How Does Blockchain Work?

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Most people who have a general overview of cryptocurrencies will know the fact that the technology they are built upon is decentralized and uniquely secure is intrinsic to how they work. They will also know that this technology is called Blockchain. They will most probably be aware that Blockchain is a ‘peer-to-peer’ ‘digital-ledger’ system. Beyond that, a slightly smaller percentage of observers will be aware the transactions are verified through ‘mining’ and that this mining process involves computers solving complex mathematical problems. Also, that the cryptocurrency ‘miners’ are rewarded for their endeavor with new cryptocurrency can be considered relatively common knowledge.

However, beyond this very broad overview of Blockchain’s role in cryptocurrencies, most don’t really understand the finer details of how this quite ingenious system works and what potentials it has. That is what we are going to explain here in as straightforward a way as possible.

What Does Blockchain Do?

Blockchain technology fulfills two core functions in a decentralized way, which requires no central authority or management:

  • Recording the entire history of a digital ‘object’ or piece of information
  • Ensuring that record is indisputable

Blockchain achieves this through a combination of three pillars:

  1. Cryptography for security
  2. A decentralized ledger system for record keeping
  3. Incentivisation of the p2p community to service and maintain the first two pillars

1. Cryptography

Two parties wish to exchange a digital data package. This could be a unit of cryptocurrency or a patient’s medical records or anything in between. Both parties have two keys – a public key and a private key connected to their own unique data and identity. The combination of these two keys constitutes a secure digital identity reference. This digital signature authenticates ownership and the combination of two digital signatures provides a strong authentication of ownership and the consent to transfer of ownership.

2. Decentralized Ledger System

The role of the decentralized ledger system is to bear reliable witness to a transaction that transfers ownership. One key strength of Blockchain technology is that it provides a huge number of witnesses (essentially all other users) to corroborate a single event (the ownership transfer of a data package). This corroboration is achieved through mathematical verification rather than visually recording it.

The first step in this process is the sender of a data package making the announcement through their private key that they wish to transfer it to the intended recipient. This announcement is then attached to the recipient party’s public key.

A block of data is then formed. This contains the digital signature formed by the combination of the two keys, the time of the transaction and any other relevant information (which will vary depending on the kind of data being sent (eg.) a cryptocurrency unit. This is then broadcast to all of the ‘witnesses’ that form the decentralized ledger. These witnesses are called ‘nodes’ and are part of the system by virtue of the fact they also own or transfer the same kind of data packages at some other moment in time. This could mean they are also owners of the same kind of cryptocurrency or whatever other kinds of data the particular Blockchain supports.

3. Incentivisation

But why are witness nodes available to perform the mathematical verification that confirms a transaction takes place? In the case of open Blockchains such as those which cryptocurrencies are built on, the answer to this question is ‘mining’. A miner offers the computer processing power to run the network. To provide the mathematical verification that corroborates a transaction is incentivized by economic reward. In other words, Bitcoin miners are paid in Bitcoin. Self-interest services the public need.

The same data package must be verified as unique. The possibility that the same data, (eg.) a Bitcoin, is involved in multiple transactions at the same time must be eliminated. The nodes create and maintain the network that means the same data package can’t be duplicated by solving proof-of-work mathematical problems. New data blocks are then either accepted or rejected by each miner node. A majority of miner nodes must all agree a data block is valid for it to be added to the Blockchain.

What constitutes a valid transaction and what is required for it to be verified differs between Blockchains. The exact verification process and incentives for node witnesses and miners can also vary between Blockchains. The technology is still being experimented with and used for a variety of different and new applications. The best solution to validation, verification and locking the information immutably into the ledger will vary between Blockchain applications.

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