Updated: Jul 13, 2021
These days almost everyone has heard of cryptocurrency and possibly kicked themselves for not jumping on the Bitcoin bus back in 2008. But while they may have heard of it, many don’t really know or understand anything about it. According to Wikipedia:
“A cryptocurrency (or cryptocurrency) is a digital asset designed to work as a medium of exchange that uses strong cryptography to secure financial transactions, control the creation of additional units, and verify the transfer of assets.”
The thing about cryptocurrencies like Bitcoin is that they’re not backed by a central bank. Nor are they backed up by any tangible measure of value, such as gold. It is completely virtual. The only place where it exists is in the digital world. So how do you give a value to something that is essentially formless? And, once you have, how do you prevent people from counterfeiting or double-spending these units?
Enter blockchain technology. The whole reason that cryptocurrency is able to exist is because of the record-keeping technology behind the Bitcoin network. If you Google “What is blockchain technology?” the definition you’re most likely to find is of a "decentralized, distributed public ledger that keeps a record of all transactions related to a digital asset.
But what does that even mean??
Blockchain technology is a very complex idea, but once you know the basics it’s a lot easier to understand. So, to help you do exactly that, here is our next level guide to blockchain technology.
What exactly is a blockchain?
At the most basic level, a blockchain is literally a chain of blocks. In this context, the term block refers to digital information and the chain to a public database – or ledger. What makes it complex is how these blocks store that digital information and the fact that each block is connected to the one before it.
Each block contains information that can be divided into three parts.
1. The first is impersonal information about a transaction that includes data like the date, time and the dollar amount of a purchase. From the example in this link, we can see that something was sold for $43.50 at 16:48 on 2020-03-20. There are no details about what was sold though.
2. The second part adds details about who was involved in that transaction. However, this information is stored with a unique digital signature rather than with a physical name. How this digital signature is created involves some fancy algorithms, but essentially you have a private key that creates a public key, which in turn creates a unique address. This becomes your “username” in a blockchain.
These two parts are what make up a single transaction within a block and are measured in bytes. In the case of the example above it equals 193 bytes. One block measures 1mb or 1,000,000 bytes though, so each block can contain hundreds or thousands of transactions.
3. The last part is where the information that distinguishes each block from one another is stored and comprises five pieces of metadata which are:
– Version This describes the structure of the data inside the block or its “language”. This is only important because it tells computers how to read the information in each block correctly.
– Last blocks hash Each block in a blockchain gets a unique identification number known as a hash, which is generated by running the data contained in each block through a hashing algorithm. Because it is far more secure, the most commonly used hash function is the SHA-256 algorithm. And because the hash of each new block includes the hash of the previous block, the blocks in a blockchain build on each other. Without this element, there would be no connectivity or chronology between the blocks and the whole system would fall apart.
– Merkle Root Hash The first thing you need to understand about a Merkle Tree is that it effectively works in reverse. The separate leaves represent individual transactions that are turned into unique hashes. Then pairs of hashes are concatenated or placed next to each other and hashed again. This continues up the chain until you finally end up with a single hash for the entire tree – this is known as the Merkle root hash. Every field is unique but this particular single line of text is arguably the most important piece of metadata in each block.
– Timestamp This gives the exact time that the block was mined, or officially added to the blockchain.
– Target This can be a little difficult to understand but the target is the value that miners work with to try and add a new block to the blockchain. It is calculated by using the difficulty, which is a hash value that a bitcoin network will set in order to regulate how difficult it is to add a new block of transactions to the blockchain. The size of each hash is measured in bits, and the lower the target or the more zeros it has at the beginning – the more difficult it is to find the hash that is considered valid.
A new block is created when a miner has hashed all the metadata contained in a block header and achieved a result that is below the specified target value.
How blockchain technology works
You already know that a blockchain is multiple blocks of information strung together to form a chain. But before a new block can be added to a chain there are four things that need to happen.
A transaction must take place. In other words, one user must send digital information (i.e. cryptocurrency tokens) to another user.
The transaction must be verified. With a normal database, a single person or entity is responsible for vetting new data entries. But blockchain technology is decentralized and so a whole network of computers confirms the details of the transaction.
The transaction must be stored in a block. Once verified the details regarding the time of the transaction, the dollar amount and the participants are added to the “ledger” along with hundreds or thousands of other transactions – until the total number of transactions equals 1mb of data.
This block must be given a hash using all the metadata we’ve already described as well as the nonce. A nonce is a random number a miner uses to help them get a block hash that is below the target value. Once the nonce that works has been found, the block is considered solved and added to the blockchain.
Once a new block is added to the blockchain anyone can view the information in that block. This public record is what gives blockchain technology its transparency and is one of its three core elements.
Is blockchain technology secure?
The simple answer to this question is yes. That might lead you to ask how something that is made up entirely of digital information can possibly be secure. After all, digital information can be changed, or even worse, it can be hacked and then changed. But this is where the beauty of blockchain technology lies. We’ve mentioned hashes a few times now and you’ve probably figured out that they’re pretty important in blockchain technology.
What you might not have realized is that they’re pretty much the whole reason that blockchain technology is such a success. Now in order to understand that statement, you need to understand what a hash value is. The basic definition of a hash value is a hexadecimal numeric value with a fixed length that is used to identify a piece of digital data. In other words, a hash value is the fingerprint of a digital file. Make a single change to any part of that file, and it will create an entirely new fingerprint.
For example, here are some transactions that have been hashed using the SHA-256 function:
Here is a valid transaction
Now, let's change something so the transaction becomes invalid
Only one letter has changed but we get two entirely different hashes. When verifying these two transactions, the blockchain network will confirm that the first is a valid transaction that actually happened and the second one is not. Now, let’s say we perform the exact same transaction two minutes later, the transaction is verified and then added to the block.
Remember that Merkle Tree we mentioned before? In order to get the next level of hashes we concentrate the two valid hashes like this:
And then we hash this string which gives us:
we used the invalid hash from the example above we would have ended up with this hash:
What this shows is that any changes to any piece of the information that makes up a single block will change the final Merkle Root hash and therefore change the entire block. So what stops people from doing exactly that? This once again has a seemingly simple answer that needs a little explanation if you want to fully understand it. And the simple answer is the fact that blockchain technology is decentralized. So, what does decentralized mean?
Until now you have almost exclusively used centralized services. The idea behind them is very simple. You have one person or entity who stores all the data about a certain thing, and in order to get the information you want, you have to interact with them. The simplest example of this is a bank. They store your money there, as well as all the transactional data regarding your money. And the only way you can access that information is by going to that specific bank.
With a decentralized network there is no single entity that stores every piece of information. Instead, every single computer in the network has an exact copy of the entire blockchain. And we can be sure it is an exact copy because of those hashes we created from that information. So you can ask one person what the hash is for a certain transaction, and no matter who else you ask – they will be able to give you the exact same hash.
This means you can cut out the middleman, who in this case is the bank, whenever you want to do anything with your own money. There are thousands, or in the case of Bitcoin, millions of copies of the same blockchain and you can ask any of them for the information you need to perform whatever transaction you want to.
This decentralization is the second core element of blockchain technology. It is also what makes the third core element possible: this third core element is immutability. When something is immutable, it can’t be changed. This characteristic is the reason why blockchain technology is considered so secure.
While the information on each node in a blockchain network is identical, because it is spread out across so many places it is near impossible to manipulate any of it. Simply put, a hacker would need to find and change every single copy of the blockchain if they wanted to steal, counterfeit or double-spend any cryptocurrency that uses blockchain technology.
Blockchain technology is the backbone of a new type of internet
In 2013 Vitalik Buterin published a paper titled Ethereum Project which suggested that blockchain technology could be applied to more than just cryptocurrencies. You now know that a blockchain can store data about monetary transactions. But it happens to be a pretty effective way of storing information about a multitude of other transactions as well.
Although blockchain technology is an incredibly complex idea, its decentralized form of record-keeping means that there is almost no limit to its potential applications. To date it is being used for smart contracts, supply chain records, property rights records, healthcare record keeping, banking transactions and more.
The concept behind blockchain technology was first proposed in a research paper back in 1991 and has seen its fair share of scrutiny over the last three decades. Businesses all around the world have been speculating about what blockchain technology could be capable of and the direction the technology will take in the future.
With a Deloitte survey finding that 34% of the companies they studied were already using a blockchain system, and 41% stating that they planned to deploy a blockchain application in the next year it is clear that blockchain technology is finally making a name for itself. No longer just a buzzword in the FinTech industry, the question isn’t “if” legacy companies will implement blockchain technology but “when” they will.
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