Throughout history, humanity has invented new ways to exchange values and protect buyers and sellers. After coins, paper money, and banking systems, today’s most obvious solution for exchanging value is electronic payments (also known as e-payments).
Credit card systems, the internet, and mobile technologies were all important innovations that improved the convenience, speed, and efficiency of transactions. However, in the modern business environment, these transaction mechanisms have their shortcomings, including limited transaction sizes, the need for third-party validation, increasing transaction costs, and a weak trust-based model. Besides fraud and cyberattacks are unavoidable which also increases costs for payment operations.
Satoshi Nakamoto describes a method for using cryptocurrency with a distributed peer-to-peer timestamp server to create a computational proof of the chronological order of transactions.
We'll define all these terms, explain how they support blockchain technology, and then we'll discuss what is involved in building a blockchain network.
What’s a Blockchain?
A blockchain is like a group of people, all standing in a circle taking turns to name different words.
Each time someone says the last word that has been said to them, they would then pass it on to the next person in the circle until everyone had taken their turn. The participants would be performing transactions by naming words to each other within this blockchain (formed by computers that are part of the network), and these computers perform computations to verify any new transactions coming into the group.
These virtual computers are called nodes, each able to interact with one another across a computer network where all of them own an identical copy of the blockchain.
How Exactly Does the Blockchain Work?
Technically, a blockchain is a chain of non-trusted blocks, one that references the previous block and contains data. Additionally, a block has its hash and the hash of the previous block tied to it.
A block is a set of data that is encrypted or verified by computers on the network. Data inside a block can be anything - an amount of money, a share in a company, a digital certificate of ownership, a vote during an election, or any other value.
A blockchain contains information about the parties whose interaction resulted in the data now stored within it. For example, an eCommerce transaction will involve the names of both the seller and buyer.
Each block also has a hash. If we were to compare the block’s hash to a fingerprint, we'd say that it's unique and helps identify the specific block and its contents.
Once a block is created, a hash has been made. By changing something in the block, one can create a hash of that altered block. Therefore, the hash also reflects changes to the entry in this specific block.
In addition, every block contains the hash of its preceding block. For instance, if there are three blocks in a blockchain, block 3 will contain the data from the previous 2 blocks and so forth.
If anyone were to modify any one of the data in a single blockchain then that single block itself would become invalid.
A cleartext hash is what's needed to ensure that transactions are valid. However, simply knowing the hash alone doesn't provide enough security for a distributed ledger. To ensure that historical records are correct and to protect against tampering, blockchain technology uses several processes including proof-of-work.
Blockchain uses proof of work called hash to make transactions secure. Hash is used because it's easier to verify the data but difficult to modify. It takes several participants to agree on any modification. Each participant then must create a block that contains a new transaction. The block that has a hash matching the pattern will be accepted by the rest of the participants.
This process is very much like a dice game. Imagine that you need to roll a specific number, let's say a 9 for example, and it might take some attempts but sooner or later you'll get it.
Now imagine this with many people trying to do the same thing at the same time, whoever rolls the correct number first will win.
This is the same principle behind blockchain technology, where math problems are solved by computers.
The difference with blockchain is that the mathematical problem at hand is a lot more complicated than rolling dice and the reward for solving such a problem works on a token-distribution system.
This means that the computer that was first to solve a given problem steps in to have a chance at getting its hands on certain tokens which makes it all the more interesting as it encourages active participation among different computers globally.
Since blockchains are made up of so many complex nodes, each of them completes proof-of-work at the same time. This means that several blocks can get validated by many nodes at once which gives rise to the contentious hard fork where the blockchain forks off into two separate chains.
The longer a block builds up, the higher the possibility that it becomes a part of one of the valid chains. Blocks from other forks get rejected by blockchain nodes, causing transactions contained within those blocks to be sent for verification again.
So far, the longest chain of blocks is no more than five in a row.
Beyond the vital need for hashing and proof-of-work, a blockchain wallet also serves as a safe box for your transactions. A wallet generates paired public and private keys that further fortify transactions with peer-to-peer encryption.
A public key can be compared to a mailbox. Anyone can drop something in the mailbox but they won't be able to get it back out of there without putting in the code on the private key that they also have access to.
This is similar to how the private and public keys of a blockchain work. Anyone can send a transaction using a private key to the address of a receiver. This is similar to putting a letter in a postbox. But only the owner of that opportunity who also holds the public key can access the value of that transaction.
Anyone is allowed to attend a blockchain networking event. When someone joins a network, this person will have their full copy of the blockchain in their possession. Distributed storage of data along with effective hashing and proof-of-work mechanisms helps to prevent nearly any fraud from occurring.
For someone to add a block containing invalid data, duplicate an existing block, or perform a fraudulent transaction they would have to hack the computer of every blockchain participant at the same time and slip in the invalid block into all network participants' chains simultaneously, which is practically impossible.
Even if this were possible, none of the nodes would verify such a block. In essence, it would be ignored, as if it never existed in the first place.
The blockchain is something that has frequently been associated with cryptocurrencies, the most popular being Bitcoin, Litecoin and others. The blockchain cryptocurrency model doesn’t rely on a central agency but rather issues digital currency through various mining sectors spread out over the world.
Blockchain is also now being applied to trading and deal-making. In the past, it's been difficult to monitor that a deal or contract has been fulfilled as it is often recorded in a court of law by a judge. However, smart contracts make sure a deal happens as set out without a third party stepping in for arbitration if something goes wrong. And the real beauty is, they can do this for a wide range of applications
The blockchain has the potential to go beyond cryptocurrencies and smart contracts. It can be used to track transactions of real estate, land titles, personal inventory, commercial transactions, taxes, medical information, intellectual property rights and security interests (for example).
The blockchain can help with tax compliance issues as well as help with processing collectables like art pieces by proving the history of ownership for different pieces of art. The blockchain is capable of disrupting even monopolistic spheres like energy distribution or distribution of governance services.
Gradually, blockchain technology is changing the way we trade - opening new opportunities for individuals and businesses alike. Aside from its applications in financial services, blockchain will become the foundation of many prominent industries, creating space for growth among existing businesses by improving their efficiency with decentralized security.