How Does Blockchain Technology Work?

How Does Blockchain Technology Work?

The blockchain is certainly one of the best new technologies since the invention of the Internet. It allows us seamlessly exchange currency without any centralized authority.

The most well-known and widely discussed application of the blockchain technology is called Bitcoin. Just like a Dollar (USD), Euro (EUR), or Chinese Yuan (CNY) Bitcoin can be used to exchange currencies, products or services. Considering the popularity of Bitcoin, let’s use it as an example of how this technology works.

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“At its core, bitcoin is a smart currency, designed by very forward-thinking engineers. It eliminates the need for banks, gets rid of credit card fees, currency exchange fees, money transfer fees, and reduces the need for lawyers in transitions… all good things.”

Peter Diamandis

Founder and chairman of the X Prize Foundation

What is a Distributed Ledger?

Imagine that one bitcoin is a single unit of the Bitcoin (BTC) digital currency. Just like Euro, it does not have any value itself. And to keep track of the number of bitcoins, there is a distributed ledger that can record transactions between two parties.

This file is not kept in any central server, such as a bank or a single data center. The ledger is distributed across the world via a network of computers, which represent a “node” and keeps a copy of a ledger file.

As you can see in the table above if Brian wants to send Bitcoins to David, he announces this message to the network showing that amount of Bitcoins in his account should decrease by 3 BTC and the amount of David’s account should increase by the same amount. Each node in this network will receive the notification and apply a requested transaction to the ledger, thus keeping the account balances updated.

How to Make Transactions on the Blockchain?

If you want to perform transactions on the blockchain, you need to create a wallet. This is a program or an app that allows you to buy, sell, and exchange bitcoins. Taking into account that you are the only person who can dispose of your assets, each wallet is secured by a cryptographic method that uses an exclusive combination of two different keys: a private and a public one.

If a message is encrypted with a public key, you are the only one who can decrypt the message - as no one else knows your private key. Otherwise, if you encrypt your message with a private key, only the paired public key can be used to decrypt it. Using our example above, when Brian wants to send bitcoins, he broadcasts a message protected with a private key of his wallet and no one except for him knows a key to unlock his wallet. Each node can make sure that the transaction comes from Brian as they can decrypt the transaction request with the public key of his wallet.

How to Make Sure that No One Can Interfere in Your Transaction?

When you encrypt the request with your private key, you are simultaneously creating a digital signature that is used to double-check the authenticity of this transaction. This digital signature is composed of a private key and a transaction request which make it a unique combination that cannot be used for other transactions. If you change just one character in the transaction, the digital signature will change that’s why potential hacker can modify your request or the number of Bitcoins you are sending.

To send bitcoin, you have to prove that you are the owner of the private key as you need to use it to encrypt the transaction request message. Note that you can never reveal your private key since you broadcast the message.

If you want to perform transactions on the blockchain, you need to create a wallet. This is a program or an app that allows you to buy, sell, and exchange bitcoins.

As the Bitcoin network is open-source, anyone with a laptop and internet can operate transactions. If any mistake appears in the code used to broadcast a request message, the associated currency will be lost forever. Since the network is distributed there is no customer service that could solve this problem. That’s why, if you decide to transact on the Bitcoin network, we advise that you use only the open source and official Bitcoin wallet and keep your passwords in a safe place.

The Advantages of Blockchain Technology

Now you have an understanding of how blockchain technology works, let’s see why it is so attractive to users.

Using blockchain technology has several obvious benefits:

  • You have a complete control of the assets you own. No third party controls this value and limits your access to it.
  • The cost to make a transaction is very low no matter where it happens. It allows micropayments.
  • It takes just several minutes to transfer a value.
  • As anyone can verify the transaction at any time, the whole process is considered transparent.

The Challenges of Blockchain Technology

However, blockchain technology has several challenges:

  • There is an option to send and receive transactions anonymously. On the one hand it guarantees a certain level of privacy, but on the other hand, it can cause the illegal activity as no centralized institution can keep track of the user's identities.
  • In spite of growing popularity of bitcoins, it is still useful when it comes to buying actual goods and services. However, this can change in the nearest future.
  • Bitcoin price just like a price of any other currency is very volatile and can be affected by significant events, or news in the industry.
  • Although security is not a weak point of the blockchain, the technology is still in its infancy. New tools are developed every day to improve the stability and security.
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