How does blockchain work: A comprehensive guide to understanding the technology

jackmartinJune 21, 2023

Blockchain technology has become increasingly popular in industries that require trust and security such as healthcare and supply chain management. It works by creating blocks that contain unique identifying numbers and linking them together using cryptography. With no single point of control, it offers decentralized trust through a distributed network of computers.

What is a blockchain?

A blockchain uses a decentralized system, meaning the network of computers maintains a complete image of the blockchain ledger, and transactions are stored in blocks with unique identifiers and cryptography.

Blockchain vs traditional ledger

Unlike traditional ledgers, a blockchain ledger is decentralized, meaning it is not owned or controlled by a single entity. Transactions are stored across the network in a distributed fashion, and each block contains a cryptographic hash of the previous block, creating a secure and transparent chain of information. In contrast, traditional ledgers are centralized and controlled by a single entity, making them more vulnerable to manipulation or fraud.

Blockchain and digital asset

In addition to recording financial transactions like a traditional ledger, blockchain technology can also enable the tokenization of other assets that can be stored and transferred on the blockchain. These digital assets can represent anything from real estate to intellectual property rights, and they can be traded and exchanged just like cryptocurrencies.

History of blockchain

The history of blockchain dates back to the 1990s when Stuart Haber and W. Scott Stornetta introduced a system for storing digital documents that could not be tampered with or altered. However, it wasn’t until 2008 that blockchain technology gained notoriety with the introduction of Bitcoin, the first cryptocurrency. Satoshi Nakamoto, the anonymous creator of Bitcoin, wrote the Bitcoin white paper, detailing the technology behind it and how it can be used to build a decentralized financial system. Since then, blockchain technology has continued to evolve, with new applications and use cases emerging constantly.

Blockchain milestones and development

In 2009, Bitcoin was launched as the first application of blockchain technology.
In 2013, Ethereum was launched, making it possible to build decentralized applications (dApps) on top of blockchain technology.
In 2015, the first private blockchain, MultiChain, was launched, making it possible for organizations to use blockchain technology for their internal operations.
In 2016, the Hyperledger project was launched, an open-source blockchain platform designed for enterprise use.
In 2017, a record-breaking number of initial coin offerings (ICOs) were launched as blockchain technology gained even more popularity.
In 2020, blockchain became a key technology in the fight against COVID-19, with various blockchain-based solutions being developed for contact tracing and supply chain management.

How does blockchain work?

If you’re wondering how does blockchain work, it is used in industries requiring trust and security, such as healthcare and supply chain management. The technology works by creating blocks that are linked together using cryptography and distributed across a network of computers, with each computer maintaining a copy of the ledger.

Basic blocks and hash functions

Blocks are created by recording transactions, with each block containing a list of verified and timestamped transactions. Blocks also contain a unique identifier called a hash, which is generated by a hash function. The hash function takes the transaction data and creates an output of a fixed length, ensuring that any change to the block’s data will result in a different hash. This creates a secure and tamper-resistant system, since any change to a block will affect all subsequent blocks in the chain.

Consensus algorithms

In order to maintain the integrity of the blockchain, a consensus algorithm is used to ensure that all computers in the network agree on the state of the ledger. There are several types of consensus algorithms, including proof-of-work, proof-of-stake, and delegated proof-of-stake. These algorithms require computers in the network to perform complex calculations in order to validate transactions and add new blocks to the chain.

Mining and rewards

In a proof-of-work consensus algorithm, computers in the network compete to solve a mathematical puzzle, with the first computer to solve the puzzle earning the right to add a new block to the chain. This process is known as mining, and the computer that successfully adds a new block is rewarded with newly created cryptocurrency. Other types of consensus algorithms use different methods to validate transactions and add new blocks to the chain. Overall, blockchain technology offers a secure and decentralized system for storing data in a way that is resistant to tampering and fraud. Understanding the basic blocks and hash functions, consensus algorithms, and mining and rewards involved in blockchain technology is crucial for anyone looking to utilize this revolutionary technology.

Bitcoin vs blockchain

Bitcoin is the first and most popular application of blockchain technology, but both terms are often used interchangeably, leading to confusion. Here, we will look at how Bitcoin is a use case for blockchain, followed by understanding bitcoin mining and blockchain limitations for Bitcoin.

Bitcoin as a use case for blockchain

Bitcoin is a decentralized digital currency that operates on the blockchain. It utilizes blockchain technology to maintain records of all transactions made with the currency. The technology ensures that the data is encrypted and secure, making Bitcoin safe to use. Because of its popularity, Bitcoin became the first successful use case for blockchain technology and helped revolutionize the payment industry.

Understanding Bitcoin mining

Bitcoin miners validate transactions and add them to the blockchain. Miners race to solve a mathematical problem to verify and add the next block of transactions to the ledger. The first miner to solve the problem receives a reward in Bitcoin. The process is energy-intensive and requires a lot of computer power, making it expensive. Because of the limited availability of Bitcoin, mining activity is now dominated by a few select players, making it more centralized and less democratic.

Blockchain limitations for Bitcoin

Bitcoin transactions are public and cannot be altered, creating transparency and immutability, but this transparency also makes it more difficult to ensure privacy. Blockchain technology used for Bitcoin operates on a proof-of-work consensus algorithm, leading to several limitations such as scalability, energy consumption, and speed. These limitations have led to the development of alternative blockchain technologies such as Ripple and Ethereum.

Overall, while Bitcoin was the first successful use case for blockchain technology, it also highlighted several limitations and constraints of the technology. These limitations paved the way for the development of newer and more efficient blockchain technologies and alternative consensus algorithms.

Major players in blockchain landscape

There are many major players in the blockchain landscape, including:

Bitcoin: the first and most well-known cryptocurrency.
Ethereum: a blockchain platform that allows for the development of decentralized applications.
Ripple: a blockchain platform focused on remittances and cross-border payments.
Hyperledger: an open-source blockchain platform designed for enterprise use.
IBM: a major player in the blockchain space, developing blockchain solutions for various industries.

As blockchain technology continues to evolve, we can expect many more players to enter the field, as well as the emergence of new applications and use cases.

Blockchain applications

Blockchain technology has many real-world applications that are revolutionizing industries such as supply chain management, healthcare, and voter fraud prevention. By leveraging the power of blockchain, businesses are able to create more secure and transparent transactions, leading to increased trust and efficiency in a variety of sectors. Here are a few examples of how blockchain is being implemented in various industries:

For supply chain management

Blockchain offers a way to track products and ensure their authenticity throughout the supply chain, from raw materials, to manufacturing, to delivery. This helps to prevent fraud, reduce errors and inefficiencies, and promote sustainable practices.
Blockchain also streamlines the delivery process by automating many processes, such as inventory management, shipping, and payment processing.
Companies can offer greater transparency and accountability to consumers, by showing the entire journey of a product, from its origin to its final destination.

For healthcare

Blockchain is revolutionizing healthcare by providing secure, real-time access to medical records. This helps to reduce errors and increases efficiency, since all providers can access this information at the same time.
Blockchain also enables secure sharing of sensitive health data between patients and providers, without the risks of traditional data storage methods.
Smart contracts can be used to automate many healthcare processes, such as insurance claims processing and payments.

For voter fraud prevention

Blockchain provides a secure and transparent way to vote that is resistant to hacking and manipulation.
By storing votes on the blockchain, each vote becomes a unique and immutable record that cannot be altered.
Blockchain also enables real-time vote counting and auditing, which helps to prevent fraud and increase confidence in election results.

As you can see, blockchain has many real-world applications that are making a positive impact on various industries, creating a more secure, transparent, and efficient future for all.

Future of blockchain

The future of blockchain is exciting, with emerging technologies, changing the internet, and disrupting industries. Blockchain technology is constantly evolving, and this section explores how it’s shaping the future.

Emerging blockchain technologies

Interoperability: Blockchains must communicate with each other to achieve widespread adoption. Interoperability enables different blockchains to transfer value and data seamlessly.
Scalability: The performance of blockchain networks has always been an issue, particularly with public blockchains. Emerging technologies such as sharding, layer-two solutions, and sidechains promise to solve scalability problems.
Privacy: Blockchain solutions like zero-knowledge proofs and advanced cryptography can provide privacy to blockchain users. These technologies hide transaction details, ensuring they remain anonymous.

How blockchain will change the future of the internet

Decentralization: By removing the need for intermediaries, blockchain makes the internet more decentralized. This shift increases trust and security.
Data privacy: Blockchain provides privacy improvements such as user encryption and pseudonymity, it offers a better alternative to traditional data privacy regulations.
Data ownership: Currently data is centralized, but blockchain technology changes that by giving users greater control over their data. Blockchain-based data storage solutions will become essential for a more secure digital world.

The role of blockchain in industry disruption

Decentralizing the internet: With blockchain technology, users can control their identity and data without intermediaries. Decentralization will shift the balance of power back to the users.
Distributed finance (DeFi): DeFi platforms are blockchain-based financial services that can operate with more efficiency and transparency than traditional financial services.
Supply chain management: Blockchain-based solutions empower businesses, auditors, and regulators to track the movement of goods through complex supply chains easily.