What is Blockchain & How Does it Work (The Future of Money & Contracts)

In our previous post, we talked about blockchain but we did not go into detail. It is also very obvious that many people do not know how it works or what it is.

To get a better understanding of what it is, you need to visualize it.

Picture this; You and a friend are transferring money from one account to another. Usually, you would have to contact the bank and ask them to transfer the money to the account of your friend.

When the transfer happens the banks will keep an entry on their respective registers as proof that the transaction happened. Both the receiver and sender’s entries will have to be updated on their respective accounts.

The problem with this is that it is a vulnerable system and anyone with access can tamper with it. Because of the ease with which a transaction can be changed or manipulated, many people do not trust banks and for good reason.

These vulnerabilities are a problem. Satoshi Nakamoto invented blockchain to make transactions safe and secure. In our previous topic, we used the example of an Excel sheet to explain how the ledger works.

The Mysterious Origin of Blockchain

Blockchain technology was first released in 2009 when it was used for the application that we now know as Bitcoin. Bitcoin is a cryptocurrency and blockchain is the technology that we build it on.

Bitcoin is the creation of a person or a group of people going by the name Satoshi Nakamoto. Nobody knows who he or they might be. Satoshi explained the vision in a 2009 whitepaper that had the title ‘Bitcoin: A Peer-to-Peer Electronic Cash System.’

To date, the creator of Bitcoin remains a mystery. The person or group of people created a Revolutionary way of transacting value, but they have never come forward to take credit for it. However, the technology is here with us now and it is up to us to decide how we use it. Understanding it is just the first step. It is the most crucial step for anyone.

The Blockchain

Blockchain works the same way as an Excel sheet or a Google spreadsheet. It shares the sheet among many people or many computers where everyone has a copy, but no one can edit it.

In an Excel sheet, we have rows and columns. When using blockchain’s Ledger, we swap the rudimentary columns and rows for blocks.

In a blockchain, a block is a collection of data. We add data to the block by connecting with other blocks, hence creating a chain of linked blocks. Each of them contains data that anyone can view when they all connect. The first block created is named The Genesis block.

We mentioned that the blockchain is a distributed Ledger. In simple terms, it means that we spread the ledger across the network among all peers. Each of the peers holds a copy of the complete Ledger.

How Blockchain Works

To understand how blockchain works, we have to go through the process step-by-step. Here’s how:

1. The transaction starts at a node that creates and then digitally signs the transaction with its private key. We create the key using cryptography. A transaction can be many actions in a blockchain. Usually, a transaction represents the transference of value between users on the network. The transaction can also contain the relevant rules, source, destination, and validation information.
2. Propagation of the transfer happens using a flooding protocol that we called the gossip protocol. The transaction goes to peers who validate it based on preset criteria. To verify a transaction, we require over one node.
3. After validation, we include the transaction in a block which is then added to the network. Once this point has been passed, the transaction is termed as confirmed.
4. The transaction creates a new block of data that now becomes part of the Ledger. The next block links itself cryptographically back to this Block. We refer the link to as a hash pointer. The transaction gets the second confirmation, and the block gets the first confirmation.
5. They confirm transactions every time they create a block. For the transaction to be final, six confirmations in a network are adequate.

As you will find out in the topics that we will get into later, the basic concept applies to almost everything.

How Is It Better Than Traditional Methods?

It does not take long to notice that blockchain uses the same basic concept as traditional ledgers. So, what makes it better than the traditional systems of keeping information? Is it good enough to prompt everyone to abandon the old way?

Let’s find out:

1. Peer-to-Peer

When you first get introduced to the blockchain, the most cited reason for using it is that it was decentralized and still is. Many of the banks we use are under the authority of Central Banks because they have an authority that controls and manipulates everything.

Using hierarchy in banks does not allow people to talk directly to one another. It will always involve the bank when you’re making a transaction. When using blockchain, we make directly data exchange with no third parties involved.

2. Distributed Ledger

When blockchain was first introduced, many people assumed that it was impregnable, and they were right. Blockchain is difficult to hack because it spreads the Ledger across the whole network which makes tampering insanely difficult, if not impossible.

3. Cryptographic Security

For security, the Ledger’s security comes from cryptographic encryptions to make it unhackable. To hack it, you would need to take control of half of the nodes and then somehow decrypt the cryptography to access the contents.

4. Add-Only

Be added to the blockchain. Once it is added, it becomes impossible to change and is considered immutable. A phrase we use to explain this is, ” the right to be forgotten or right to erasure,” explained under; Art. 17 GDPRRight to erasure (‘right to be forgotten’).

5. Consensus

Because blockchain is not centralized, adding anything to the Ledger or changing it requires consensus. There is no central authority who can update the Ledger all by himself. Instead of a single authority, all the people invested in the particular Ledger have to consent to a change before it can happen.