How Does Blockchain Technology Really Work? A Deep Dive

What is Blockchain Technology?

In the past and even now in the traditional world, everyone would have their own records, and where sharing was necessary, then the parties involved would have to hire a third party whom they could all trust in order to make sure that everyone had access to the same information. As you can imagine and probably have experienced at some point in your life, this process was time-consuming and quite cumbersome. Blockchain evolved as a technology to solve this problem by allowing people to share records across their computers without relying on a trusted third party to edit or maintain the records. In many ways, it has paved the way for a communal ledger to which all parties have access. But how does it achieve this?

This communal access relies on three key aspects:

1. The cryptography. Every block of the ledger comprises transactions, which are identifiable by a hash, which is what we can refer to as the unique fingerprint assigned to each batch of transactions. When blocks are being chained together, they include the hash from the previous block to create the chain. This way, if anyone were to change the history of the transactions, it would break the chain, which would alert the other parties to the change. It is like an in-built alarm.
2. The distribution. You might wonder where people can access this ledger. Well, it exists across different machines. Each time users create a block, copies of it remain on independent machines. As such, if a copy were to get lost or tampered with, as we stated under cryptography, then other users would be able to access the original copies that existed before the chain was broken. Again, this prevents people from altering the transactions and also provides a history of the changes.
3. The consensus. So, how do blocks come together in the chain? This role falls on the nodes that agree on the transactions that are valid to be added to the chain, as well as the order in which they should be added. These nodes are governed by software that relies on the rules set out by the public, as we will explain in the next section.

The combination of these three features ensures that Blockchains offer users access to transparent and unchangeable information that can also be easily verified by using the hashes. Best of all, this trustworthiness exists all without involving a third party to keep an eye on the transactions.

The Making of Consensus

We mentioned that consensus is vital to the working of the Blockchain and that it sets out the rules for what happens within the chain. But who decides on this consensus in the first place? Well, there are several ways to achieve these rules, all of which come with different speeds, energy usage, and security. They are as follows:

1. Proof of Work (PoW). In this case, miners (also referred to as nodes) compete to solve a puzzle. For context, miners are participants in the Blockchain. The first to get the puzzle right also gets the opportunity to add the next block and gets a reward in turn, which can be newly created crypto with the addition of the transaction fees. Blockchain users love this mechanism as it is highly secure, as attacking it would require a very high level of computing power, which would have to be more than the rest of the network combined. Moreover, it allows more people to participate, which makes it more trustworthy. But since PoW also requires a high level of power, its energy consumption also serves as a downside.
2. Proof of Stake (PoS). Here, validators (who are also participants in the Blockchain) put up their cryptocurrency as collateral. The system then randomly chooses a validator to propose a new block, which other validators can confirm. Validators are able to earn transaction fees this way and are sometimes eligible for tokens. However, if they do not comply with the guidelines, they can lose part of the collateral that they put up. The idea behind this mechanism is to incentivize validators to be honest when securing the network, seeing as they have something to lose if they do not do the right thing.

In some cases, consensus systems rely on a smaller group of elected or known validators to set the rules. For example, a system can comprise delegated PoS token holders who take turns coming up with the blocks. This option works fast because block confirmation relies on only a few people, which makes it a great choice for private applications like supply chains. However, when it comes to public records, you will find that consensus mechanisms are PoW or PoS to inspire trust by allowing more people to be part of the decisions.

A Note on Decentralization

Traditional systems are highly centralized, such that we rely on specific institutions for our transactions. Take money transfer as an example. Both the sender and the recipient rely on banks for the transfer to take place, such that the bank serves as the center. When the bank’s systems are working fine, then the transfer goes through without a hitch. But if the bank’s servers go down, then the transfer cannot take place because the entire system depends on them. This centralization serves as a barrier to system efficiency, not just in finance but in many other industries.

Decentralization removes this center by ensuring that no single user or institution is responsible for making and implementing decisions. That means that users are not free to change rules, rewrite history, or engage in any other actions that would affect other users without getting the approval of others. Instead, decentralization distributes power across thousands of computers such that all users work together to keep the systems running through three dimensions:

1. The structure. Since there are thousands of independent nodes running the network, the systems keep working even when some nodes fail or are compromised. As such, users can continue transacting on the network, being none the wiser of these failures as they are not affected.
2. The governance. As we said, nobody has the right to make decisions alone. Whether users want to change parameters or introduce upgrades to the network, these decisions must be confirmed by other users. Decisions are arrived at through processes such as on-chain voting and community proposals, thus ensuring that nobody ever has the reins over the whole network, which you would see in a typical organization.
3. The logics. Many organizations position themselves as the centers of certain processes and will even go as far as making it difficult for their clients to switch services. But with Blockchain, the data is designed in a way that users are free to move between other providers of the same services or even create their own networks if they so please. This way, people never feel forced to keep using a system if it no longer matches their needs or preferences.

Decentralized systems offer users a say. However, it helps to note that this comes at the cost of speed. As we said, where decisions are based on public input, it can take a while to arrive at a consensus compared to highly centralized systems, whose decisions are much faster owing to less user buy-in. Even so, decentralization is not binary, and instead it is a spectrum such that systems can vary from minimally decentralized through to highly decentralized.

Examples of Applications in the Real World

Blockchain has become so popular over the past few years that it has made its way to several industries. Take gaming as an example. Many game developers are now using Blockchain to share information on how game results are arrived at, which helps their players trust the outcomes much more. But gaming is not the only winner in this decentralization era. Here are the top two industries that have embraced Blockchain with open arms:

Finance

We cannot talk about Blockchain adoption without touching on one of its biggest beneficiaries, which is finance. Top among the Blockchain uses that most people are familiar with is cryptocurrency, which allows people to transfer money globally without relying on third parties like banks. But did you know that Blockchain also helps people tokenize their assets?

That’s right! Investors are now able to present assets such as bonds in terms of tokens, which enables them to offer fractional ownership and sales to interested parties. On top of this, Blockchain has been instrumental to the popularity of smart contracts, which have eased lending and trading to a great extent.

As a whole, Blockchain has reduced transaction times and fees while opening up financial markets to more participants. But on the downside, smart contracts carry a degree of risk and require a lot of monitoring and testing to ensure they do not fail or have bugs.

Data Security

Data breaches come with many risks, including identity theft, financial losses, and more. Over the years, organizations handling massive amounts of data have sought effective ways to organize this data while keeping it out of reach of people who may not have the best intentions. Blockchain has served as a reliable tool in this regard. Not only does it allow organizations to create logs that can show cases of tampering, but it also enables them to create decentralized user IDs that do not reveal the personal data of the people in the records.

What’s more, just like with finance, organizations are using smart contracts to determine who can access and edit the data in these logs for added privacy. It’s no wonder that supply chains, health organizations, banks, and other organizations that deal with sensitive information have jumped on this trend.

A Look into the Future

Blockchain technology comes with many benefits, not just for organizations but also for individual users. With more people hoping to capitalize on its advantages, there have been, and there will be many changes in this technology, as follows:

• Decentralizing the cloud. Cloud storage is the in-thing, and with decentralization, people are able to store and access their data without relying on a specific provider, as has been the case for years.
• Machine-to-machine commerce. IoT (Internet of Things) devices will now be able to pay each other for data or services such as bandwidth or energy through micro payments, which will create a new commerce of its kind. This change is still in the works, but users are hopeful that it will come into effect soon.

Interoperability will also become a mainstay where networks will allow the flow of assets and messages between different networks, thus connecting different Blockchains for easier access.