A blockchain is a digital ledger that’s shared across a network of computers. While many acknowledge that blockchain technology is powerful, few understand the reason for its existence and the basics of how it functions. Learning how blockchain works can give you the ability to appreciate this new technology and bring you one step closer to using it to your advantage.
This article covers the basics: understanding how a blockchain works and how to use blockchain applications in various real-world industries today. We also highlight the benefits of using blockchain networks.
- Blockchain basics
- Types of blockchains
- Purposes of blockchains
- Blockchain network benefits
What is blockchain?
A blockchain operates on a Distributed Ledger Technology (DLT), where each new transaction is recorded on a digital ledger that’s distributed across a computer network. It stores information electronically in groups called blocks. Any information stored on a blockchain is considered secure.
Understanding blockchain basics
To understand how a blockchain works, you’ll want to understand the concept of a block. Databases usually structure information in tables, but a blockchain uses blocks that link together to form a chain, which becomes the blockchain.
Information is stored as a record, and multiple records can be stored inside a block. The block groups together and stores records until its storage capacity is met.
At this point, it’s closed and linked to the previous block on the chain using a hash, which is a unique code. Any new information is compiled into a new block, which is linked to the latest one once it reaches capacity.
The blockchain stores information without letting anyone edit it retroactively. Once a block has been filled, no changes or edits can be made to it without the entire chain being disrupted.
If an edit is made to a block after it’s been committed to the blockchain, its hash will also change. When this happens, the next block in line—which used the previous hash to link itself to this block—will become unlinked.
It’ll then have to be modified to be relinked to the first block. As a result, even the smallest edit to a block can trigger a domino effect that’s both significant and undesirable.
Worth noting, a record must be checked before it’s added to a block. In place of a centralized authority to verify the information, different computers within the peer network—called nodes—take responsibility for this task.
They can all access this data and compete with one another to be the node that adds a record to a block. Only after verification can the information be included in a block or blockchain.
How can you trust the nodes in the network? Unlike centralized authorities in charge of other technologies, the nodes are operated anonymously. To build trust, blockchains require prospective nodes to prove themselves by passing certain tests called consensus models.
Proof of Work (PoW) and Proof of Stake (PoS) are two examples. The first demands that nodes employ great amounts of computing power to mine blocks and prove to others in the entire network that they can be trusted. In the second, interested parties purchase certain tokens, permitting them to mine more.
This distributed system of verification—coupled with the difficulty of editing a block after it has been added to the blockchain—establishes confidence in blockchains as legitimate and secure ways to store information digitally.
Types of blockchains
Now that you understand the basic logic of blockchains, let’s look at a few classes of blockchains and examine their relevance.
- Public blockchains
- Private blockchains
- Permissioned blockchains
- Consortium blockchains
A public blockchain is open to all, meaning anyone can access and contribute to it. As the entire ecosystem is open source, there are no restrictions on who can perform activities related to that blockchain.
Mechanisms like Proof of Work (PoW) and cryptography are employed within the algorithm to secure the database. PoW is a way to add new blocks to the original blockchain network. Cryptography is a method of securing information so no one can understand it apart from the intended recipient.
Bitcoin is a cryptocurrency operating on a public blockchain.
Public blockchains use incentives to encourage participation and interest. They’re also the most decentralized and distributed chain solution, with no possibility for a central figure to take control of the system.
A private blockchain only admits verified participants to the network. You usually require an invitation to the blockchain network, in addition to some form of approval. This approval can be executed by a network operator or is a clear protocol defined by the rest of the network.
Private blockchain networks limit access to the blockchain network and its activities, including the management of the shared digital ledger. Unlike in a public blockchain, network operators have certain prevailing powers, such as the ability to make changes to the blockchain.
Even verified nodes may have limited access to activities on the blockchain. Not everyone is permitted to validate changes, for instance.
Therefore, a private blockchain is distributed to an extent but not decentralized. It relies on basic blockchain technology, but its trust mechanisms are a significant departure from those of a public blockchain. A private business, for instance, may benefit from using such a blockchain to document its financial history.
Permissioned blockchains provide a middle ground between public and private blockchains. These are built to offer high levels of customization for each actor, so virtually anyone can participate in the network after passing certain validation checks, but with varying degrees of access.
Depending on the actor’s role in the blockchain network, they can be permitted to perform certain activities and not others. This flexibility makes permissioned blockchains a viable consideration for many businesses that don’t want to close off the blockchain but may want to restrict permissions, like writing information into the blockchain, to certain participants.
Like permissioned blockchains, consortium blockchains are semi-private. However, they serve a specific purpose: to strengthen cooperation efforts between companies.
Often, companies or organizations collaborate to deliver high-impact solutions. They rally around common goals and work together to meet them. Blockchains amplify the trust between them by offering these groups more transparency and accountability mechanisms for their operations.
Consortium blockchains also make it easier for new actors to join established coalitions and build on existing work.
Purposes of blockchains
The proliferation of different types of blockchains has also allowed the technology to penetrate a wide range of industries, like real estate, non-fungible tokens (NFTs), and financial services such as credit cards.
Below, we explore some use cases of blockchains in the real world today:
- Banking and finance
- Smart contracts
- Health care
- Supply chains
Blockchains are most closely associated with cryptocurrencies like Bitcoin and Ethereum, since they store information about transactions. Blockchains were first presented in a research project in 1991, but they quickly rose in popularity with the introduction of Bitcoin by Satoshi Nakamoto in 2009.
Fiat currencies like the U.S. dollar are controlled by a central authority, putting an individual’s wealth in the hands of financial service providers like banks. Any damage to these institutions can result in significant consequences for people’s financial holdings.
Cryptocurrencies are significantly more secure because they rely on a blockchain. Transactions can’t be edited without the knowledge or approval of the network. With these kinds of digital currencies, the risks are lower, as are the transaction costs, because no singular entity serves as a middle person.
Banking and finance
More traditional money exchange systems can also benefit from using blockchains for their operations. The technology isn’t bound by certain constraints that limit the functioning of these institutions.
For example, banks can reduce processing times and offer their services around the clock by incorporating blockchains for recording transactions.
Blockchains speed up the process of making transactions between institutions and can deliver them more securely. Longer processing times render the money in transit more vulnerable, especially in large amounts.
A smart contract is a code written into the blockchain to execute the terms of a contract agreement. The code is bound by a set of conditions and runs automatically only when the conditions, which the users decide, are met.
Transacting parties must submit their part of the deal to the blockchain. The code verifies that the conditions they set are met. These conditions could indicate the amount to be paid by one party or a deadline to do so; for instance. If the conditions aren’t met, the transaction or deal doesn’t go through.
Smart contracts eliminate the need for a middle person to sign off on the deal and assure both parties that they won’t be cheated. In place of this third party, the contract is the verifying authority that guarantees a secure transaction between the actors involved.
Smart contracts can be used for any kind of agreement between two parties, monetary or otherwise, like keeping records of real estate transactions.
Blockchain technology is also attractive to medical professionals and institutions. It can enable secure medical data storage, such as patients’ health records.
A medical record can be written into the blockchain, guaranteeing a patient’s data can’t be tampered with owing to the blocks’ immutable nature. For further security, these can be located on private blockchains using private keys, so only relevant medical professionals can access the data as needed.
Raw materials and finished products change hands throughout the production and manufacturing process. A blockchain can add a layer of trust and verification, as suppliers and retailers can trace the path that the materials took before reaching them.
An entry can be added to the blockchain every time the material is passed from one actor to another. With no way of modifying the information without every actor in the network knowing, this can act as a reliable source of information. Companies can benefit from using consortium blockchains to keep track of this information.
Blockchain technology can revolutionize voting by forming the basis for a secure online system. It can increase transparency and prevent malicious actors from tampering with votes. Results would also be available almost instantaneously, as the blockchain eliminates the need for election officials to manually count or recount the votes.
Blockchain network benefits
Regardless of the kind of blockchain you decide to use, blockchains offer many potential benefits.
- Highly accurate. The blockchain verifies information without human intervention. This does away with any related risks. Relatedly, the watchful eyes of multiple nodes ensure that mistakes are avoided.
- Efficient. A blockchain gets the job done and is fast. Smart contracts, for example, can execute only if certain agreed-upon conditions are met. A block can only be linked to the newest one that’s already on the blockchain. There’s no room for bending such rules when most of the control sits within the technology itself.
- Secure. Blockchain systems, even public ones, have mechanisms of validation in place and can’t be altered. The cryptographic hashes that link blocks together are essential pieces of the puzzle, as they build the blockchain and ensure the blockchain security system is robust and safe from those with malicious intent. Depending on the blockchain network, nodes must be approved by some form of consensus.
- Transparent. Barring more private blockchains,the existence of everything on a blockchain is visible to all participants in the network of computers. With high levels of transparency, accountability is almost built into blockchain-based systems.
- Decentralized. One of blockchain technology’s biggest contributions is its elimination of centralizing authorities. It distributes control and management of the blockchain across the network. Individuals need only trust the technology and each other, as opposed to relying almost exclusively on an unknown party.
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