How does Blockchain really work?

Unless you have been living under a rock, you might probably have heard of the word Blockchain. It seems to be one of the buzzwords of the past years. But many people seem to know what blockchain is or how does it work. But… How does Blockchain really work?

To understand blockchain technology and its potential impacts, it helps to get your head around a few non blockchain concepts. Here’s the thing, blockchain has the potential to fundamentally transform the global economy as we know it by changing the way governance systems, individuals and businesses function and transact with each other.

Imagine you and your friend are transacting/transferring money from one account to another. You would first reach the bank and ask them to transfer the money to the account address of your friend.

On transferring the money from your account to your friend’s account, the banks keep an entry on register of transactions. The entry needs to be updated on both, receiver and sender, account. But there is one problem:

It is Tamper-able. Entries of transactions can be manipulated easily or change.

People who know how the banking system works are trying to avoid them because of this problem. This is where Blockchain comes in.

Let’s start from the beginning. The first major application of blockchain technology was bitcoin which was released in 2009. Bitcoin is a cryptocurrency and the blockchain is the technology that underpins it. A cryptocurrency refers to a digital coin that runs on a blockchain.

To keep track of the amount of bitcoin each of us owns, the blockchain uses a ledger, a digital file that tracks all bitcoin transactions. The ledger file is not stored in a central entity server, like a bank, or in a single data center. It is distributed across the world via a network of private computers that are both storing data and executing computations. Each of these computers represents a “node” of the blockchain network and has a copy of the ledger file.

The fact that the ledger is maintained by a group of connected computers rather than by a centralized entity like a bank has several implications:

• In our bank system we only know our own transactions and account balances; on the blockchain everyone can see everyone else’s transactions.
• While you can generally trust your bank, the bitcoin network is distributed and if something goes wrong there is no help desk to call or anyone to sue.
• The blockchain system is designed in such a way that no trust is needed; security and reliability are obtained via special mathematical functions and code.

Now, next:
How does Blockchain work?

1. A node starts a transaction by first creating and then digitally signing it with its private key (created via cryptography). A transaction can represent various actions in a blockchain. Most commonly this is a data structure that represents transfer of value between users on the blockchain network. Transaction data structure usually consists of some logic of transfer of value, relevant rules, source and destination addresses, and other validation information.
2. A transaction is propagated (flooded) by using a flooding protocol, called Gossip protocol, to peers that validate the transaction based on preset criteria. Usually, more than one node is required to verify the transaction.
3. Once the transaction is validated, it is included in a block, which is then propagated onto the network. At this point, the transaction is considered confirmed.
4. The newly-created block now becomes part of the ledger, and the next block links itself cryptographically back to this block. This link is a hash pointer. At this stage, the transaction gets its second confirmation and the block gets its first confirmation.
5. Transactions are then reconfirmed every time a new block is created. Usually, six confirmations in a network are required to consider the transaction final.

Overall, the blockchain technology has the potential to revolutionize several industries, from advertising to energy distribution. Its main power lies in its decentralized nature and ability to eliminate the need for trust.