Last Updated: July 27, 2020
I know what you think.
That this would be one of those articles that tries to explain what blockchain is “like you are five”, but instead fills your head with technological terms and crypto mumbo jumbo.
Still, as you’ll soon see, this one’s actually different.
Here we will look at the blockchain in such a manner, that by the end, you’ll be able to say: “Now I really know what the blockchain is.”
In case you want the really simple explanation – here’s the blockchain definition in short:
The blockchain is a ledger of records, called blocks. They are interconnected via cryptography. It’s a decentralized, immutable, transparent network, and each one usually comes with its own cryptocurrency.
That’s it. Simple, eh?
Anyway, if you genuinely want to understand what blockchain technology is, keep reading.
The Mystifying Blockchain Explained
Since this isn’t another “Blockchain for dummies” or a “Blockchain tutorial” article, we’ll take a different route.
Imagine the blockchain as a book.
Each word on a page contains specific information.
On the other hand, it also holds information about the previous word, thus they are logically linked to each other.
Once written, the book is reviewed by an editor, who validates each word and agrees on the information it carries.
Now imagine each sentence is a block in the blockchain.
Every block is connected to the subsequent one, thus creating a chain of blocks. Just like logically connected sentences create a book.
There you have it – that’s the blockchain technology explained.
There’s one thing you should know, though – blockchain is not Bitcoin.
It’s the underlying technology of cryptocurrencies, but it has the potential to improve many other industries. We’ll get to that in a bit.
First of all, to understand the hows and whys of blockchain, let’s go back a decade.
Who Created the Blockchain Technology and Why?
Bitcoin’s inventor’s identity remains unknown to this very day. When Satoshi Nakamoto presented his/their idea of the Bitcoin blockchain, it needed an incentive (bitcoin rewards) to be supported and adopted by the world.
Today the technology is known and appreciated more and blockchains are now applied for different reasons than money.
Apparently, they have the potential to save money as well. In fact, financial companies can save up to $12 billion a year from using blockchains.
The main issues the blockchain tried to address back in 2008 were the financial institutions, i. e. the intermediaries. That’s why Satoshi Nakamoto presented the idea of a decentralized, peer-to-peer system. That system would make payments faster, more secure, and would require smaller fees (which would be necessary to sustain the network.) And the main goal – the removal of the middle man.
So you see, blockchain is more than a technology, it’s also a philosophy.
Let’s imagine you want to send money to Bob, who is abroad.
This is where the banks kick in, and it gets a bit complicated.
Initially, your bank takes a fee for the transaction, reducing the amount of money Bob will receive. Then – it takes time to wire money abroad. Sometimes up to a week.
As this takes place, the bank from which Bob will withdraw also takes a cut, thus reducing the amount even more. Finally, Bob will have to exchange his dollars to the native currency (if the bank didn’t do it automatically, making a profit from the exchange rate as well.)
If you don’t use a bank, but a remittance service like Western Union, maybe you could cut the time for the transaction but in exchange for a higher fee.
Still, if you and Bob relied on a blockchain-based digital currency, all these intermediaries wouldn’t take part in your transaction, thus saving you both time and money.
That’s what peer-to-peer means – one-to-another, nothing in-between. And that’s just one of the features of the blockchain technology.
Crucial Elements in the Blockchain Network
Remember the analogy, a while back, about the blockchain being like a book?
To be able to understand the next part, imagine the writer of the book as a miner – he creates (mines) the words and turns them into sentences (blocks). And the editor represents a node – he verifies the blocks.
What Is a Blockchain Miner?
“Miners” are actually high-powered computers, which solve a complex mathematical problem – that’s how they create a block. Each miner requires some time (around 10 minutes in Bitcoin’s case) to work on that problem. Once it’s solved, the miners start working on another block. Once the block is verified, the node keeps it forever. So you can think of miners as … well, miners. And the nodes could represent the accountants in a mining operation.
What Are the Blockchain Nodes?
“Trust, but verify” – Ronald Reagan
Nodes validate the blocks, proposed by the miners. A full node keeps a complete copy of the blockchain ledger. Unlike miners, the nodes keep the information about every preceding block since the beginning of the blockchain. That way, the info in the blockchain is always backed by all the nodes. When a block is added to the blockchain, all nodes receive a real-time update of their copy of the ledger.
What Is a Blockchain Transaction?
In essence, the blockchain transaction doesn’t differ from a typical one. You send digital currency via your digital wallet to someone else. The two main differences from traditional transfers are the blockchain saves you time and money. Coincidentally, these are two of the most precious personal resources in the modern world.
So how does this happen?
First of all, blockchains operate as peer-to-peer networks. No third party is involved in slowing the transaction down, and the system doesn’t require excessive fees.
Secondly, a blockchain is usually a vast network of miners and nodes that guarantee its security. No one from the network will call to tell you there’s been a problem with your transaction because of something or other (unlike banks). All you need is some coins, your private key, and the recipient’s public key. The blockchain technology will take care of the rest.
Public and Private Keys
There are four things you need to make a transaction in the blockchain.
- Тhe amount of cryptocurrency you want to send. (Duh)
- А cryptocurrency wallet. An app that allows you to make cryptocurrency transactions.
- Your private key to access your money. Think of it as login password to an account, the same as your email. If this analogy doesn’t work, you can think of the private key as a signature on a check.
- A public key, which is like the recipient’s bank account. The public key is visible to everyone. Once you send the funds, the recipient uses his private key to access them.
In general, that’s how transactions work. Now we can focus on the underlying technology.
How Does Blockchain Work?
By now, you already have a fairly decent knowledge of what blockchain is. Now it’s time to find out how it works step-by-step.
When Satoshi Nakamoto published the Bitcoin whitepaper, the word “blockchain” didn’t appear in the text. Instead, the author/s used two separate words – block and chain. The whitepaper presented two different terms, which are inseparable today. That means the structure is relatively simple – it’s a network comprised of blocks, connected via a cryptographic chain.
This is a simple representation of the blockchain’s structure:
Blockchain structure. Image by the author.
Each block contains a certain amount of data. These are the three need-to-know elements, comprising a block:
- The hash of the previous block
- Transaction details
Now, we’ll review each of these elements, so that none of these terms remains a mystery for much longer.
What Does Hash Mean?
In simple words – “hash” is the information a block contains. Only that it represents a sequence of numbers and letters. The hash depends on what encryption the blockchain uses. For the next example, we’ll look at SHA-256 – the encryption used by the Bitcoin blockchain.
Usually, a bitcoin block can contain about 3500 transactions. To keep it simple, let’s say a block includes information about two operations:
John sent one bitcoin to Bob.
Lisa sent 0.5 bitcoin to Jenny.
In that case, the hash of the block storing this data will be this:
The code above summarizes all the transactions included in the block. Blockchains use the Merkle Tree structure to organize the information. The Merkle tree represents a massive structure of data blocks, where each branch of the “tree” contains a different set of blocks (leaves). Each leaf contains the information (hash) about the other leaves in the branch.
To simplify it even more – the hash is like the ID of a block, containing all the information in it. And the hash of a block is passed on to the subsequent one. Once this operation is concluded, the blockchain marks the block with a timestamp.
What Is a Timestamp?
The timestamp is the information about what and when happened in the blockchain. This is especially important since it eliminates the possibility of spending the same unit of cryptocurrency twice. You can think of it as a notary, who verifies that the data in the block is accurate, and that it happened at the mentioned precise moment. The timestamp is crucial to blockchain technology because each node can trace back when each transaction occurred.
Cryptocurrencies don’t move like fiat money. You can’t pull out a digital coin from your blockchain wallet and give it to someone.
Instead, you change the ownership of the currency you had to that of the new owner. Just like with selling a house, you don’t transfer the house to the new owner’s location, right? That’s how cryptocurrencies work as well.
As mentioned before each block contains up to several thousand transactions. These are the details included in each one:
- The exact time the operation took place.
- The name (hash) of each transaction.
- The input (sender’s address) and output (recipient’s address).
- The amount of cryptocurrency transferred and the corresponding fee.
When a miner successfully mines a block, not only does it get a reward, it also receives the fees from each transaction in the block. These fees are usually a tiny percentage of the transferred amount. Each transaction is protected by cryptography on every level, thus making them secure.
If one word could define the blockchain, it would be “security.”
The network is almost unhackable. If cybercriminals want to tamper with a block, they’d have to take control over at least 51% of the entire blockchain. Since blockchains are typically vast networks of miners and nodes, this makes hacking the blockchain practically impossible. Using cryptography to link the blocks only adds to the blockchain’s security.
What Is Cryptography?
Cryptography is utilized in blockchain technology to transform plain text into an unreadable sequence of numbers and letters.
You can think of it as a code – like the ones used in WWII (any fans of The Imitation Game?). To be able to read the message you need to use a decipher. In the bitcoin blockchain, the decoder is called a private key. Only you have it and can use it to receive or send a transaction. You can think of the key as a document, which verifies your identity. The thing is, the personal key doesn’t tie a user to the person in real life.
Privacy in the Blockchain
The key mentioned above ensures users’ privacy in the network. You and only you have the personal key. If you lose it, that’s that. You don’t have any other means to reach your coins.
Thing is, you don’t have to validate your real life identity at any point. No one asks for your personal information. The only thing that matters to the blockchain is the consensus of its nodes, not their names.
The Blockchain Consensus
In centralized systems – like banks, for example, there is no need for the majority’s consent. The bank itself decides if a transaction is valid or not. But when you have a decentralized system, by definition there’s no single entity that decides if operations are valid.
That’s why blockchain technology uses a system called the“Consensus Mechanism.”
To understand what consensus means in blockchain terms, let’s check out a famous allegory.
The Byzantine Generals Problem
Imagine a castle, surrounded by divisions of Byzantine troops. Equally ranked generals are in charge of each division. For their attack to succeed, they have to coordinate their actions. The thing is, there are a couple of things that could go wrong.
- The enemy could intercept the messengers and counterfeit the messages.
- One or more of the generals could be a traitor and abandon the attack.
That’s why the loyal generals have to verify the messages they receive and achieve a consensus when and how the attack should commence.
That’s an analogy of how nodes in the blockchain achieve consensus. Untrusted entities comprise the system, and the way for it to work is for the majority of nodes to reach an understanding if a transaction is valid or not. However, there isn’t a single solution for achieving a consensus.
While the blockchain development is still a work in progress, we may expect new types of consensus mechanisms. Still, so far different blockchains use four major protocols to resolve the consensus issue.
Proof of Work (PoW)
The bitcoin blockchain uses this protocol to verify transactions. The proof of work requires a miner to solve a complex mathematical problem to create a block and queues it for verification. Then the nodes in the network either verify the block or not, thus adding it to the chain or deleting it.
The downside of this protocol is the sheer amount of computing power and electricity used in the mining process.
Proof of Stake (PoS)
Soon to be adopted by Etherum, the proof of stake protocol provides a different consensus mechanism than the PoW. In simple words, this protocol requires the nodes to place some of their cryptocurrency as a stake for the block’s validation. Once the block is verified, the node receives a reward based on that stake.
Using the POS protocol is more resource-friendly and needs little (much, much less) computing power.
Delegated Proof of Stake (DPoS)
This is the most democratic system. Each user, who owns any amount of the blockchain’s cryptocurrency, votes for a validator. The chosen validator becomes a delegate and receives the right to validate transactions, thus obtaining the rewards for its efforts.
Delegated Byzantine Fault Tolerance
This protocol works like a country – meaning, it has citizens, delegates, and speakers. It sounds confusing at first, but let’s break it down.
Here’s the deal.
The citizens represent users who own the base cryptocurrency. These citizens then elect the delegates (the nodes), which verify the transactions. Once a block is ready, a speaker (a randomly selected delegate) proposes the block to the chain. Then 2/3 of the delegates have to validate the block, thus adding it to the blockchain. This protocol was introduced by NEO – also known as the Ethereum of China.
Now that you already know a lot about blockchain technology, let’s see what makes it such a brilliant idea.
The Backbone of the Blockchain
So why is the blockchain such an incredible invention?
It certainly isn’t because bitcoin stock’s value is over $11,000 (at the time of writing.)
It’s actually because of its simplicity.
Not that the technology is simple itself, but its philosophy is quite elegant.
Today we live in a centralized society. We have governments, banks, and many businesses we use daily – like Amazon, Facebook, Google, etc.
With each passing year, since the caveman era, more and more power has been focusing in the hands of a few people and enterprises. Satoshi Nakamoto wanted to change the status quo, so he proposed to give some of the power back to the people.
The decentralized network means there is no single entity in control of blockchain technology. The consensus mentioned above is the central pillar of its decentralization. The system itself is responsible for its existence and well-being.
Decentralization changes the way we think about money. It also provides greater security, compared to centralized entities, which represent an easier target for cybercriminals.
And the best thing about most blockchains is they aren’t just decentralized. They are distributed networks, which makes them almost invulnerable to attacks.
Centralized vs. Decentralized vs. Distributed network. Image by the author.
In terms of security, there’s another feature which makes the blockchain attack-proof.
What Is Immutability in Blockchain’s Context?
The blockchain is immutable – meaning its history can’t be altered or deleted. This is one of the key benefits of blockchain technology. The immutability comes handy if, for some reason, you have to inspect any of the blocks. You know that the data recorded a year ago would still be the same. In contrast, paper documents can be tampered with, or destroyed.
But it gets better.
Since the network is transparent, everyone could audit the blocks.
Blockchain Transparency Explained
This is a topic which usually bewilders people – how can the blockchain provide both privacy and transparency at the same time. Aren’t both terms in contradiction?
See, the blockchain, as explained above, provides privacy by not linking the public key to any personal information.
At the same time, the network is transparent – everyone can see every transaction that’s ever occurred.
This distinguishes blockchain technology from traditional financial services. Today, if you want to review your transactions, you have to go to the bank and ask for the data. With the blockchain, you can open the blockchain explorer and see it all. You don’t need to be a part of the blockchain to see all the transactions and the amount of cryptocurrency transferred.
The cryptocurrencies represent a form of digital cash or internet money. The need for their birth was that the current financial system has too many flaws – like double-spending, high fees, too much time required to wire funds. And not to mention all the frauds, thefts, and attacks on centralized networks.
That’s what the blockchain tried to change a decade ago with Bitcoin. BTC was the first adopted digital coin that was used for payments. Today there are more than 2,250 cryptocurrencies.
Cryptocurrencies aren’t solely a way to pay for goods and services. Backed by blockchain technology, they represent an entirely new financial system. It’s the whole package, so to speak.
Why Cryptocurrencies Have Value
The answer to that question can lead to a whole new article about money, its origin, why kings invented it, etc. To avoid all that, here’s the straightforward answer:
Cryptocurrencies have value because people accept them as being of value.
Once again, it’s more of a philosophical puzzle than a technological or financial one.
So let’s review, in short, the most famous cryptocurrencies in 2019.
What Is Bitcoin?
We have an entire article dedicated to Bitcoin, but these are the essentials you need to know:
Bitcoin, created by Satoshi Nakamoto, became the most known cryptocurrency in the last decade. It pioneered the blockchain and formed an entirely new market.
The Bitcoin blockchain uses the proof-of-work protocol and is permissionless. Everyone can join it, without any limitations. The only requirement is for miners to have enough computing power and for full nodes to have sufficient hard drive space network.
So far it’s unable to replace fiat currencies, for several reasons, one of which is its high volatility.
For instance, it started June 2019 at around $8,500 for a bitcoin, jumped to over $13,800 only to go down to about $11,700 by the end of the month. That’s not an asset you can use for your kid’s college fund.
Now that we got to know the champion a bit, it’s time to meet the runner-up.
What Is Ethereum?
Both Ethereum and Bitcoin are blockchain-based systems. Unlike Bitcoin, which is a peer-to-peer money system, Ethereum provides decentralized computation for every application on its network.
For example, you’ve created a game and you want to put it on a blockchain. The Ethereum network gives you the computing power, on which you can run it.
What’s innovative in the Ethereum blockchain is the use of smart contracts. They represent a program which is designed to perform specific actions. In Bitcoin’s case, smart contracts are limited to bitcoin transactions. Ethereum, on the other hand, allows developers to create their own smart contracts for any type of valuable data, not just money.
If you think of Bitcoin as a mine, where miners mine the cryptocurrency, then Ethereum is more like a field, where developers can sow whatever they want.
The Ethereum blockchain also has a cryptocurrency, called Ether, which is used to purchase services in the Etherium ecosystem.
Since you already know what blockchain is, how it works, and the two most popular cryptocurrencies, let’s have a look into the future.
What’s Next? Facebook’s Libra or Something Entirely Different?
In 2019, Facebook announced its cryptocurrency named Libra. We already looked at Libra’s inner workings, but we can’t explain what blockchain is without looking ahead at its future development.
In short, Libra will be a decentralized blockchain-based cryptocurrency, backed by fiat money.
In theory, it has the potential to disrupt the current financial system, which is already feeling the pressure of the existing cryptocurrencies. Be that as it may, Libra will launch in 2020 and we’ll see if it has any real impact on the way we know how money works.
In the meantime, there’s undoubtedly a bright future for the blockchain technology.
Blockchain Applications – an Unlimited Source of Possibilities
The shared economy is gaining more and more popularity for the last few years. Many companies, like Uber and Lyft, claim to be disruptors of the status quo. The thing is, they aren’t. They are still intermediaries, which connect people searching for a service and the people providing it. They’re still collecting fees, or a percentage of the services’ costs.
What can really disrupt the status quo is blockchain technology.
Imagine a world without intermediaries, where the shared economy could reach its full potential. In a peer-to-peer network you can purchase a service, or a product, without the middleman. You can save both time and money.
Instead of hailing an Uber and paying the driver and the company, how about just pay the driver directly? The use of a blockchain could solve this hypothetical situation.
And that’s just one of the many potential cases where blockchain can be a game-changer.
What about the artists?
What if singers didn’t have to sign with a record label to produce their music, but instead they sold it directly through the blockchain?
And the same goes for writers. This tech can allow you to pay for a book directly, and the funds will go to the author without the publishers taking the lion share of the profit.
And speaking of arts, let’s not forget all the copyright issues that could be easily resolved since there will be a timestamp on each block. If you invent, let’s say, a new fingerprint door handle and add it to the blockchain, no one else can argue that you were the first to come up with this invention. That’s because the blockchain is immutable.
In short, everything that has a ledger, or any other data, could be stored in the blockchain. There are many practical use cases for blockchain technology – powering voting systems, storing medical records, and improving the usability of land-titling services – among others.
Fascinatingly enough, statistics show 70% of the world’s population lacks access to land titling. That’s just one of the many cases where blockchain tech will be a game changer.
There are also many companies that could benefit from the blockchain.
Walmart, for example, adopted a blockchain-based system to trace their food supplies. By adopting this technology, mangoes’ provenance could be tracked in 2.2 seconds. Before the blockchain, tracing mangoes’ origin took seven days (here’s the full case study.)
The list of blockchain applications goes on and on.
Blockchain technology offers many possibilities and advantages. Still, it’s not a perfect system.
Like any system ever invented, blockchain has its flaws.
- Excessive energy consumption
Many of the blockchains, although trying to use less power, still consume tons of electricity. This, in turn, causes environmental pollution, which is a factor of its own.
- Waste of computing power
In the Bitcoin blockchain, for example, nearly one million devices race to mine a block, and only one is successful. That means almost 999,999 participating devices out of every million waste their computing power.
- Smaller blockchains are vulnerable to a 51% attack
Usually, the more miners in a blockchain, the more secure it is. If that number drops too much, the system becomes vulnerable. That leaves the door open for entities to take control of over half the miners (or add the same amount of miners +1 to the blockchain), thus gaining the power to alter or rewrite the blocks.
- Insufficient speed of transactions
Blockchain enthusiasts have a habit of praising the technology for validating transactions quickly. In reality, that’s not always the case. In the Bitcoin blockchain, a verification could take much longer than the usual 10 minutes. And sending a more substantial amount of bitcoins could take up to 10-12 hours to be verified enough times to be considered secured.
Luckily the newer blockchains address this issue and offer better transaction speeds.
If you don’t know how blockchain technology works, you might be inclined to think it’s like an alien entity that controls invisible money.
The truth, as it’s already obvious, is much simpler.
Today we covered all the essential elements which comprise the network. You now discovered how the blockchain technology works, its possibilities, advantages, and disadvantages.
That basically sums up what the blockchain is.
If you have any questions or want to share a thought, use the comments section below.
Till next time.