As anyone with even the most basic knowledge of Bitcoin and other cryptocurrencies will be aware, they are built on a technology called Blockchain. In short, Blockchain is a decentralized digital ledger where transactions are recorded publicly and in chronological order.
Bitcoin, the first cryptocurrency to make use of Blockchain technology, was devised by Satoshi Nakamoto, which is a pseudonym for the anonymous creator(s) of the cryptocurrency. As Nakamoto foresaw, if this first cryptocurrency were to have any chance of success, there were a number of fundamental problems to address. A currency, digital or otherwise, can only practically function if a number of key criteria are met:
- Ownership must be conclusively established
- Transactions must be completed and recorded efficiently
- Counterfeiting must be effectively prevented
- Inflation must be controlled
One of the deficiencies of fiat currencies that Bitcoin was envisioned to address was the mediation role of central banks and financial services companies and the corruption potential in their power. As such, all of the criteria of a functioning currency had to be achieved without the need for a corruptible or self-interested central authority.
Nakamoto believed the vested interests and power wielded by the established financial system are to the detriment of the users of fiat currencies. Particularly those further down the chain. Central authorities controlling the fiat currency system were thought to facilitate the status quo in terms of inequality of wealth. An intrinsic quality of Bitcoin and other cryptocurrencies is that they are decentralized and truly peer to peer, which eliminates the need for any middleman or central authority.
Blockchain: The Answer to Bitcoin’s Technology Challenge
As described above, Blockchain is a distributed ledger, a way to track and record peer to peer transactions. On the Blockchain, data is “distributed” over an entire global network rather than in a central location. For Nakamoto, Blockchain was the technological solution that could solve proof-of-ownership, facilitate and record peer to peer transactions, and prevent counterfeiting, and do all of this within a self-sufficient loop.
While Blockchain is most commonly associated with Bitcoin and other cryptocurrencies, the technology has many other potential applications. The Blockchain is actually the basis for countless possible applications. The technology is already being used for things like smart contracts, medical records and many other uses that require a trusted ledger of transactions between parties sharing data. There are also differences in the way Blockchain technology is used by different cryptocurrencies and there are still many possibilities that are as yet unrealized.
In Blockchain, groups of recent transactions between parties form a block of data. Each block contains a hash. A hash is a code (the cryptography that puts the ‘crypto’ into cryptocurrencies) that contains the data linking back to the previous data blocks of transaction records, creating a chain. The chain contains every transaction in cryptographically-sealed blocks meaning no-one can go back and alter past data.
A nice analogy is that Blockchain is like a box of Lego from which different blocks can be taken and put together in different combinations that produce different results. In the case of cryptocurrencies, these blocks of data are financial transactions. However, they can also be other forms of transaction, such as an updated contract or agreement being passed between parties, or a medical record being shared between doctors. At its core, Blockchain is a decentralized data storage system on which virtually any form of shared data can be stored. Given the countless more precarious ways data is currently stored, the potentials of Blockchain are endless.
One of the key characteristics of Blockchain is that the ledger exists as an exact copy in numerous different digital locations, which mutually update each other in close to real time. When an approved change is made in one location, it is made all over the network.
- It most commonly exists over a peer-to-peer network.
- It employs cryptography and digital signatures to verify identity, ownership, and enforce read and write access.
- It has checks and balances that make it extremely difficult, if not impossible, to alter historical records and attempts to do so are easily detected.
- If any data already encrypted in the Blockchain is accessed by an unauthorized user, the network can instantly detect it and take action to protect the data.
Each new transaction must be verified by all the ledger copies distributed over the network, which essentially act as automated witnesses that the transaction was completed as stated. This means users don’t need to physically verify all transactions. The digital copies of the ledger do this automatically. Since there are numerous copies of the very same ledger required to verify and approve any transaction or update, Blockchain negates any doubt among users that the other party is fulfilling their end of the bargain.
And that’s a brief overview of how Blockchain works. It really is a phenomenal technological innovation and even those fundamentally opposed to cryptocurrencies as a concept recognize that Blockchain technology is set to revolutionize many industries on a level comparable to the internet and cloud computing.