What Is Blockchain Technology & How Does It Work?

What is a blockchain?

Simply put, a blockchain is a ledger, or list, of transactions that is distributed across a secure network of computers. Blockchains are generally considered “decentralized” because they require a majority of participants in the network to validate its transactions, as opposed to a “centralized” entity like a bank who has sole authority. In other words, there is no central body providing security, but instead a collective agreement among network participants.

The name “blockchain” actually points to the two key components that make the system work: blocks and chains. A “block” represents a unit that stores a certain amount of information or data. Once the block size limit has been reached, a new block is created in which more data will be stored. The new block is then attached to the previously built block and ends up forming a chronological chain of blocks, or “blockchain.”

Another way to look at a blockchain is as a community-run database. A database is an application for storing information in a way that can easily be organized, searched and updated. Ordinary databases have administrators, or gatekeepers, who control access and usage. The admin might decide to impose conditions, delays, or fees, or they might alter, delete or lose your data, with or without informing you.

This is why the blockchain is such a remarkable innovation. It allows the existence of a database that no one owns, but is nevertheless reliable. Collectively, the entire community – a network of computers that make up the blockchain and separately store the database’s information – is responsible for keeping the network honest.

How does blockchain work?

Generally speaking, there are 6 steps to updating the ledger on a blockchain and pushing the database forward.

1. A user requests to make a transaction.

2. The transaction is added to the latest block on the blockchain.

3. The block is broadcast to all nodes in the network.

4. The nodes validate the block and the transactions within it.

5. The blockchain’s ledger is updated and the block is verified.

6. The user’s transaction gets executed.

One defining characteristic of a blockchain which makes it a stable and secure system is that each block includes replicated data from the block that preceded it. This replicated data is called a “cryptographic hash.” The name stems from a form of math called “cryptography,” which is used to transcribe information into secret codes.

What this means is that legacy data on the network can’t just disappear. In fact, every time a new block is built, all the previous blocks are re-audited, making the blockchain extremely resistant to modification of records. Encrypting this “hash” data also ensures it’s less prone to hacks or other cybersecurity breaches.

What are the advantages of blockchains?

There are a number of reasons why blockchains are powerful technology and can benefit society.

1/ Available to anyone with internet access

Permissionless blockchains like Bitcoin and Ethereum are available to anyone with an internet connection, and require no authentication or approval to use. This creates an open, financial ecosystem for people around the world to participate in. As discussed, all the information on the blockchain is verifiable and permanent, as its decentralized characteristics secure the data in a trusted format.

2/ Promote democracy

If a blockchain is decentralized, it also means the information and transactions in the database are censorship-resistant. No one entity can decide something should be pulled or canceled just because they want it to be. Blockchain is a form of digital democracy.

3/ Lower fees and settlement times

Most blockchains also offer much lower fees and settlement times compared to the existing financial infrastructure, increasing efficiency for businesses and individuals everywhere.

Blockchain vs Cryptocurrency - What’s the difference?

The terms blockchain and cryptocurrency are sometimes used interchangeably, but they actually refer to very different things:

Blockchain is a distributed computing architecture where every node on the network executes and records the same transactions.

Cryptocurrency is a digital asset that lives on a blockchain and can be transferred from wallet to wallet. In other words, cryptocurrency is the asset, and blockchain is the platform needed for its operation.

Why is blockchain important?

We’ve discussed the efficiencies that blockchains bring to payments, but this innovative technology is important for a number of other reasons as well.

1/ Transparency

Blockchain brings a level of transparency to the financial system that we’ve never seen before. Public blockchains allow for anyone to login to a website and download, monitor and analyze all transactions that have happened across multiple different networks. In society today, where trust is as low as ever, this visibility makes the potential of blockchain extremely attractive.

2/ Universal Impact

Blockchain can also be used in verticals outside of finance — Healthcare, retail, insurance, supply chain, logistics, manufacturing, education, and agriculture are just a few examples. Many people believe blockchain will have a bigger impact on the world than the Internet itself. Now that’s big.