Have you ever heard the term “blockchain technology”? It is often used in connection with cryptocurrencies such as Bitcoin. Blockchain is a term used frequently, but for people who are not familiar with the concept, it can be confusing. In this article, we will explain what blockchain technology is and how it works.
What is blockchain?
Blockchain is a decentralized, immutable ledger that can be used to record transactions involving tangible or intangible assets. An immutable ledger is a database that has the ability to remain unchanged. The digital ledger technology known as blockchain was first described in 1991 by Stuart Haber and Scott Stornett. Storing digital documents without the possibility of their return or forgery was the original principle of the blockchain. A year later, Merkle trees were incorporated into the first blockchain design and became an early instance of blockchain implementation.
In 2008, Satoshi Nakamoto (a pseudonym used by an individual or group of individuals) published a document on the Internet called Bitcoin: a peer-to-peer electronic money system. In 2009, Nakamoto implemented the first blockchain as an alternative to the current financial system. In a sense, the blockchain was developed specifically for Bitcoin but has since expanded to other areas.
What are the main elements of the blockchain?
- Distributed ledger technology
Network members have access to a distributed ledger and an immutable record of transactions. It allows transactions to be recorded once, avoiding the duplication of effort required in traditional business networks.
- Immutable Records
After the transaction is recorded in the public ledger, none of the parties involved can change or falsify it. If there is an error in the transaction record, a new transaction must be added with the correction, and both transactions will be visible.
- Smart contracts
A set of rules (“smart contract”) stored on the blockchain network is used and executed automatically to accelerate transactions. A smart contract can set terms for transferring corporate bonds, add payout criteria for travel insurance, and more.
How does blockchain work?
- Each transaction is stored as a block of data.
Transactions reflect the movement of an asset. You can fully control the content of the data block.
- Each block is connected to the previous and next blocks.
Blocks form a chain of data. They confirm the exact timing and sequence of transactions. In addition, blocks are inseparably linked, eliminating the possibility of changing the block or inserting a block between two other blocks.
- Transactions form an immutable chain of blocks: Blockchain
Each new block is considered an additional confirmation of the authenticity of the previous block and the blockchain. In this way, the blockchain is protected from unauthorized changes, and this is one of its main advantages — immutability. Since the possibility of hacking by intruders is eliminated, a reliable transaction book is created.
How does the Bitcoin blockchain work?
The Bitcoin blockchain resides on computers worldwide, unlike the ledgers kept by traditional financial institutions. Miners, the owners of the computers that store the blockchain information, are responsible for recognizing transaction requests from network users, combining, validating, and adding them as new blocks to the blockchain.
The validation process ensures that the person actually owns BTC after the transaction and has not yet spent them elsewhere. Ownership in the Bitcoin blockchain is determined by two cryptographic keys: public and private keys. The first key is publicly available in the blockchain, while the second is available only to its owner. When someone sends an encrypted message, he uses the public key. To encrypt it, the recipient uses the private key.
In blockchain technology, transactions are signed with private keys corresponding to the public keys associated with the coins they want to spend. And when the transaction is processed, a new public key is assigned to those coins. A user signature on a transaction confirms the authenticity of the transaction. The entire transaction history is stored by each network member simultaneously, so everyone can verify who owns specific coins.
If multiple participants are involved in the execution of the operation, the issue of irreversibility becomes important. If a single bank operated the blockchain with a number of known validators operating in the same jurisdiction, transaction execution would be a simple matter.
However, each block in the Bitcoin blockchain contains a group of transactions sent from the previous block. Each block confirms the integrity of the previous one starting from the first block in history called Genesis to maintain the integrity of the chain.
In the Bitcoin blockchain, the integrity of the blockchain is encrypted using the SHA256 algorithm. In this process, a special program takes data of any size and changes it into an unrecognizable set of numbers and letters called a hash. It is impossible to change the data in the blockchain — the slightest change in the original data significantly alters the hash.
When someone asks about your Bitcoin address,they mean a series of numbers and letters that identify your wallet. Usually, the address consists of 26–35 letters or numbers, which usually start with the numbers 1, 3, or the prefix bc1. If you have used cryptocurrencies before, you have probably noticed that your Bitcoin address changes after transactions. In reality, the originally generated address remains unchanged, and third-party services change it to maintain the illusion of anonymity.
As mentioned earlier, new Bitcoins appear on the network thanks to miners verifying blocks and adding them to the blockchain. This is because Bitcoin uses Proof of Work consensus. In PoW blockchains, miners are in a computational race to process new transactions.
All transactions are stored in a public database that is made available to the miners. Their computers go through various hash combinations looking for one that matches all new transactions. Once the hash is guessed, the block of all transactions is written to the blockchain, and the miners start selecting the next hash based on the following parameters:
- the new hash must be based on the hash of the previous block;
- the new hash should be the sum of the hashes of all bitcoin transactions in the last 10 minutes;
- the new hash should contain a random, non-repeating number generated by the miners.
How Proof of Work Makes Blockchain Technology Trustworthy
To create new blocks, bitcoin miners must have all the information about transactions. They compete with each other because the miner who created the block first receives compensation for his work. The question is, what prevents the miner from deleting previous transactions in the blockchain. This way, none can steal coins, but they can perform the same transaction multiple times. For example, pay for the goods and then delete the information about the transaction. To prevent this, all miners on the network must have the same copy of the blockchain.
When a miner adds a new block, it must provide cryptographic proof of the transaction. To obtain proof, the block goes through several rounds of a hash function, a mathematical calculation that turns an arbitrary amount of data into a fixed-length alphanumeric string called a hash. The blockchain algorithm requires that the resulting hash begins with a certain number of zeros to make the process more reliable. Since it is impossible to tell in advance which hash will result in a particular record, miners perform the calculations repeatedly, inserting a random number into the record each time. When this number changes, a new hash value is generated. As a result, the miners get the correct number of zeros. The miner who finds the correct hash sends the block to other miners. They verify it and add it to the full version of the blockchain contained on their computers.
Miners spend their money to maintain the network — they buy equipment and pay for electricity. To change a block in the blockchain and perform the same transaction twice, they have to spend twice as much money, so fraud becomes unprofitable.
It turns out that miners provide expensive proof and then get paid for their work. New blocks store the hash of the previous block. So any changes to old blocks will result in invalid hashes for all subsequent blocks. In addition, with each new block, the cost of changing the previous one increases. Therefore, it is not possible to insert dummy modifications into a previous block without repeating all the work done after that block.
How Is Blockchain Used?
Today, usage of blockchain technology is no longer limited to cryptocurrencies. It has gained acceptance in many fields: financial technologies, logistics, education, tourism, healthcare, and many other industries. The blockchain helps companies to:
- establish trust between the parties, which, accordingly, allows you to interact and exchange reliable data with each other;
- eliminate fragmentation of data by integrating it into a single system through a distributed registry shared across the network;
- restrict access to this registry to parties with appropriate permissions;
- ensure a high level of data security;
- eliminate the need for the services of intermediaries;
- guarantee the authenticity and integrity of the products sold to participants;
- track and control the movement of goods and services in the supply chain.
Let’s check the main areas of blockchain application.
1. Decentralized Finance, or DeFi in short
DeFi means financial instruments and services implemented based on the blockchain. Such products make it possible to replace the services of traditional banks and financial companies and thereby solve the problem of underbanked).
Key Benefits of DeFi:
- lower fees compared to traditional market participants;
- high level of transparency;
- broader availability and faster service delivery.
The Defi infrastructure and its regulation are still under development and discussion. This hinders the development of technology and related projects. However, banks are already
showing interest in DeFi, as blockchain allows them to improve many processes, such as money transfers. The introduction of blockchain into the banking industry will help to reduce costs and make most operations more efficient and reliable. Blockchain is also actively used by exchanges, brokers, asset managers, and other institutional players.
2. Non-fungible token, or NTF
A token is an entry in a ledger within a blockchain. Some tokens, like Bitcoin, are fungible, meaning that another can replace one Bitcoin. The non-fungible token was created to bring unique items to the blockchain. In other words, NFT is an asset that is unique and cannot be replaced by another token. In this way, people can use this technology to secure ownership of unique items. No one can change the ownership record or copy/paste a new non-fungible token into an existing one. NFTs are now taking over the world of digital art and collectibles everywhere.
3. Smart contracts
Blockchain technology allows you to bring the process of concluding transactions to a new level. A transaction can be completed by executing a certain algorithm, written in the form of sequential “if…then” conditions. The contract will be concluded only if each participant fulfills all the requirements. This technology can be applied in various areas: sale and rental of real estate, settlements with contractors, and others.
A smart contract has several advantages:
- Accuracy, efficiency, and speed.
The contract comes into force when the participants fulfill each of the necessary contractual conditions.
- No paperwork.
- Transparency and reliability.
The agreement is in the registry in encrypted form, which excludes the possibility of changing and distorting information by the participants in their favor.
To conclude a transaction, you no longer need to resort to the services of intermediaries, such as notaries or registrars, which, in turn, saves money and time.
The immutability of the contract, of course, ensures its reliability but at the same time deprives it of flexibility — it is quite difficult to make changes to the contract. In addition, the development of a smart contract requires significant time and material costs. Therefore, smart contracts are an excellent solution for concluding typical transactions.
What are the benefits of blockchain?
- Building trust
When you join the Blockchain network, you can be sure that you will always receive reliable and up-to-date information and that your confidential Blockchain records will be accessible only to the network members you choose.
- High security
A transaction requires all participants to agree on the accuracy of the data, and the records of all verified transactions are immutable. No one, not even the system administrator, can delete a transaction.
- Improving Efficiency
A distributed ledger that all network members can access eliminates the time-consuming reconciliation of records. A set of rules (“smart contract”) stored on the blockchain network is used and executed automatically to speed up transactions.
Blockchain over the past decade has gone from a niche technology for the creation and operation of cryptocurrencies to a worldwide innovation that has found application in almost all areas of human life. It is no coincidence that some experts compare the evolution of the blockchain with the development of the Internet. Now the technology is going through a growth stage, but most companies implementing the blockchain will be able to feel the real benefits only in a few years.
Integrating blockchain technology into the operations of crypto bank PointPay has allowed us to offer better services compared to traditional banks. For example, we can serve unbanked customers worldwide, promoting financial freedom worldwide. In addition, blockchain technology has allowed us to improve the efficiency and transparency of our services while ensuring a high level of security. We believe that blockchain technology will revolutionize various industries and improve our lives.