ medical records. Once the medical record is created and signed, it is written to the blockchain, providing the patient with proof and assurance that the record has not been tampered with. By encrypting these personal health records with a private key and storing them on the blockchain, only certain people will be able to access them, ensuring privacy.

Asset register

If you have spent any time at your local land registry, you will know that the process of registering deeds can be cumbersome and inefficient. Nowadays, deeds in kind must be sent by an official to the local registry office, where they are manually recorded in a central database and in the county archives. In the case of property disputes, it is necessary to check the property claim against an official index.

This process is not only costly and time-consuming, but also prone to human error, as inaccurate information reduces the effectiveness of property tracking. With blockchain, there is no need to scan documents or track physical documents at the local registry office.

When property rights are stored and verified on the blockchain, owners can be sure that their documents are accurate and recorded forever.

In conflict-torn countries, or in areas with little public or financial infrastructure, let alone a civil law registry, it is almost impossible to prove ownership of assets. If groups of people living in such areas have access to a blockchain, they can create a transparent and clear chronology of ownership.

Smart contracts

A smart contract is a piece of computer code that can be incorporated into a blockchain to facilitate, verify or trade contracts. Smart contracts operate on the basis of a set of conditions agreed by the user. Once these conditions are met, the terms of the contract automatically come into effect.

For example, suppose a prospective tenant wants to rent a flat using a smart contract. The landlord agrees to give the tenant the door code of the flat after the tenant has paid the deposit. When both the tenant and the landlord send their part of the contract to the smart contract, the smart contract stores the door code and automatically exchanges it for the deposit on the day the tenant initiates the contract.

If the landlord does not provide the door code at the end of the lease date, the smart contract will return the deposit. This avoids the costs and formalities normally associated with the use of notaries, third parties and lawyers.

Chain of custody

As in the IBM Food Trust example, suppliers can use the blockchain to record the origin of purchased materials. This allows companies to verify not only the authenticity of products, but also common labels such as “organic”, “local” or “fair trade”.

As Forbes magazine reports, the food industry is increasingly using the blockchain to track and secure food from farm to fork.

Voting rights

As mentioned above, blockchain can be used to simplify modern voting systems; as tested in West Virginia in mid-November 2018, blockchain-based voting has the potential to eliminate voter fraud and increase voter turnout.

Using blockchain in this way makes electoral fraud virtually impossible. Blockchain protocols also maintain the transparency of the electoral process, reduce the number of staff needed to conduct an election and provide the authorities with the results almost immediately. This eliminates the need for recounts and the fear of fraud affecting the election.

Advantages and disadvantages of blockchain

The blockchain, due to its complexity, has unlimited potential as a decentralised recording medium. The applications of blockchain technology can range from improving privacy and security for users to reducing processing costs and errors, and go beyond the above. However, there are also disadvantages.

Types of blockchain

There are four types of blockchain

  1. Public blockchains
    A public blockchain is an open, decentralised computer network that anyone can access to request and verify (check the accuracy of) transactions. The person who verifies the transaction (the miner) receives a commission.

Public blockchains use a consensus-building mechanism called proof-of-work or proof-of-stake (see below). Common examples of public blockchains are the Bitcoin and Ether blockchains.

  1. Private blockchains
    A private blockchain is not public and has limited access. Anyone wishing to access it must obtain permission from the system administrator. They are usually managed by a single organisation, which means they are centralised. Hyperledger, for example, is a licensed private blockchain.
  2. Hybrid blockchain or consortium
    A consortium is a combination of a public blockchain and a private blockchain containing both centralised and decentralised elements. Examples include the Energy Network Foundation, Dragonchain and R3.

Note: There is not 100% agreement on whether they are different terms. Some distinguish between the two, while others consider them to be the same.

  1. Side chains
    A side chain is a blockchain that runs in parallel to the main chain. It allows users to move their digital assets between two different blockchains, increasing scalability and efficiency. An example of a sidechain is the Liquid network.

History of Blockchain

Blockchain is not just a database, but a new “digital trust” technology that will revolutionise the way value and information is exchanged on the Internet by removing the “gatekeeper” from the process. For more information, see our article “The history of Blockchain technology”.

The history of blockchain is much older than you might imagine, but we’ve shortened it by answering four basic questions

Who invented blockchain?

The first person to propose a blockchain-like protocol was cryptographer David Chaum in 1982. Later, in 1991, Stuart Haber and W. Scott Stornetta wrote about their work on federated systems.

However, it was Satoshi Nakamoto (probably a pseudonym for an individual or group) who invented and implemented the first blockchain network after launching the world’s first digital currency, Bitcoin.

Who owns blockchain technology?

Blockchain technology cannot be owned because it is the technology behind the blockchain. It is like the internet. However, anyone can use this technology to create and own their own blockchain.

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