How Does Blockchain Work? An Overview

Blockchain technology has become famous since it is the technology behind most cryptocurrencies.

Blockchain technology has revolutionized the way we transact and has brought in a great improvement in the digital world.

The blockchain is a very secure and transparent technology that uses cryptography to bring about a revolution in the field of decentralized transactions.

It is a system where transaction records are maintained simultaneously by participants (called nodes) on a distributed ledger.

This technology has played a vital role in facilitating transactions between two parties without having to rely on any third party or intermediary such as banks, governments, and other financial institutions.

In this blog, you will learn about what blockchain is and how blockchain works.

What Is Blockchain?

Blockchain is a network that enables the distribution of the ledger across many different computers, without it being centralized.

Before blockchain was implemented, ledgers were centrally stored which meant hackers could potentially corrupt them.

Now any computer on the same network as the ledger has a copy of it and the record is shared between all computers on this network (also known as nodes). This makes it almost impossible to hack.

In addition, blockchain is the technology that underpins cryptocurrencies such as Bitcoin and Ethereum.

Blockchain is a constantly growing list of records called blocks. Each block contains a cryptographic hash of the previous block and a timestamp.

Blockchain technology is based on peer-to-peer (P2P) networks. To make any changes to the recorded transactions, there should be a consensus between all parties participating in the chain.

How Does Blockchain Work?

As stated, a network containing many nodes is needed to store the ledger. In this way, all computers have a copy of the same document – the Blockchain.

As soon as a new transaction or information is uploaded, all the computers on that network validate it and then store it as a block in the chain.

This validation process ensures that no cheating takes place and everyone abides by the rules of the system.

And because of this decentralization, hacking such a network is next to impossible.

Therefore, the Blockchain is a huge database that everyone can access. But more importantly, it's an open-source network that ensures the security and privacy of transaction information.

Let's consider an example to understand it better.

Step-by-Step Demonstration of How Blockchain Works

Suppose we have Alice and Bob as our two participants. Now, Alice is transferring some amount to Bob. She broadcasts the message on the network that she is sending some money to Bob. Then this information gets recorded in all computers on the Blockchain through cryptography, i.e., solving mathematical puzzles (known as mining).

Now, for Alice transferring money to Bob, everyone should agree that Alice is the sender and Bob is the receiver. This information should be agreed upon by everyone.

This network of computers (nodes) will validate Alice's transaction based on three things:

• Alice has sufficient funds for this transaction.
• The message provided by her is valid.
• All previous transactions are also valid.

If all the transactions are valid, the puzzle is decoded and Alice's transaction will be validated.

Then this information gets recorded in all computers on the Blockchain through cryptography, i.e., solving mathematical puzzles known as mining.

Now if Bob wants to transfer money to Carol, he should send that transaction request to the network of nodes just like Alice did.

These nodes validate Bob's claim by checking if he has sufficient funds and that the message is not a duplicate.

After validation, the puzzle would get decoded and Bob's transaction will be validated.

Now, this information also gets recorded in all computers on the Blockchain just to ensure that there are no duplicates or any other errors in the transactions.

So, when Alice wants to send money or validate a transaction, she can use her and Bob's digital signature and encrypt that information using Bob's public key.

This way only Bob's computer will be able to decrypt this message because it uses his private key to do so.

And once decrypted, he gets the information about Alice's transaction.

And, as soon as he gets it validated, his next step would be to remove that from all the computers on the Blockchain.

This is how transactions occur in a blockchain network without middlemen or third parties and just because of two digital signatures.

Now that you know the basics of how the Blockchain functions, let’s understand the key components of blockchain technology.

What Are the Key Components of Blockchain Technology?

Blockchain technology constitutes of the following components:

• Digital Transactions:
  This refers to the exchange of digital assets, such as cryptocurrencies.
• Digital Signature:
  This is a kind of electronic signature that guarantees the authenticity of a transaction or an asset. In blockchain technology, this ensures that all transactions are secure and cannot be hacked easily.
• Distributed Database:
  The ledger is a distributed database where all transactions are recorded simultaneously across the network. Transactions are grouped into blocks, which should take around 10 minutes to add on average. Each block is then appended sequentially within the chain, hence the name blockchain.
• Consensus Protocols:
  There must be a consensus on the ledger of transactions to validate them–this is ensured through protocols such as proof-of-work or proof-of-stake.
• Mining:
  Once a transaction is processed, miners will validate and record the transaction on the blockchain by solving complex mathematical problems using computing power. Miners are rewarded for their work with cryptocurrencies such as Bitcoin (BTC).
• Addressing:
  When you send coins to someone else, an address or code is generated to keep track of the transaction. To keep your identity anonymous, you will often be assigned a random alphanumeric address that is only linked back to you digitally.
• Public Key Cryptography:
  It's what provides anonymity when users transact with one another. A private key (secret code) is used to sign transactions so they are valid while a public key.
• Blocks' Chaining:
  All blocks are chained together for immutability. This is one of the biggest advantages Blockchain technology has to offer as each block references its previous block, which can never be changed (when new transactions are added). It is practically impossible to rewrite history by changing older records because all blocks that follow would also need to be re-written, which would require more computing power than currently exists on the planet. This immutability is what makes cryptocurrencies possible with Blockchain technology.
• Decentralized Network:
  There are no centralized third-party conducting transactions. In a decentralized network, all peers share the responsibility of processing and validating transactions.
• Peer-to-Peer Network:
  Blockchain technology uses a peer-to-peer network to conduct and verify transactions on the ledger without a central authority or trusted intermediary. All nodes in a blockchain have equal status and work together to achieve consensus.

How Can We Use Blockchain?

Blockchain can be used in various ways. Some of them are listed below:

• Storing information:
  This refers to the most common use of blockchain where we can store information across a network using blockchain technology.
• Digital assets:
  Blockchain is used to create digital assets like cryptocurrencies and make secure transactions with them. You can think of cryptocurrencies like the US dollar having a value in different types and forms.
• Document verification:
  This type of use is similar to the first one where information is stored across a network.
• Track items:
  Blockchain is used to track unique items like diamonds, vehicles, cargo containers, and so on. This ensures that there's no duplication or fraud involved.
• Maintaining records:
  In this case, blockchain can be used to securely store information related to transactions, digital assets, and other types of records.
• Transferring money securely:
  Blockchain enables you to make secure transactions without the need for a third party. You can verify that each transaction is valid and see what's happening in real-time.

How Can Blockchain Transform Our Lives?

Over time, Blockchain has evolved into something more powerful than just being a decentralized ledger.

Blockchain has many applications beyond just cryptocurrency transactions. It can be used to secure property records, voting systems, and even medical records.

The main goal of blockchain technology is to create a decentralized system where everyone can see all the transactions. By doing so, this technology eliminates the need to trust an intermediary like banks or governments because now we can trust each other. Such a system eliminates the risk of shady businesses and corruption.

With blockchain technology, our world is heading towards a more transparent society where everyone knows everything about each other.

Admittedly, Blockchain technology still needs some work before it becomes mainstream. But once it is fully adopted, the implications will be far-reaching.

This technology is also pushing us towards a world where we can trust each other more and not fear that someone is going to take advantage of us behind the scenes.

What Are Some of the Advantages of Using Blockchain Technology?

The advantages of using blockchain technology are as follows:

• Transparency
  The blockchain is a decentralized ledger technology where every transaction related to the digital asset is digitally signed so that it can be verified. Thus, you can trust the source of your cryptocurrency without needing third-party verification. This transparency reduces or removes corruption within organizations and institutions alike.
• Human error and fraud
  As human beings, we make mistakes. Whether it is an innocent mistake or done with malice, blockchain technology can protect against these actions thanks to cryptographic hashes that verify all transactions within the ledger. This will reduce the number of errors and instances of fraud.
• Scalability
  Blockchain technology can scale as needed since it has no limit to how many transactions can be processed per second. If the demand for transactions rises, computers simply add more capacity.
• Decentralization of services
  Services provided through blockchain technology are decentralized, which means there is no one central authority that controls the cryptocurrency. No single company or central source is in charge; it's controlled by the people who use it. This means that no one can manipulate, take away or destroy this currency since there is no central server.
• Enhanced Security
  The integrity and chronological order of data stored in blockchains are virtually unbreakable. If someone wanted to, they would need more computing power than every single computer in existence combined to be able to break the system.
  Through cryptography, transactions are more secure on the blockchain than using traditional banking systems. The cryptography not only hides information but makes it unreadable to any third party trying to intercept the transaction.
• Fast Transactions
  Blockchain transactions are almost instant because they happen on a peer-to-peer basis without having to go through any intermediary procedures for verification.
  In other words, when you make a cryptocurrency transfer to someone, the recipient has it in their possession almost immediately. This is opposed to traditional bank transfers where a third party must verify and process your payment before routing the funds to the recipient's account.

What Are Some of the Challenges of Using Blockchain Technology?

The challenges of using blockchain technology are as follows:

• Lack of Awareness
  While there are a lot of people interested in understanding how this technology works, the majority of them still do not have a complete idea of how it will impact or change their lives. In some cases, people share certain misconceptions about Blockchain technology as well.
• Price Volatility
  Right now, Bitcoin has become a type of cryptocurrency that has the highest value, but there are others as well that have a lower market price. The value of digital coins can fluctuate from day to day and it is also difficult to predict what they will be worth in the future.
• Slow Speed
  The speed at which transactions are processed through Blockchain is significantly slower than those that take place through banking institutions. This is attributed to the time it takes for the digital ledger that records these transactions to be updated.
• Security Threats
  Just like any other technology, Blockchain has its weakness and one of them is security. Hackers continue to find new ways on how they can exploit flaws in the system despite ongoing efforts to ensure the safety of the data being stored.
• Centralization Of Power
  Since Blockchain is still in its infancy, there are only a few people who understand how it works and this makes it tough for businesses to choose between implementing traditional payment systems or exploring other routes that could lead them down the blockchain route that many are not ready for.
• Slow Adoption Rate
  Despite its numerous advantages, Blockchain still needs to be developed further for it to become more efficient. It also takes time before businesses can fully adopt this technology which could slow down the process of introducing new services.

Conclusion

Having understood all the different aspects of Blockchain technology and how it works, it is time for you to decide if it is something that your business could benefit from. This will help you decide whether to invest in the technology now or wait before exploring other options.

You are ready to apply this knowledge to your business and encourage digital transformation.

We've tried to answer all questions related to blockchain technology in our blog, but if you still have some unanswered questions, please do not hesitate to contact us.