How Does Blockchain Work?

How does blockchain work?

The Blockchain is the new buzzword around, and while most people have some idea that it relates to cryptocurrency, few know how it works. Blockchain and cryptocurrency are often thought to be the same thing, but they are very different.

Cryptocurrency is an electronic currency that does not have a physical form. The blockchain is the network on the internet that permits the use of cryptocurrency.

Without the blockchain, the cryptocurrency system would not work. However, the blockchain and the technology behind it have far more applications than just supporting crypto transactions.

The blockchain and what it does

Here we explain how the blockchain works and the different applications it supports. There are some terms that are heard in relation to blockchain and cryptocurrency.

These include:

  • Wallets
  • Digital signature
  • Smart contracts
  • Protocols
  • Mining
  • Consensus

By explaining each of these terms further, we will also give you a better understanding of how the processes work.

Wallets: A digital wallet is a software that helps to securely store your private key. There is no cryptocurrency stored in the wallet, but your private key can access records of your transaction records. Records are stored on the distributed public ledger, but your private key is what keeps you connected to your own transactions. Crypto wallets aren’t so much like a purse that holds your money but more like a safe that holds your bank records and keeps them updated.

However, the function of the wallet goes beyond just storing your private information. The wallet also holds public keys. With the public keys, you can make and receive cryptocurrency payments. Every transaction requires your private key to match with a public key. If you receive cryptos, once the transaction is verified, the value in your wallet will show an increase. Consequently, when you use cryptos to buy something, the value will decrease.

Digital signature: A digital signature is an innovative way of digitally signing and sealing a document. Unlike a personal signature that is unique to an individual, the digital signature is unique to the document that it is placed on. When you want to send a document to someone else via the internet, you can use a digital signature to ensure that the writing does not get altered.

When you use the digital signature algorithm for an email, the software will use the content of the email to generate a series of characters that make the digital signature. You need to have a private and public key to be able to place a digital signature on the document. Your public key will also store a copy of the digital signature. The recipient of your mail can verify the signature against the one stored in your public key, and they will know if the document has been altered in any way. Because the digital signature is based on content, any change in the content will alter the signature.

Smart contracts: A smart contract enables online transactions without the need for a trusted third party to intermediate. Normally, if you were making an online payment, you would do so through your bank or credit card company. That way, if for some reason the transaction falls through, you can have the payment reversed or blocked. You also have the transaction on record in case there is a need to dispute.

In a decentralised system, you deal directly with the person or party you are transacting with. To help safeguard interests, a smart contract is entered into. A smart contract is a code that predetermines the terms of the transaction. Only once all the terms are met, the smart contract locks and the transaction is completed. For example, if you are buying land from someone, you agree to transfer X amount of bitcoin to them, and they agree to transfer the ownership deed. The bitcoin and the deed have to be first placed within the smart contract. When both conditions are met, the contract locks and assets are redistributed.

In this way, your bitcoin remains safe within the smart contract until the ownership deed is also uploaded and verified. A smart contract removes the need for hiring lawyers or other third-party go-betweens. They also remove the guesswork and risk from making online transactions with strangers.

Protocols: A blockchain protocol is a program that governs the set of rules on which the blockchain is developed. Because blockchain technology has so many applications, each company that develops a blockchain network adapts slightly to suit the purpose it was intended for. A blockchain developed for cryptocurrency will follow one protocol while one developed for gaming will follow another.

The protocol is an important feature of the blockchain, and it lays the foundation of what the blockchain can be used for. It is important to note that a blockchain developed for entertainment purposes is probably not the best place to try and develop a DApp or initiate a smart contract. Protocols add nuances to blockchain networks that most people did not know existed.

Mining: Mining is probably the single most important activity in cryptocurrency that gives the system any value. It is the Miners’ job to validate every new transaction that takes place on the network and to record it. The Miner creates the hash of the transaction and stores it in a block that becomes part of the blockchain. It is because of mining that cryptocurrency can function as a decentralised system with no overseeing governing body.

Mining uses a considerable amount of electricity and requires a very fast CPU. For their efforts, Miners get paid in bitcoin which are specially generated for their services. Miners are competing with each other to solve cryptographic mathematical problems. The Miner who solves the problem can show the solution as Proof of Work. The Proof of Work allows a Miner to get paid but also allows a transaction to proceed on the blockchain network.

Consensus: When working with a decentralised system, it is important to maintain some amount of stability in the system. The system is monitored by Nodes that are distributed all over the network. For the nodes to function properly, a consensus algorithm is put in use. The consensus algorithm helps the different nodes to reach an agreement on hash values and operate in sync with each other. Consensus helps to maintain the security and the authenticity of chains of blocks submitted to the ledger.

Proof-of-stake algorithm (PoS) and the delegated proof-of-stake algorithm (DPoS) and the Byzantine Fault

Tolerance algorithm are all types of consensus algorithms.

All these features come together to give the blockchain its functionality.

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