What is Blockchain & How Does Blockchain Work?

Updated: Mar 2

A definition of blockchain can be "a distributed database that records a continuously growing list of chronological records, known as blocks, which are connected using cryptography." Blockchain acts as a database, storing information in a digital format. Blockchains are well known for their critical role in keeping a secure and transparent record of transactions in cryptocurrency systems like Bitcoin. The innovation of blockchain technology lies in ensuring the authenticity and security of a data record without the requirement for a trusted third party.

What Is Blockchain Technology?
Blockchain Technology

A blockchain organizes data into an agglomeration called blocks that are inter-connected, each block being a reservoir of data with specific storage capabilities, which when full, are closed and linked to the preceding block, producing a data chain known as the blockchain. When implemented in a decentralized manner, this data structure creates an irreversible data timeline. When a block is filled, it becomes permanent and part of the timeline. All additional information is then added to a newly compiled block which is subsequently added to the chain after it is full. A cryptographic hash of the preceding block, a timestamp, and transaction data are all included in each block.

Thus, another blockchain definition according to its features can be that it is a decentralized, distributed, and public data structure used to record transactions across many computers in such a way that the record cannot be changed subsequently without affecting all following blocks and the network's consensus.

How does the Blockchain Work?

Blockchains are also known as distributed ledger technology(DLT). The purpose of blockchain is to enable the recording and distribution of digital data without the ability to modify it. In this sense, blockchain securities serve as the foundation for incorruptible ledgers, or transaction records that can't be changed, erased, or destroyed.

How Does Blockchain Work?
How Does Blockchain Work?

Here are the basic steps of a blockchain transaction:

1. A request for a transaction is made

2. A block is created to represent that transaction

3. Every node in the network receives the block

4. The transaction is validated by the nodes

5. Proof of work is rewarded in cryptocurrency to nodes

6. The block is then uploaded to the blockchain

7. The information is sent throughout the network

8. The transaction has concluded

Some important transaction steps that explain how does blockchain works:

Authentication: Though the blockchain is supposed to function without a central authority (i.e., no bank or regulator deciding who can transact), transactions must still be validated. Cryptographic keys, a string of data that are similar to a password, are used to identify a user and grant access to their "account" or "wallet" of value on the system. Each user has a private key and a public key that is visible to everyone. Using them together generates a secure digital identity that can be used to authenticate users via digital signatures and 'unlock' transactions.

Authorization: The decision to add a transaction to the chain on a public blockchain is decided by consensus. This means that the transaction must be accepted by the majority of "nodes" (or computers in the network). The people who own the computers in the network are rewarded for confirming transactions which are termed as Proof of work.

Proof of work: To add a block to the chain, Proof of Work asks the people who own the computers in the network to solve a complicated mathematical problem. This is known as Mining. Once the problem is solved, miners are usually compensated in cryptocurrency.

However, mining is a difficult task. The mathematical challenge can only be solved through trial and error, with a 1 in 5.9 trillion chance of succeeding. It necessitates a significant amount of computational power, which consumes a significant quantity of energy. This means that the benefits of mining must surpass the cost of the computers and the electricity used to power them because a single computer would take years to solve the mathematical problem.

Proof of stake: Later blockchain networks used "Proof of Stake" validation consensus procedures, in which members must have a stake in the blockchain - typically by owning some cryptocurrency - to be eligible to choose, verify, and validate transactions. Since no mining is required, this saves a significant amount of computational power. Furthermore, blockchain technology has grown to include "Smart Contracts," which execute transactions automatically when specific criteria are satisfied.

Uses of blockchain:

  • Transfer of Funds: Faster and economical money transactions, especially cross-border transactions.

  • Financial Exchanges: A decentralized exchange does not force investors to deposit their assets with centralized authority, thus, they have more control and security. While cryptocurrency is the primary focus of blockchain-based exchanges, the concept might be extended to more traditional investments as well.

  • Lending: Faster and cheaper loan processing with better rates due to smart contracts built on blockchains. With the help of blockchain, we can see the future of peer-to-peer lending, as well as faster and more secure loan processes in general, and even complicated programmed loans that mimic syndicated loan structures or mortgages.

  • Raising funds: Companies that use blockchain technology can speed up the process of funding by acquiring capital in a variety of methods instead of cash. Initial Exchange Offerings (IEOs), Equity Token Offerings (ETOs), and Security Token Offerings (STOs) are all examples of uses of blockchain in funding. Because of its legal protection, STO has been the most preferred alternative.

  • Trade finance: By digitizing and removing the time-consuming manual method, blockchain can help to streamline the trading process of all financial activities connected to international trade and commerce.

The blockchain is an exciting new alternative to traditional currency, centralized banking, and transaction systems that is revolutionizing not only how we handle financial transactions, but also how we use technology in general. Meanwhile, it will be intriguing to see where blockchain technology goes in the future, particularly in terms of money transfers, banking services, decentralized markets, blockchain supply chain, etc. For more articles like these visit our digital transformation agency.

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