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Everything You Need To Know To Understand How and Why Blockchain Technology Works

As millionaires are made overnight with the rise and fall of bitcoin prices, the technology that underlies it - blockchain - is under the spotlight. These two dual technologies are so closely linked that many people commonly mistake bitcoin as an inherent part of blockchain. In fact, blockchain is a powerful independent technology, creating thriving ecosystems which can be applied to many sectors from healthcare, to finance, to digital currency and beyond. Let's take a look at this technology as no matter how bitcoin fares on the market, blockchain isn't going anywhere

Blockchain 101

To understand effectively how blockchain ecosystems can operate, it helps to have an overview of blockchain technology. Before we go for a deep dive, let's see how blockchain functions on a surface level.

In simple terms, blockchain functions as a digital ledger - a record of data and information, available to public viewing. The individual blocks that make-up blockchain are just that - chunks of information. Each block is linked to a previous and a further block through unbreakable cryptography, and has a unique hash ID enabling it to be examined by anyone interested. In this way, blockchain is similar to a database, but with one significant variation - the information within the public blockchain is fixed and can never be edited. Because each block comes from the previous one, and because each block is transparent and open for anyone to see, the entire system becomes an infallible record of transactions. These characteristics of transparency and unquestionable accuracy have made blockchain exceptionally popular.

A third characteristic that has helped blockchains rise is the fact that it's a decentralized system. The ledger requires no oversight, nobody to input data or potentially edit information. The system is produced organically as a transaction takes place, so nobody can take ownership of the blockchain.

How Blockchain Works

Understanding how a blockchain network works requires getting to grips with some new vocabulary: a blockchain is built up of nodes and transactions. Transactions are any exchange of data within the blockchain and lead to the creation of further blocks, whilst nodes are users within the network, inputting information. When the blockchain is updated, every node receives the update, ensuring an accurate record exists across the system.

Transactions can take place when a user, accessing the network, has two things. First, a private key which is unique to their transactions, and secondly the public key of another node, with whom they're transacting. This combination of public and private key ensures that both parties consent to the transaction within the system, and creates a new block containing the data of the transaction.

Lastly, everyone across the network is informed of the transaction. Blockchain is a peer-to-peer technology so it's hosted across a network of individual users, and not located in any centralized way. Each transaction is validated across multiple users through a consensus algorithm before it's confirmed as a block and added to the chain.

Photo by Markus Spiske on Unsplash

The Blockchain Ecosystem

Understanding blockchain requires getting to grips with a number of technical concepts. Nodes applications, a distributed ledger, consensus algorithms and virtual machines combine to create this powerful technology. The blockchain ecosystem rests on these four pillars, so let's take a look.

Distributed Ledger

A ledger is any way of recording and updating information, and in a digital setting, the distributed ledger contains information of the transactions made by the nodes. Within blockchain technology this ledger is distributed in the sense that it is held by all the peers making up the network.

Once all nodes independently assess the update to the ledger through the transaction, and agree that it's correct, the data is added to the ledger and the chain grows a block. This distributed format for storing and verifying information is what makes blockchain a decentralized platform, and why the technology is so powerful for democratizing industries such as finance which have historically been highly centralized.

Node Application

To engage with any blockchain system, you need to become a node within blockchain. As discussed, nodes are effectively users of the system, but with blockchain, users need to access blockchain through an application. SON (Service Overlay Networks) are accessed by a node application and form the foundation of the blockchain ecosystem.

Nodes are kind of like a net! Photo by Thomas Couillard on Unsplash

Consensus Algorithm

Ledgers are only valuable insofar as they contain accurate information, so the process through which nodes across the blockchain assess transactions is vital to the functionality of blockchain as a technology. This is where the consensus algorithm comes in, assuring that information is correct without needing oversight that would undermine its decentralized values.

There are a number of ways consensus algorithms can be built and different blockchains might rely on different algorithms. Bitcoin, for example, a proof of work (POW) concept to verify its mining process, but proof of stake and proof of burn algorithms are utilized effectively in other forms of the technology. A consensus algorithm validates that a block is legitimately part of the network, ensuring the infallibility of the blockchain to all involved.

Virtual Machines

Virtual machines are the final piece of architecture within blockchain ecosystems and are increasingly vital as contracts are being executed within blockchain systems. Virtual machines exist within the software of node applications and enable the entire network to work together in the form of a supercomputer. By abstracting away from individual nodes on the network and combining them, the virtual machine can allow complex tasks to be solved effectively within blockchain.

One common blockchain, Ethereum, utilizes the Ethereum Virtual Machine (EVM) for this process. EVM is at the heart of Ethereum and enables contracts to be built automatically within the system. The EVM prevents these created contracts from being externally modified, and since virtual machines are dispersed across a wide network and have no downtime, the contracts created within Ethereum are safe.

Smart Contracts

Thanks to the growing presence of virtual machines in blockchain networks, blockchain can now perform ever more complex tasks with incredible reliability. Creating contracts is one function that blockchain is increasingly being applied to - and the contracts produced within blockchains are known as smart contracts.

A smart contract can be produced automatically between two parties through a blockchain, creating a real time and secure method for the exchange of a valuable resource. After an exchange of details, both parties can determine a certain condition, such as the release of funds, that enables the exchange to take place. Thanks to blockchain's transparent interface, both parties can allow the exchange to take place with a complete degree of trust in the process.

Not a very smart contract! Photo by Sear Greyson on Unsplash

Why Blockchain Works

We've seen how blockchain technology is built, from the nodes to the ledger, and how it uses consensus algorithms and virtual machines to function. These fundamental elements of blockchain are what imbue it with characteristics that are making it so popular across the world - its decentralized character, its transparency within transactions and its immutability and security. Let's take a closer look at why blockchain is taking over the world.

Immutability

Blockchain's immutability has been described as one of its major assets and its why industries from finance to healthcare are investing in this technology. Because each blockchain transaction is intrinsically related to the previous one and the following one, it's impossible to change any data within the blockchain. Integrity and trust are at the heart of a blockchain ledger.

Transparency

Because of the distributed nature of the ledger within blockchain technology, each participant in the network shares the same documentation, rather than multiple documentations existing at once. Further, each transaction is connected to the last, meaning the traceability of transactions through a blockchain platform is simple and straightforward. Whilst anonymity is often thought of as fundamental to blockchains such as crypto blockchains, transparency is equally fundamental to blockchain's functioning.

Decentralization

Lastly, blockchain's peer-to-peer superstructure and distributed ledger means it's a completely decentralized system of storing and managing information. This reduces a number of risks that come with holding data in a centralized system. For one thing, blockchain data is significantly more secure as there's no one point of entry available to bad actors - it's also more secure against data loss as it's not located in a centralized point.

Blockchain's decentralized network is also radical in the degree to which it removes power from any single authority. Bitcoin, for example, differs from traditional currencies in its decentralized nature, with no bank setting monetary policy or interest rates.

Conclusion

Blockchain is an increasingly popular technology and it has the power to revolutionize any number of industries. In healthcare, blockchain's secure ledger can be used to manage data records of patients and secure health records whilst the construction industry blockchain can be used to provide a single source for knowledge within project management.

Thanks to blockchain's decentralized nature and its transparent functioning, it's a democratizing technology, allowing individual users to have faith in larger projects. As big-name brands develop their own blockchain tech for commercial use, like the IBM blockchain, it's sure that this technological trend is going to grow and grow.


About the author:

Ashley Halsey is a science and technology writer at Nursing Assignments. She enjoys demystifying technical processes, bringing science education to the masses. She lives in Austin, Texas with her daughter.

Disclaimer:

The above references an opinion and is for informational purposes only. Do not take this as personalised financial advice or investment advice. The views expressed by the author do not necessarily represent the opinion of BitPrime.

Last updated: 26/03/2021

1 thought on “How and Why Blockchain Technology Works”

  1. I am looking for a way to fund conservation projects in New Zealand in a more efficient, effective and integrated way. The idea is to combine funding from public sources (the government) with local private donors to fund conservation projects carried out by both paid workers and voluntary labor. Even within local districts there are multiple voluntary groups and agencies competing over funding and territory. Would blockchain and a cryptocurrency specifically for conservation projects be a way of increasing funding and better conservation outcomes? If so, how would it be set up?

    Reply

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