How do blockchains work?

Cryptocurrencies like Bitcoin, Ethereum and Solana share a common foundation, they are all powered by blockchain technology. But, what exactly is a blockchain? And, how does it actually work?

Let’s think of a blockchain from a literal perspective, thinking of it as a chain of interconnected blocks. If we look closely at each block, the individual blocks in the chain function as a store for data and retain a comprehensive set of transactions that anyone can view and verify. 

When we reference the fact ‘anyone can view and verify’, this refers to the ability for anyone to access the details of all the transactions recorded on-chain. Meaning, any participants in the network, referred to as ‘individuals’ or ‘nodes’, can look back and inspect any, or all, transactions in the history of that specific blockchain.

The term "block" in blockchain refers to a piece of digital information. Each block in a blockchain contains a list of transactions. Whenever a Bitcoin transaction is made, it is added to a block.

When transactions are made, they are first verified by network participants, called miners. Once a transaction is verified, it’s bundled with other transactions to create a new block. This new block is then added to the blockchain.

Each block contains a unique code, called a hash, as well as the hash from the block before it. This links the blocks together in a chain—this is why it's called a 'blockchain. The inclusion of the previous block's hash in the next one, creates a secure connection between them.

A key feature of a blockchain is its decentralized nature. This means that there is no third party, such as a bank or government, to verify transactions; it is open to everyone in the network to see and verify those transactions. 

Verification, in this context, is the ability for the individuals in the network to confirm the legitimacy of transactions. So, an individual in the network can independently verify the proposed transaction, they would do so by examining the data from existing blocks to ensure the new transactions comply with the protocols of the associated blockchain. 

Let’s use the example of Bitcoin to illustrate this: The Bitcoin blockchain stores a record of every single transaction involving bitcoin. It is the blockchain technology that enables the successful transfer of value over the internet without the need of a third party, such as a bank who would facilitate the ‘traditional’ bank transfer payments most of us are familiar with.

Another way blockchain technology can be described is as a distributed ledger technology (DLT). The concept here is similar to that of a traditional ledger, or balance sheet. 

Typically, a ledger, in the context of a bank for example, would showcase all the transactions and money flows in and out of bank accounts. However, in the example of a bank, it is the banking institution that controls the ledgers records. For a blockchain there is no individual, organization or third party controlling these records. Instead, it is a peer-to-peer network of computers using open-source software to check and validate the accuracy of all transactions stored on the blockchain. 

The peers providing their computing power to validate the transactions earn rewards, in the form of cryptocurrency, for effectively validating and securing the transactions. It is this collective computing power from the network that continually secures the accuracy of the blockchain ledger.

If we take it back to our analogy of a chain of blocks, where each block holds records of transactions, the further back on the chain you look the older the transactions you’ll see. It is this level of transparency, where the entire record of the cryptocurrencies transaction history is displayed, that is considered particularly advantageous. 

Specifically, from a security perspective the high level of transparency is a key advantage as any attempts to manipulate previous transaction entries will ‘break’ the chain, exposing the change to the entire network. Thus, making it extremely difficult, borderline impossible, to manipulate.