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What Is Blockchain Technology and How Does It Work?

Today, e-commerce is an integral part of many industries, such as retail, wholesale, and fashion. It has changed the way people buy goods.

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In this comprehensive guide, we’ll cover:

  • What is a blockchain?
  • How does a blockchain network work?
  • Is blockchain safe?
  • What are the biggest benefits of blockchain?
  • Does blockchain have flaws?

What Is a Blockchain?

Blockchain is best described as a new digital system that can be used to record data. A blockchain system is a network of participants who control each other. There is no central party or intermediary in this network.

There are two types of networks: centralized and decentralized networks.

Centralized Networks

​The best way to understand centralized networks is to think of banks.

Imagine: Noah wants to transfer $50 to his friend Adam, and he does it through his bank. In this example, the bank is the central party and checks Noah’s account (is there enough money in the bank account?), then the bank debits the amount, and it is credited to his friend Mahmoud’s account. Noah and Adam trust the central party (the bank) to transfer the $50 and record the transaction.

Decentralized Networks

A network without a central party is also called a peer-to-peer network, or a decentralized network. In such a decentralized network, everyone verifies each other and everyone is responsible for transactions in the network. Therefore, in a decentralized network, a central party such as a bank is not used. The fact that all network participants register and agree to a transaction makes the blockchain network unique and powerful.

Here is a good example of a decentralized network:

​Noah wants to transfer the same amount as above to his friend Adam. This question is sent to the network so that everyone else in the decentralized network can confirm that Noah actually has $50 to spend. Once all participants within the network verify, using a digital ledger, that he has $50 to spend, the transaction is approved and can proceed.

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How Does a Blockchain Work?

Blockchain is a decentralized network. To perform verifications and keep the blockchain network secure, a minimum of three participants is always required. Controlling transfers is the most important task in the Blockchain network. But how exactly does the blockchain network work? We will explain it to you!

Imagine: Adam, Noah, John, and Smith live together in a house. Unfortunately, Muhammed leaves the house and a room is available. Agreements and payment obligations can easily be transferred to the new resident via the blockchain. Additionally, no resident is liable if the new occupant is unable or unwilling to pay rent on time.

Moreover, other data can also be logged into the blockchain—for example the refund at the end of the month after all the housework is done and this is also verified by the blockchain participants. Blockchain can be used for various purposes: from transferring a certain amount of money to recording personal data.

Nodes, Block, and Chain

Nodes, Block, and Chain

Terminology

As you read before, A blockchain network is a digital-decentralized network or peer-to-peer network with people connected to each other. To put it into words easily, a person within the blockchain network has a notebook and folder. Later in this article, I will explain the real terms for this “script” and “folder”. But let’s first go back to the example:

Our blockchain network consists of four people. Noah, Smith, John, and Adam. Noah wants to transfer $100 to Smith. Then, Noah tells everyone that he wanted to transfer $100 to John. First of all, everyone checks if Noah has enough to spend to transfer $100 to John. Does everyone agree? If so, permission is given to transfer $100. Then everyone in the network records the transaction in their own notebook (or ledger).

Did everyone in the network record the transaction in their notebook? If so, the next transfer can take place again. This process continues until one page in the notebook is filled. This page is then saved in the “folder”. Now let’s get into the technical terms of blockchain.

Block

In blockchain parlance, our “map” is called a block. This block contains a lot of data. The first block in the chain (hence the name of the blockchain, the chain) is called the genesis block.

Contract

Adam, Noah, John, and Smith are referred to as “the contract” in official Blockchain terminology. These people (actually, their computers) control and verify all transmissions via algorithms. All data is checked, logged and eventually ends up in the block.

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Is the Blockchain Secure?

You are undoubtedly wondering: What if the notebook was completely full? The transfer of data or money within a blockchain network can continue for a very long time. This validation and permission process continues until one page of the proverbial script is filled. This page is then saved in the “folder” (block) and the next page can be used. This process takes a long time.

Once a page of the notebook is full, it is stored securely in the folder (the block) and the folder is placed in a chain. Pages are secured with a specific key that everyone in the network agrees to. This key, along with another secure key, is the electronic signature of the page and directory. This is to ensure that no one can change, alter or delete the data in the block.

Mining and Keys

In the language of the blockchain, closing the page is called mining. This is done by miners in the network. Anyone in the network can be a miner. The page is closed with a unique key. This key is called the public key and is known to all. This key is important for identifying yourself, among many other things. Finally, there are also so-called private keys. These keys are kept strictly confidential and are used, among many other things, to verify their authenticity.

In the past, the central party guaranteed him that something that was recorded could never be changed. In the decentralized network we are talking about now, trust has arisen from the fact that through mining and public/private keys, data cannot be changed once it is securely stored.

Hash

So much for the basics and operation of blockchain. You may be wondering: How is this block closed? We are happy to explain that to you too!

You need a special code to close a block and put it in the chain. This code was generated by someone in the network via some kind of black box model. Literally, something whose content or process is unknown. The black box uses different data and works as follows: You put certain data (input) into a so-called black box and that data outputs differently, but still has the same content (output).

The data in this black box varies. These can be transactions, but also personal data. However, the data that appears is always unique. The black box also works from one side only. Just think of an egg: An egg that’s been fried can’t be boiled again. This also applies to the black box: It is impossible to know the original data if you only know what the output is.

Hash Function

This is what is called a black box in formal terms. The hash value, hash symbol, or hash value indicates the output of the hash function (black box).

Proof of Work

Finally, we’d like to tell you about the proof of work: We call a string of volumes (blocks) a master string. Each new block added to the main chain makes the chain more reliable. It is important to constantly expand this main chain with new blocks so that the chain remains reliable. Every miner in the network wants to add their own block to increase trust.

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The person who is allowed to add their mass to the main chain will receive compensation. As you can read earlier, this process is called mining. Now you may be wondering: How will this series be expanded? What is the next block to add to the chain, and does everyone agree? The proof of work protocol was created for this purpose and is very important in the blockchain network.

When a network participant computes the output (the hash token), this data is forwarded to other people in the network and the blocks are then scanned by miners. The person who first viewed the folder on the network can get compensation for this. This fee ensures that network participants make continuous efforts within the network.

Now you know all about the blockchain. But what are the advantages of this network? Why should we use it?

Advantages of Blockchain

For as long as we can remember, we’ve been dependent on a central network or broker when it comes to trust. Consider, for example, a bank or a town hall. Of course, it’s fine to take your money to a bank or register your details at city hall, but blockchain is becoming more and more popular. Hence, you may wonder: Is it a problem that we still depend today on a central party such as the bank?

What makes this case interesting is the fact that there is only one central system, one organization, or one broker. If something goes wrong or someone does something wrong, on purpose or by accident, a great deal of chaos can arise in the world all through one system, one organization, or one broker.

Imagine: A major disaster destroys the entire bank’s payment history, rendering it unusable. Can you remember exactly how much you had in your bank account two months ago?

What if you make an appointment with a broker to withdraw $50 from your account? That person will then withdraw $500 from your account. How does this fit? Did you have to agree to this, or did it happen by chance? But what if all of the above examples were intentionally implemented?

You may ask yourself: Is there a possibility to create a platform ourselves, for example, where we record our transactions ourselves instead of having someone else do it for us? The blockchain network is perfect for this!

Different Blockchains

The blockchain network is available to everyone and can be used for many different purposes. This means that anyone who knows this can create their own blockchain network. However, you must adhere to a number of rules. These rules are different for each network, and therefore different blockchains are created.

Let’s give some examples of (well-known) blockchain networks:

Bitcoin

Bitcoin is a digital cryptocurrency, also known as cryptocurrency, that is specifically designed as money for the internet. Throughout the entire mining process, new bitcoins are generated, which can eventually lead to inflation without the intervention of a central party such as a bank. Bitcoins can be bought with real money or traded on special exchanges. You can compare bitcoin to dollars, but there’s a big difference: Bitcoin is completely digital.

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There are also blockchain networks in stocks, for example. This is done via an ICO, which stands for: Initial Coin Offering. Using this system, companies, or startups, can market their cryptocurrency (such as bitcoin), where each so-called “currency” represents a stake in a particular company.

Ethereum and Smart Contracts

Private contracts can be used to create agreements between health insurance companies or clients, for example. The blockchain network is a great opportunity for health insurance companies and customers to use it many times in the future. If you need sponsorship, you can send it to your contract. This contract can then decide for itself whether you are insured to get the help you require.

Are you insured? Then the care you require will be automatically compensated. The most famous blockchain that uses these private contracts is called Ethereum. This blockchain has its own code language for programming these "smart" contracts. This code language helps in recording certain decisions in the contract.

Patient Information

The same applies to data from hospital laboratories. This data is still mailed to other hospitals, who then manually enter this data into the computer. This process can take a very long time and errors can occur. With a blockchain network, it is possible to store the same data as well, but faster and without errors!

Even producers, songwriters, and authors can benefit from the blockchain network. For example, it is possible to request/receive a fee every time someone uses that person’s copyright.

Blockchain Security

As you read before, all the data in the blockchain is automatically copied to all computers. Hence, the blockchain network is not dependent on one large database. If one of these computers crashes, it will not have immediate consequences because there will always be other “nodes” that have stored and preserved the information safely. In addition, the blockchain network is also replacing paper contracts, for example. Instead, smart documents are created and secured correctly. All this makes the blockchain network extremely secure.

Unfortunately, it is of course impossible to set up a 100% secure system. The same goes for the blockchain. As technology gets smarter and better every day, there is a possibility that in a few years there may be a way to change or even delete the content of such a block. In the past, many weaknesses were found in the blockchain network.

51% attack

A well-known example is the 51% attack.

The block is accepted if at least 51% of the miners agree. If less than 50% of miners agree, the block will not be accepted. The point we want to make is this: If someone from the network owns 51% of the blockchain network, then that person is the majority. This means that he/she can do whatever he wants.

This can have serious consequences. For example, important data can be changed or untrusted blocks accepted. It is clear that preparing and executing such an attack requires a lot of time, effort, and time because many servers and computers are needed to carry out such an attack, but this is theoretically possible.

Thus, the blockchain can be vulnerable, but that is quickly forgotten when you think about how secure the blockchain really is. These weaknesses can only be realized under special circumstances. Finally, almost all blockchains provide protection against known vulnerabilities.

The Future of Blockchain

As it now appears, the hype surrounding blockchain continues. Many banks and large companies are planning to use the technology. In the past, it was sometimes said that “Blockchain is Bitcoin.” This is of course no longer true. It is true that Bitcoin was the basis of the blockchain. However, the blockchain network has endless possibilities that can be used in the future.

For example, blockchain is expected to play a role in both our business and our private lives. It is still unknown when this will happen. However, it is expected that it will take some time before everyone uses blockchain technology. Overall, it is clear that blockchain technology will bring a lot of change in our daily lives. Are you looking forward to it yet?

Disadvantages of Blockchain

This technology is always accompanied by criticism. First of all, blockchain technology is sometimes used as a “cure to all diseases”. Various reports, especially in the media, claim that blockchain is the panacea for everything.

Second, there is the criticism that blockchain cannot be changed. Blockchain is also public in many cases. Imagine that incorrect data about you is stored in the blockchain, so it cannot be changed again.

There is also a lot of criticism of the anonymity of blockchain technology. However, in some cases, you really have to give up your identity or certain personal data. Are you planning to buy bitcoins? Then you will have to do it using your own bank account balance.

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There is also some criticism when it comes to the technology that makes blockchain possible. For example, there are regular complaints that the technology is sometimes too slow and that it is difficult to improve. The work of “miners” also requires a lot of energy and raw materials, which does not make blockchain technology very environmentally friendly. We will tell you more about this later.

Finally, it is not easy to start using the blockchain. A lot of technical knowledge is required to start using different blockchain technologies.

Fortunately, sufficient measures have been taken to ameliorate these criticisms. For example, one can compare the rise of the blockchain with the rise of the Internet. This did not go smoothly either. Blockchain technology is expected to see the same kind of development.

Energy

The process of adding each block to the chain requires a lot of energy and electricity. Finally, the entire blockchain network also consists of thousands of computers. Did you know that all bitcoin transactions and activities consume more energy than a country like Austria, for example?

This is why there is a lot of research on technologies that will make this whole process more environmentally friendly.

Blockchain in a Nutshell

In short, blockchain is a new decentralized system for recording various data or making transactions. This system does not use an intermediary like a bank, which makes blockchain technology very secure. Blockchain technology is expected to make great progress in the coming years and be used for both commercial and private purposes.

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

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