If you have heard a thing or two about cryptocurrencies, you may have heard about the blockchain, which is the technology that powers Bitcoin and hundreds of other cryptocurrencies. Beyond this common definition, do you know what the blockchain really is? Do you know how it works?
The blockchain as we know it today is the ingenious brainchild of Bitcoin’s pseudonymous inventor, Satoshi Nakamoto. Described simply, the blockchain is a decentralized public and permanent record of transactions. In other words, the blockchain is a public ledger where entries cannot be altered once they have been added. However, it is also decentralized. What does this mean?
Decentralization means that there is no central authority in charge of the power to make decisions. Instead, this responsibility is delegated to all organization members. With the blockchain, this responsibility rests with all the computers within the network. Therefore, no one entity can regulate the blockchain. Instead, the members relate with each other based on mathematical rules that all of them have to obey. If a decision or transaction has to be made, all the computers in the network have to agree that it has indeed occurred in order for it to be verified. To make the concept of decentralization easier to understand, let’s take an example.
Traditionally, when two people wanted to collaborate on a document, one person would work on the document and send it to the other person so that they could add their revisions to it. In this scenario, the first person cannot see the changes made by the other person until a copy of the revised document is sent back. The first person would also need to wait for the revised document to be sent back before making any further changes.
In the end, it would be up to one person to decide which version should be used as the correct version. However, if the two people were to use the software Google Docs, both of them would simultaneously have access to the document. Both could make changes at the same time and the latest version of the document would be available to both of them at the same time.
Having to send the document for changes to be made can be compared to how databases work today. This is the system used by banks to process money balances and transfers. Access is briefly locked on one side, the transfer is made and then access is reopened. The blockchain, on the other hand, can be compared to the Google Doc application, where everyone has the same record of the public ledger at all times. However, instead of being shared between two people, the blockchain is distributed among several people.
However, the blockchain takes it a step further. Instead of having one person make a decision on which document should be used as the correct version, all the people with access to the document have to come to an agreement on the correct version. Doing this gives the blockchain robustness that is similar to that of the internet. It cannot be controlled by any one person and it has no single point of failure.
Just like the Google Doc app, the blockchain is always in a state of consensus. It checks in with itself every few minutes and automatically updates itself to the latest version on all nodes. The groups of transactions between each automatic update are known as a block. The constant state of consensus has two effects. First, it enhances transparency since the latest version of the database is visible to everyone within the network.
More importantly, it means that the blockchain cannot be corrupted. Corrupting the blockchain would mean gaining control of a majority of the computers in the network. While this seems possible in theory, it is very unlikely to happen since it would need massive amounts of computational power. Taking control of the blockchain would also destroy the value of cryptocurrencies.
A Network of Nodes
The blockchain is made up of a network of computers known as nodes. These computers run the blockchain protocol, allowing them to send and receive messages from each other. Nodes can join the network voluntarily. Once a new node joins the network, it automatically downloads the latest version of the blockchain. These nodes are one of the most important elements of any blockchain network.
Once a node joins the network, it becomes a co-administrator on the network. It is given the responsibility of helping to verify every single transaction that is made on the blockchain. After verification, the node records the transaction to a block. This goes on until a block is complete, after which the node adds it to the blockchain. The chance of winning newly created coins acts as an incentive for the nodes to perform these administrative tasks on the blockchain network.
When a user sends coins to another user, the nodes check the transaction data to ensure the validity of the transaction. It compares the transaction data with its version of the blockchain and ascertains that the coins have not been double-spent. In the event that the node determines that the transaction data is invalid, it automatically rejects the transaction. It also rejects any further communication with the node that sent the transaction. Nodes have a non-trust-based relationship with other nodes on the network. Therefore, if one node sends invalid data to the other nodes, they immediately cut communication with this node and ban it from the network.
However, if the node ascertains that the transaction data is valid, the transaction is forwarded to miners. Miners group transactions together based on chronological order to form blocks. Once a block is completed, it is passed back to the nodes for verification. All validation is done by nodes since it is impossible for them to propagate incorrect information. Once the nodes confirm the validity of a block, they can now add it to the blockchain.
The effectiveness of blockchain technology is based on the following three principle technologies:
Private Key Cryptography
The blockchain makes it possible for people to make transactions over the internet without the need for a trusted third party. However, for the transaction to be safe and secure, there has to be a form of trust. On the internet, trust boils down to two things – authentication (proof of identity) and authorization (proof of permissions). Put simply, there has to be a way of verifying that someone is indeed whom they say they are and that they have the permission to do whatever they are trying to do.
In the case of blockchain technology, trust is established through the use of private key cryptography. Cryptography relies on mathematics to encrypt information into secret code that cannot be accessed by unauthorized entities. For one to access the information, they need a key to decrypt the information.
A cryptocurrency transaction basically involves someone sending encrypted data to another person. Whenever someone makes a transaction on the blockchain, the transaction is encrypted using cryptographic keys. For every transaction, two mathematically linked keys – a public and a private key – are generated. For one to make an encrypted transaction, the public key is needed. To decrypt the transaction, one has to have a private key. The private key is the cryptocurrency wallet address, which allows anyone to send encrypted data (the crypto coins) to the owner of the wallet.
However, for the owner to receive the coins, they have to decrypt the data using their private key. The private key shows that you are the owner of the wallet address. The private key also confirms that you have permission to transact, i.e. you have enough coins to make transactions. Through the private key, the blockchain confirms authenticity and authorization, thereby solving the issue of trust.
A Distributed Network
For the blockchain to be effective, authentication and authorization are not enough. There is also a need for a distributed peer-to-peer network. This network helps solve the issue of security and record-keeping. For transactions to be accepted as valid, they have to be confirmed by the entire network. This can be explained using a famous thought experiment known as the ‘if a tree falls in the forest’. However, our thought experiment will be tweaked slightly.
If a tree fell in a forest and two cameras are recording the event, then we can be certain that the tree actually fell since there is visual evidence of the event. However, if one camera recorded the falling of the tree while the other did not, then we cannot be certain that the tree actually fell. This is the concept behind the value of the blockchain network.
The nodes within the network are the cameras in our analogy. If the nodes are in consensus that the event happened at a particular time, then there is a certainty that the event happened. For a transaction to be confirmed as valid, the majority of the nodes have to reach a consensus that the transaction actually happened. However, instead of using cameras, the nodes use mathematical puzzles for validation.
When private key cryptography is combined with this distributed network, the blockchain becomes more effective. A person, using their private key to prove authenticity and authorization, announces to the network that they are making a transaction, the whole network watches the transaction and confirms that it has indeed occurred.
An Incentive for Security and Record-Keeping
While the combination of private key cryptography and a distributed network seems foolproof, it has one flaw. Why should the nodes be waiting to observe and confirm that a transaction has indeed taken place? Put differently, how does the network attract nodes to confirm transactions and thus make the network secure? This is where mining comes in. By performing administrative tasks and ensuring the security of the network, the nodes are rewarded with newly created coins. The self-interest of the nodes is used for the public good.
