Blockchain Explained: The Mechanics Behind Cryptocurrencies

Blockchain Explained

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Blockchain is the underlying technology for cryptocurrencies like Bitcoin, Ethereum, and all other major cryptocurrencies in the world. Investors looking to invest in cryptocurrencies should understand this technology, which is difficult to understand given the complexity of mining new coins and validating transactions on the network.

A Blockchain is a chain of blocks containing information generally considered as transactional records shared between all nodes in the network. These blocks are also known as digital ledgers.


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This technique was originally described in 1991 by a group of researchers and was originally intended to timestamp digital documents so that its not possible to backdate them or tamper with them in any form. However, it went by mostly unused until it was adapted by Satoshi Nakamoto in 2009 to create the digital cryptocurrency called Bitcoin.

A Blockchain is a distributed ledger that is open to anyone and once data is recorded in a blockchain it becomes very difficult to change it.

Blockchain Network

How does a Blockchain work?

To understand a blockchain, it is important to understand a block. Each block contains some data, the hash of the block and the hash of the previous block.  The data stored in a block depends on the type of blockchain, the Bitcoin blockchain for example stores the details of a transaction such as the sender , the receiver and amount of coins.

Components of a Block

Hash

The block also contains a hash which is a unique encrypted key of the block, it can be compared to a fingerprint which is also a unique identifier of a person the same  way the hash is for a block in the blockchain. Once a block is created its hash is being calculated and changing something inside the block will cause the hash to change.So in other words, hashes are very useful to detect changes to blocks.

The third element inside the block is the hash of the previous block, which effectively creates a chain of blocks and its this technique which makes the blockchain very secure.

Blockchain Example

Now let’s take an example of a blockchain with three blocks. Each block has a hash and the hash of the previous block. So block number 3 points to block number 2 and number 2 points to number 1. Now the first block is a bit special, it cannot point to a previous block because its the first one. We call this block the genesis block.

Now let’s say you tamper with the second block, this causes the hash of the block to change as well, which in turn makes block 3 and all following blocks invalid because they no longer store a valid hash of the previous block. So changing a single block makes all the blocks invalid. However, using hashes is not enough to prevent tampering.

Computers these days are very fast and can calculate hundreds & thousands of hashes per second, you could effectively tamper with a block and recalculate the hashes of all other blocks to make your blockchain valid again. So to mitigate this blockchains have something known as Proof-of-work.

Proof-of-Work & Consensus Mechanism

It is a mechanism that slows down the creation of new blocks, in Bitcoin’s case it takes about 10 minutes to calculate the required proof-of-work and add a new block to the chain. This mechanism makes it very hard to tamper with the blocks because if you tamper with one block then you need to re-calculate the proof-of-work for all the following blocks. Hence the security of a blockchain comes from its creative use of hashing and the proof-of-work mechanism.

Proof-Of-Work Mechanism

But there is one more way that blockchain secure themselves and that’s by being distributed. Instead of using a central entity to manage the chain, blockchains use a P2P network and everyone is allowed to join. When someone joins the network he gets the full copy of the blockchain. The node can use this to verify if everything is still in order.

Now let’s see what happens when someone creates a new block. The new block upon creation gets sent to everyone on the network. Each node then verifies the block to make sure that it has not been tampered with, and if everything checks out each node adds the block to their own blockchain. All the nodes in the network create consensus as they agree with which blocks are valid and which aren’t.

Peer-to-Peer Network

Blocks that are tempered with are rejected by other nodes in the network , so to successfully tamper with a blockchain you will need to tamper all the blocks in the chain, redo the proof-of-work for each block and take control of 50% of the peer-to-peer network . Only then your tampered block will become accepted by everyone else which is almost impossible to do.

Mining

In Blockchain technology, the process of adding transactional details to the present digital/public ledger is called ‘mining.’ Though the term is associated with Bitcoin, it is used to refer to other Blockchain technologies as well. Mining involves generating the hash of a block transaction, which is tough to forge, thereby ensuring the safety of the entire Blockchain without needing a central system.

Potential Application for Blockchain Technology

  • Bitcoin, Blockchain’s prime application and the whole reason the technology was developed in the first place, has helped many people through financial services such as digital wallets. It has provided microloans and allowed micropayments to people in less than ideal economic circumstances, thereby introducing new life in the world economy.
  • Collaborative technology, such as blockchain, promises the ability to improve the business processes that occur between companies, radically lowering the “cost of trust.” For this reason, it may offer significantly higher returns for each investment dollar spent than most traditional internal investments.
  • Many financial institutions are viewing cryptocurrencies backed by blockchain technology to be future of digital currencies which has the ability to change the way we transact with each other on a daily basis. 

Conclusion

Blockchains are constantly evolving, one of the more recent developments was the creation of smart contracts. These contracts are simple programs which are stored on the blockchain and can be used to automatically exchange coins based on certain conditions.

The creation of blockchain technology peaked a lot of people’s interests and soon others realized that the technology could be used for other things like storing medical records, creating a digital notary, or even collecting taxes. Judging by its success and increased use, it seems that Blockchain is poised to rule the digital world of the near future.

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