Blockchain is a new technology popularized by Satoshi Nakamoto’s white paper about Bitcoin. The Bitcoin blockchain came into being back in 2009.
How does blockchain work exactly? This article gives you a quick and simple overview about what blockchain is, how it works, and why it is important for you to learn more about it.
What is Blockchain
Blockchain is a new way to organize, store, and control data. Specifically, financial data. It runs on what’s called a distributed ledger. Think of this like a giant global Excel spreadsheet. The difference between ye olde Excel and a blockchain? No one person owns it while anyone in the world can look at the data recorded on it.
Entries made to this global Excel spreadsheet are validated by a group of volunteers called miners. Except they’re not true volunteers because they work for compensation. In exchange for providing the computers and the energy to power the blockchain network, they receive compensation in the form of a cryptocurrency.
Blockchains were originally designed to store financial transactions in order to create a new peer-to-peer, decentralized financial system. AKA you can now store, send, or receive money on a blockchain without having to go through a bank. While blockchain was invented with the financial system in mind, it has applicability beyond just managing money.
The data stored on a blockchain forms a public database. The transfer of money – or information – on a blockchain can be both protected while also being publicly verified.
This makes blockchains trustless and permissionless, meaning you don’t need to put your trust in a third-party – like the government or a bank – to facilitate transactions. New applications of this technology are being developed in order to do things like increase transparency in supply chains, automate contracts, or improve how electronic health records are managed.
How Does Blockchain Work
A blockchain uses principles of cryptography to encode information. Basically, you need a set of digital keys to access the blockchain, kind of like how you would need a cipher to unlock a secret message.
Remember the message Ralphie decoded with his special pin in A Christmas Story? That’s how cryptography works and is kind of similar to how data is protected on the blockchain.
Encoded information is recorded on the blockchain through a distributed network of computers. The point of this is to eliminate centralized control of data. This means instead of relying on your bank to correctly process transactions and store all of that information on their internal network, the blockchain can store that information for you.
Once data is on the blockchain it can’t be changed. This makes it “immutable.” How? The digital keys you use to access the blockchain create a digital signature. This signature combined with some other cryptographic wizardy, creates a “chain” of numbers that is impossible to change. At least with the technology we have right now.
New information is stored on the blockchain in the form of a block. This is kind of like entering information in a cell on a spreadsheet. Everytime a new block is created, it is added to the end of the blockchain. When it’s added it essentially concatenates all the digital signatures of all the blocks preceding it before it before appending the new block’s signature to the end.
Here’s a very simplified way of looking at how encoding data on the blockchain works.
Block A, Block B, Block C, and Block D all represent blocks on the blockchain. For Block B to be recorded, it must include the digital signature of Block A. Meanwhile, for Block D to be recorded, it must include the digital signatures of Blocks A, B, and C before adding it’s own digital signature at the end.
This creates a chain of interlinked blocks, hence blockchain. The process of concantenanting digital signatures repeats every time a new block is added. This is what makes blockchains so hard to tamper with and thus trustworthy. To change the blockchain signature of Block D, you would also have to go back and change the corresponding signatures for Blocks A, B, and C in all of the blocks preceding it. When there are millions of blocks in a blockchain this is nearly impossible to do.
Cryptography is not only used in encoding information within blocks, it is also used to add new blocks to the blockchain. Essentially miners add new blocks after successfully sovling a cryptographic puzzle.
The process of solving the puzzle is based off of Alan Turing’s process of cracking German codes as depicted in The Imitation Game. Miners basically race against one another to guess a sequence of numbers until someone finds the right one. (More on this in a forthcoming article about Proof of Work).
Blockchains are run on a peer-to-peer network of computers. Unlike the way the internet works now, there is no single entity that controls the servers or digital infrastructure running the blockchain. Because it is founded on the principle of being able to share data with peers, it also makes centralized institutions – like banks – redundant.
This isn’t a new concept from a financial perspective. Apps like Venmo and CashApp already use peer-to-peer technology that allows you to send money between people. What makes blockchain different is that it eliminates the need for a bank entirely. Instead of linking a bank account to your Venmo account and withdrawing or depositing money from that, the blockchain is able to process payment transfers independently. This means you get to become your own banker.
Why Blockchain is Important
Everything in our world is centralized and power is concentrated in the hands of a few entities. The invention of the internet started to change that by making it easier to access information. Now blockchain technology goes a step further by allowing you to own and control what data is available to the world and how other people can use it.
As access and control of information continue to evolve, blockchain could represent a technology that has the potential to dismantle existing power structures and redistribute power back to the people. This threatens banks and governments alike.
Everyone has the potential to benefit from this transformation, just like anyone has the power to use Google to answer a question. The problem is, if you don’t understand how blockchains work or what decentralization means, you might not be prepared to fully benefit from it.
The difference in understanding and utilizing the technology could lead to a new form of centralization and concentration of power. Instead of formal institutions controlling information – like governments or banks – blockchains may enable individuals to hold more power.
Specifically the ones developing the applications needed to make blockchain more user-friendly. AKA technocrats like Elon Musk or Mark Zuckerberg. This is why it is important to understand how data is stored on the blockchain and for whom decentralization is intended to benefit.
Big Takeaway
Blockchain is an important technology that is changing how data is stored, shared, and used. Instead of relying on governments, banks, or large corporations to be custodians of information – whether that is financial data or personal data – blockchain redistributes power back into the hands of users.
The caveat: users have to be aware that this is happening. Otherwise, information will be re-concentrated between those who know how to use blockchains and those who do not.