Understanding the Blockchain - Full Technology Explanation

Continuously growing ordered and time-stamped record of transactions

by Ivan Penkov
31 May • 6.5 min
In Tech

What Is Blockchain Technology and How Does It Work

A Blockchain is a public ordered ledger or data structure of transactions. Blocks are added in a chronological order. One of the main characteristics of a Blockchain is that it empowers a network that is resilient to censorship. Transactions on a Blockchain cannot be blocked. In 2009, Satoshi Nakamoto introduced Bitcoin and also the first Blockchain. Blockchains allow people to transact without the need of a central authority or administration and without the need to know one another. Blockchains offer a working solution to an old problem for distributed networks – the so-called Byzantine Generals’ Problem.

The Blockchain accomplishes everything through its consensus algorithm. In Bitcoin, this algorithm is called Proof-of-Work (PoW), which means that in order to create blocks and chain them together computers must solve very complex mathematical problems. The work invested in solving those problems and thus creating a block is costly and it ensures that the information in the block is difficult to alter. The electrical energy for running PoW is huge and costly. Some people consider it as wasteful and also negatively impacting the environment.

 

Blockchain Definition - What is Blockchain Technology (Overview)

The first definition of a Blockchain was given by Nakamoto, which he included in the source code of the first release of the protocol “BitCoinv0.01ALPHA” in “main.h”, starting at line 795:

“Nodes collect new transactions into a block, hash them into a hash tree, and scan through nonce values to make the block's hash satisfy proof-of-work requirements. When they solve the proof-of-work, they broadcast the block to everyone and the block is added to the blockchain. The first transaction in the block is a special one that creates a new coin owned by the creator of the block.”

 

blockchain working process

 

There are two types of Blockchain – permissionless and permissioned. Both are sometimes referred to as Distributed Ledger Technologies (DLTs). Permissionless Blockchains operate in untrusted environments, encouraging open innovation. Permissioned Blockchains encourage authorized innovation and allow a small number of people to run nodes similar to a centralized database, where nodes have to ask for permission to participate. There is also a hybrid type, which allows the public to monitor the chain, but does not permit the public to write on the chain. Permissionless Blockchains are Bitcoin and Ethereum. Anyone can join their networks and run a node. Developers can develop software and use the open source materials without asking a central body for membership.

 

The History of Blockchain

The idea of decentralized electronic cash is not new. However, in the past, it was hard to implement a decentralized e-cash with trustless peer-to-peer (P2P) nodes without using some kind of third parties. If third parties are required for a P2P e-cash, then it misses the whole point of decentralization. Nearly all of the exciting ideas and technologies in Bitcoin can be traced back 20 years ago.

For example, time-stamping, Proof-of-Work and Merkle trees originated by Haber and Stornetta, Dwork and Naor and Ralph Merkle, respectively. Those technological components can be found in the academic literature of the 1980s and 1990s. Nakamoto’s talent was to put together the underlying technologies in a specific way, which could explain why Bitcoin and the Blockchain took so long to be invented. Bitcoin and Blockchain were in the kitchen for 30 years before they were released to the public.

 

How Blockchain Works

The Blockchain is created through a process called mining, in the case of PoW, or staking, in the case of Proof-of-Stake (PoS) algorithm. PoW is a system, where mining structures burn electricity to create security for the coins so that no one can create extra coins (capped at 21 million Bitcoins) or double spend. Each new block contains transaction history and it is chained to the previous block by cryptographic hashes. Every new block includes the hash of the previous, thus creating a chain of blocks.

 

	blockchain hash

 

Each newly mined block contains also the reward that is given to the miners for providing their computing power in solving the puzzle. A block reward is a form of subsidy. This reward is included in the “coinbase transaction”, which is the first transaction of each block. The amount of the coinbase is equal to all the fees from all transactions in a block plus the subsidy. The supply of new coins comes from this block reward. Miners compete with each other for the reward and for the transaction fees and they are essential to the currency’s decentralized nature.

 

Advantages of the Blockchain

The Blockchain technology disrupts mainly the traditional middlemen model. Transactions on the Blockchain are publically reviewable and verifiable without the need of a trusted intermediary. It reduces the need for banks, for example. Blockchains give direct control over financial activities.

 

blockchain model graphic

 

In reality, no one wants to use a Blockchain unless he or she has to. Censorship-resistance is the number one reason why people would run thousands of computers to convert electricity into anonymous value for payment processing. Financial services benefit the most from having a Blockchain, because they require having an ordered data structure, and so are supply chains. It is also possible to put data on the Blockchain, but there should be a very good reason to do that because the cost for putting data on the Blockchain is very high and this data cannot be deleted once it is there.

 

Blockchain in Business - How Can It Help

As with any disruptive innovations, this technology could create new industries and potentially new markets. For example, mining pools (a way of collectively mining Bitcoins) are emerging, also, new payment systems, privacy-oriented services, and payment anonymization.

Regulatory arbitrage and censorship-resistance are for now the main themes for use cases of Blockchains. There are some other potential business uses apart from value transfer. Those use cases could be grouped into two main categories – digital notaries (time-stamping) and smart contracts.

Smart contracts with the help of digital bearer instruments (Bitcoin, Ethereum) make it possible to create a digital equivalent of legal contracts. Smart contracts can be seen as an evolution of digital bearer protocols. A Blockchain notary can be used for certifying and verifying of documents for proof of ownership and proof of existence. Some of the legal records that could be on a Blockchain include titles, birth certificates, voting, or court records.

 

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