Since the creation of bitcoin in 2008, blockchain technology has appeared to be in nearly all aspects of our lives, yet many people still find themselves asking: what is blockchain and how does it work? From copyright protection to crowdfunding to stock trading to purchasing virtual cats (yes, seriously), this revolutionary technology has reshaped the internet.
Blockahin was adapted by someone with the psyudenm Satoshi Nakamoto to power the digital currency bitcoin, but it has since evolved to other uses, making it seemingly a complicated topic to fully understand. Nonetheless, once you understand the technology behind blockchain (and bitcoin specifically), it’s a lot easier to explain how blockchain works than to explain how other monetary systems, like the Federal Reserve, function.
The true identity of the inventor of blockchain technology is still not known. Satoshi Nakamoto is the pseudonym that was used in the first bitcoin white paper that explained how this new invention called bitcoin would work. There have been rumors that the real Satoshi Nakamoto is Elon Musk, John McAfee, or the Central Intelligence Agency. It’s no wonder people are still asking the question: what exactly is it and how does blockchain work?
What is Blockchain?
Blockchain and bitcoin is often used in the same context but they are by no means synonyms. Blockchain is not bitcoin and bitcoin is not blockchain.
Blockchain technology is what powers bitcoin, which is the most well-known cryptocurrency. Simply put, blockchain provides a way for untrusted parties to transact with one another without the need of a trusted 3rd party. Don & Alex Tapscott, authors of Blockchain Revolution describe it best by stating blockchain is
“an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value”.
Blockchain technology was a result of Satoshi Nakamoto’s original goal of creating a “new electronic cash system that’s fully peer-to-peer, with no trusted third party”. In the wake of the 2008 financial crisis, there was an immense amount of increased skepticism in regards to the role banks played as safeguards of the financial system.
Many see blockchain technology positioned to disrupt the traditional financial sector, providing a complete alternative to traditional banking, i.e. ACH transfers, wire transfers, checks, etc. Blockchain eliminates the need of a bank or another financial 3rd party middlemen to verify the financial transfer between two parties. This is a huge deal.
How Does Blockchain Work?
The best way to understand how blockchain technology works is to break it down with an example. Traditionally, if you wanted to send money to another individual, you would use your bank or another money transfer service such as Venmo or PayPal, for example. In this model, the money goes from one bank to another and then to the recipients account.
This antiquated system not only takes a several days time to complete transactions, but it also adds obscene fees for money-senders, some being as high as 7.68% per transaction. Many believe the fees associated with the traditional banking system are a massive reason why financial industry leaders vehemently oppose bitcoin. Jamie Dimon, who’s head of one of the largest banks in the world, JP Morgan Chase, once famously stated that bitcoin’s only valid use is for criminals.
Once we understand how simple and effective blockchain is, and how simple and effective it is to send a form of currency via blockchain technology, Dimon’s remarks about bitcoin seem to come from a place of fear and uncertainty.
Just like how TV killed the radio, and the Internet killed TV, blockchain is disrupting the entire worldwide financial industry – and the status quo doesn’t like it.
The key difference between blockchain technology and traditional forms of sending money, is that blockchain allows for an online payment to move from one party to another without a “trusted intermediary” like a bank or a financial institution.
A network of computing “nodes” make up the blockchain. These “nodes” are computers connected to the blockchain network. When a node, also known as a “miner”, enters the blockchain network, they get a copy of the network and race to validate the transaction. Anyone can enter the blockchain network and are incentivized to join in the chance of winning bitcoins. In this way, the network is decentralized”, making each node (or computer) an “administrator” of the blockchain.
Given the rapid increase of data in our world, storing identical blocks of information across a peer-to-peer network ensures it cannot be controlled by any single entity and guarantees there will be no single point of failure – it’s simple and genius.
Acting as a “chain of digital signatures,” the “blockchain” enables each coin owner to transfer currency directly to another individual within the same network. As a result, there are many transactions that occur at the same time. Within a given timeframe, these transactions are combined to form a “block”. Each node (computer) is given a copy of the block which holds all the information regarding the transactions that occurred within that time frame.
Because each node has a copy of the same block, it’s virtually impossible to hack or exploit the data, as would be possible in a centralized system housing the same information.
Each block has three elements:
- hash of previous block
What is stored in the data of a block can vary for different cryptocurrencies, but in the case of bitcoin, the sender, receiver, and amount is stored. Keep in mind, the “sender” and “receiver” are not actual names; they are an anonymous set of unique numbers and letters.
The hash for a block is also a set of numbers and letters that is unique to each block. Think of a hash as an identifier for one block (which contains the transaction info for a transaction) in the chain of blocks. This is why blockchain is so secure. Each block not only contains its own hash, but it also contains the hash from the previous block.
For bitcoin, a global network of computers jointly manages the database that records transactions. This decentralization means the network is powered on a peer-to-peer basis. And bitcoin is just one example of a decentralized blockchain network. There are other popular cryptocurrencies powered by blockchain like ethereum and ripple.
In many ways, blockchain technology has been viewed as a reversed way of computer programming. Instead of data being stored in a single location (i.e. a database, server, data farm, etc), it exists on every computer (known as a node). It’s sort of like a form of peer-to-peer file sharing, like the original Napster.
Regardless of the perception of blockchain, it is undoubtedly taking shape in our lives in many ways. The financial sector offers the strongest use cases for the technology as it currently stands, but there are many startups and players experimenting with blockchain uses in other sectors.
Distributed ledger technology and blockchain technology each have their own pros and cons, and it’s important to keep in mind that blockchain technology may not work for everything. In the financial sector, however, blockchain provides a revolutionary alternative to send and receive money instantly, and whether we like it or not, the core technology of a peer-to-peer transaction simply cannot be erased.