ELI5: What is blockchain and how does it work?

Blockchain technology on blue background - 3D Rendering

Date Published

03/25/2020

As the presence and potential of blockchain grows, it is becoming more of a household term. But how many truly have a firm understanding of how this technology works?

It is, after all, an advanced form of tech slated to reshape the fundamentals of many key industries.

If you are new to blockchain applications like cryptocurrency or are interested in getting involved, you should first understand how it works.

But before we get into the nitty-gritty, let’s start with one of the key components of blockchain – understanding the difference between a centralized and decentralized network.

What is a centralized network?

In a centralized network, all parties involved rely on a singular central entity to carry out and verify transactions, maintaining the sole ledger on everyone else’s behalf. A bank is a good example of this.

But there are several issues with this structure that make it less appealing than a decentralized network.

For starters, investing all your trust and reliance into a single party can be a risk to the security and validity of everyone involved. These intermediaries have been shown to collect and sell data of involved parties without consent, allow data breaches, display inefficiencies, and more.

There’s also the issue of remittance, which leads to fees for sending money through several intermediaries to a recipient overseas.

What is a decentralized network?

In a decentralized network, every involved party manages its own independent ledger that tracks all transactions and works off everyone else’s ledger to verify transactions and form a consensus. The records can’t be manipulated as long as the majority of those involved are working for the good of the group.

Blockchain automates this trust. It verifies the credibility of all transactions for the whole community to see, removing threats of corruption and manipulation by any one party with more control or influence than the rest.

A good analogy for this shared and auto-verified ledger is a Google Doc. Everyone working on the doc has access to the same exact file and can see and verify updates in real-time.

With a Word doc, however, changes would have to be made by one party at a time and then sent on to the next for further editing. This is more akin to the conventional ledger style inherent in centralized networks.

Now that we’ve broken down this crucial differentiator of blockchain technology, let’s take a look at a few of the key terms involved in transacting along a blockchain.

Block

A block is a piece of digital information that includes records of the most recent transactions within the network. You can think of a block like a puzzle, where each piece represents a different transaction and its related data.

With bitcoin, a block shows all transactions that have taken place within the past 10 minutes (on average, though two blocks could be added in seconds and some blocks don’t include any transactions other than the block reward). This means that under typical circumstances, a new block (or puzzle) is created every 10 minutes and sent out to the network to be put together (or solved). More on that later.

Chain

A chain can be thought of as a shelf that stores all completed puzzles in the history of the network, with each one being different but visible to everyone involved. Once a block (or puzzle) is added to the shelf (or chain), it can never be edited or deleted except by what is known as a 51% attack.

Each block is mathematically linked to and has reference to the block that came before it, so the database becomes theoretically immutable.

Node – Users keeping the network alive

A node is a term for each individual member of the blockchain community working to solve these puzzles (blocks) and managing its own version of the distributed ledger (or shelf of puzzles). While every user has its own “version,” each user has visible access to every other user’s ledger which are essentially copies of one another.

In the case of bitcoin (the first widely used application of blockchain), a node refers to a user operating on the bitcoin blockchain to help verify transactions. This activity, in turn, works to keep the network alive, accurate, and moving.

Nodes are often also referred to as miners, though there is some distinction between the two.

A miner’s purpose is to grab and verify transaction requests that create new blocks – or in other words, to put together the puzzle once it’s created and sent out. All nodes must update their ledgers with the newly created blocks. This verification and creation of new blocks prevents transactions from being copied or used twice.

Mining

As stated, mining is the process of solving a block and adding it to the chain – or putting together a puzzle and adding it to the shelf.

When a block is solved, miners receive a reward that is set and changes over time, known as a block reward. The mining process is automated, in that the mining software and computer associated with a user do the work on their own. Faster, higher-performance machines lead to more frequent rewards for miners.

Transaction breakdown – Putting together the puzzle

Let’s say you wanted to send a friend 1 bitcoin – or 1 piece of a puzzle.

  1. This request would be broadcast to the entire bitcoin network and your piece of the puzzle along with the rest of the yet-to-be-completed puzzle would be sent to every member.
  2. Each member (miners) would then try to assemble the puzzle that includes your transaction. The member that puts together the puzzle first (solves the block) adds it to the shelf (chain) and shows the network the new version of the shelf (blockchain), which includes the newly completed puzzle that houses your transaction.
  3. All other members then agree that all puzzles shown in the new version of the shelf are valid, at which point the member that completed the puzzle and displayed the new shelf will receive a reward – and your friend will receive his or her piece of the puzzle (1 bitcoin).
  4. The mining process then starts over and the next puzzle is sent out.

This shows why miners are so crucial to the blockchain process – without them, there would be no completed transactions (that is, the puzzles would be sent out and never completed).

Why is blockchain so popular?

Blockchain’s popularity has blossomed for a number of reasons relating primarily to its decentralized nature.

Fiat money is owned by banks that can freeze funds, deny requests, and charge fees.

But with blockchain, users have an increased power over their own finances and are able to send money on a peer-to-peer basis without the need for this third-party involvement.

The structure of the network itself also fosters trust. Since miners are rewarded with crypto and invest highly in powerful hardware and hosting, any rejected transactions due to malicious behavior or dishonesty would only result in wasted time and money for everyone involved.

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Contact us to learn more.

Date Published

03/25/2020

Author

First Scribe

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