Blockchain: What is It, How It Works, and How Can It Be Used

Jakob Brezigar
Last updated: 15.April 2024
Reading time: 11 min

Nowadays, saying “I have blockchain” at a party might just be THE new “I have a startup”—guaranteed to raise a few eyebrows and possibly some venture capital. Blockchain is a distributed ledger, with the ability to record transactions in a secure, immutable manner. Instead of relying on a central authority or traditional database, blockchain systems store data from transactions across multiple computers in a decentralized fashion. Every time a transaction occurs, it gets recorded in a “block,” and multiple such blocks form a “chain.” This chain, stored on the blockchain, ensures that each transaction is tamper-proof and easily traceable.

What is blockchain?

Blockchain is a decentralized, digital ledger technology where transactions are recorded chronologically in blocks and linked together. It’s secure, transparent, and resistant to modification.

How does blockchain work?

Transactions are grouped into blocks. Once verified, these blocks are cryptographically linked to the previous block, forming a chain. This structure ensures data integrity and security.

Why is blockchain considered secure?

Due to its decentralized nature and cryptographic hashing, altering any information requires consensus and changing all subsequent blocks, making unauthorized changes highly difficult.

What are the applications of blockchain?

Beyond underpinning cryptocurrencies like Bitcoin, blockchain supports smart contracts, supply chain management, voting systems, identity verification, and more.

Why is blockchain considered secure?

Due to its decentralized nature and cryptographic hashing, altering any information requires consensus and changing all subsequent blocks, making unauthorized changes highly difficult.

The unique structure of the blockchain network offers a transparent way to conduct transactions. Each transaction record includes essential details and is added to an existing block after validation. Once validated, these transactions become a permanent part of the blockchain, ensuring that the entire database remains tamper-proof. This process has significant implications for industries, from financial institutions to supply chains, as blockchain eliminates the need for intermediaries, resulting in secure transactions and a reduction in costs.

Key Takeaways - Blockchain:

Blockchain technology securely logs transactions on a distributed ledger, ensuring tamper-proof and traceable operations.
It eliminates intermediaries like banks, reducing transaction costs and increasing processing speed.
Blockchain’s applications extend beyond cryptocurrencies; it’s pivotal in industries like supply chain management and finance.
Smart contracts on blockchains automate transactions, enhancing efficiency and trust without intermediaries.
Public blockchains are transparent and open, while private blockchains control access and enhance security for organizational use.

How Does a Blockchain Work?

At the heart of every blockchain is the idea of decentralization. Unlike a central database, where the entire database is stored in a single location, distributed ledgers spread the data across multiple computers or nodes. Each time a transaction is conducted on a blockchain network, it needs to be verified by the majority of the network participants. Once verified, the transaction data is added to a data block. Each data block has a unique code, known as a cryptographic hash, and a reference to the cryptographic hash of the previous block, forming a chain of blocks.

What is the Difference Between a Database and a Blockchain?

Databases and blockchains primarily function as information repositories. Yet, traditional databases centralize data storage, making them vulnerable to breaches. Conversely, blockchain distributes data across myriad computers. The decentralization, twinned with encryption, amplifies the security of blockchain systems. Entries in conventional databases can be modified, whereas blockchain records, once etched, are immutable. The entire blockchain, be it a public blockchain or a private blockchain, adheres to this principle.

What Are the Key Components of Blockchain Technology?

Understanding the intricacies of blockchain technology requires a deep dive into its core components. These elements intertwine to create a robust and secure system, driving the efficacy and reliability of blockchain networks.

Public Key Cryptography

Public key cryptography, sometimes referred to as asymmetric cryptography, is a fundamental component of blockchain technology. It involves generating a unique pair of cryptographic keys: one public and one private. The public key acts as an address that others can see and send digital assets to. In contrast, the private key is kept confidential, acting as a digital signature to authorize transactions. When a user conducts transactions on a blockchain, their private key verifies their identity, ensuring that the user has the right to transfer or receive assets. Losing one’s private key can be detrimental, as it provides access to digital assets stored on the blockchain.

Record the Transaction

To understand the depth of the blockchain protocol, consider the process of recording transactions. Each transaction, once initiated, goes through a validation process. This process involves network participants, often referred to as “miners” in the Bitcoin blockchain, who solve complex mathematical problems. Once a majority reaches a consensus and confirms the transaction’s validity, it’s added to a new block. This block, containing details like transaction timestamps and the hash of the previous block, is then appended to the existing blocks on the blockchain.

Secure Transactions

One of the reasons blockchain technology has gained traction across industries is its ability to process secure transactions. Every transaction on a blockchain is encrypted, making it almost tamper-proof. Moreover, each transaction is intrinsically linked to the one before it, creating a chain of interdependent records. This chaining of transactions makes it exceedingly difficult for malicious actors to alter any transaction record without disrupting the entire blockchain. Additionally, smart contracts, a form of blockchain application, can be executed automatically upon meeting predetermined conditions, further enhancing the security features of blockchain-based systems.

Link the Blocks

Delving deeper into the structure of blockchains reveals the intricacies of how blocks are interconnected. Each block, containing multiple transactions, carries a cryptographic hash of the preceding block. This linkage ensures a continuous, unbroken chain, reinforcing the integrity of the entire blockchain system. This structure not only bolsters the security of the blockchain but also establishes its immutable nature. To alter information within a block would require changing data in all subsequent blocks, a near-impossible feat, especially in public blockchains where multiple network participants must agree to any changes.

Banking and Finance

The banking and finance sectors stand as crucial pillars in the global economic framework. Historically, these industries have grappled with challenges like prolonged transaction times, susceptibility to fraud, and complex bureaucratic hurdles. Recognizing the potential of blockchain technology, many financial institutions are diving deep into its applications. Blockchain eliminates the need for intermediaries, paving the way for direct peer-to-peer transactions. This decentralization dramatically accelerates transfer times and slashes associated costs. Moreover, when you consider the traditional business networks in banking that often rely on numerous intermediaries for payment processing, the efficiency introduced by blockchain is truly revolutionary.

Blockchain vs. Banks

Traditional business networks often rely heavily on intermediaries like banks for validating transactions. This process can be time-consuming and prone to errors. Moreover, each bank account operates through a central database, which can be a potential security risk. In contrast, a blockchain network functions as a shared ledger that is open to all participants. The decentralized nature of the blockchain means that there’s no central authority overseeing or validating transactions. Instead, network participants come together to validate transactions using a consensus mechanism. This system reduces transaction fees, speeds up payment processing, and offers enhanced security features compared to a traditional bank account setup.

What are the Types of Blockchain Networks?

Blockchain technology has revolutionized the digital landscape, offering unprecedented solutions to traditional challenges faced in transactional processes, data storage, and network participation. When diving deep into the world of blockchain, we are met with an array of blockchain networks, each carved with specific features to cater to diverse needs. These networks, governed by distinct blockchain protocols, define who can participate in the network, validate transactions, and maintain the shared ledger. As we traverse this landscape, a few prominent types of blockchain networks emerge.

What's the Difference Between a Private Blockchain and a Public Blockchain?

The world of blockchain networks presents a dichotomy—public and private blockchains. A public blockchain, like the bitcoin blockchain, welcomes all; it’s an open arena where any participant can join, validate transactions, and depart at will. All transactions on this network are available for public scrutiny. Contrarily, a private blockchain, as the nomenclature suggests, is exclusive. Participation in a private blockchain network is restricted, necessitating invitations for network participation. Here, selected entities can record transactions. This form of blockchain system offers more control over who can access transaction data and is often helmed by a single organization. Between these extremes lies the consortium blockchain, which merges features of both public and private blockchains.

Public Blockchain Network

Public networks stand out due to their open nature. These decentralized platforms, often contrasted with private networks, allow anyone to join, participate, and witness all transactions. The transparency inherent in public blockchains instills a high level of trust among its users, as every participant can participate in validating transactions. However, with great transparency comes potential challenges, especially concerning privacy. Some blockchain users might be concerned about the public nature of their transactions, leading to the rise of private blockchains, which offer more restricted network participation.

Private Blockchain Network

Private blockchain networks are akin to exclusive clubs where entry is by invitation only. Unlike the decentralized nature of public blockchain networks, private blockchains operate within the purview of a single organization or entity. As a result, they offer enhanced security features, making them highly resistant to external threats. Given that these networks cater to a select group of blockchain users, they can offer faster transaction processing speeds and lower transaction fees compared to their public counterparts.

The primary allure of private blockchains rests in their ability to provide tailored solutions to meet organizational needs. Whether it’s about recording transactions in a financial institution, managing supply chains efficiently, or even integrating with existing blocks of a traditional database, private blockchains come to the rescue. Moreover, being under the central authority of an organization, they can be modified easily to incorporate new features or address challenges.

However, the centralized nature of private blockchains, while offering control, can sometimes be seen as a double-edged sword. While they facilitate streamlined operations and enhanced security, they may not offer the same level of transparency and immutability that blockchain enthusiasts cherish in decentralized blockchain. In certain scenarios, trust in the central authority becomes paramount for the system to function effectively.

Consortium Blockchain Network

Bridging the gap between the polar worlds of public and private blockchains, we find consortium blockchains carving their unique identity. These networks, also known as federated blockchains, operate under the governance of a group or consortium of organizations, rather than a single entity. This collaborative approach ensures that no single organization has unilateral control over the entire blockchain.

Consortium blockchains resonate with the ethos of shared ledger systems, where transaction data is accessible to all network participants, promoting transparency. Simultaneously, they benefit from restricted network participation inherent to private blockchain network. This balance ensures that while transactions are transparent among consortium members, the broader public remains shielded from the network’s intricacies.

Financial institutions, in particular, have been quick to recognize the potential of consortium blockchains. Traditional business networks within the banking sector have long grappled with challenges related to transparency, security, and trust. Consortium blockchains, with their unique blend of transparency and control, offer solutions to these challenges. Whether it’s payment processing, managing digital assets, or ensuring seamless cross-border transactions, consortium blockchains have demonstrated their mettle.

Furthermore, these networks pave the way for collaborative ventures among competitors. Imagine multiple banks coming together to create a shared platform for conducting transactions, validating financial assets, or even streamlining supply chain processes in the finance sector. Consortium blockchains offer this very promise, driving operational efficiencies while ensuring equitable influence over the implementation of blockchain and governance.

In essence, the vast expanse of networks, from private to consortium, offers a spectrum of solutions designed to address distinct challenges. As blockchain technology continues to evolve, so will these networks, each adapting and innovating to meet the ever-changing demands of the digital age.

Hybrid Blockchains

When discovering blockchain, one encounters various systems of blockchains tailored to different needs. Hybrid blockchains represent an innovative melding of both public and private blockchains. In essence, they imbue businesses with the authority to delineate between data that should be public and data that remains private. It’s a tailored approach, providing both transparency and control. This flexibility has positioned hybrid blockchains as a compelling option for businesses that desire the trustworthiness intrinsic to public blockchains, yet wish to retain the data discretion associated with private blockchains.

Blockchain Interoperability

As we witness the expansive growth of the blockchain ecosystem, a new challenge arises—intercommunication between distinct blockchain networks. Enter blockchain interoperability. This facet of blockchain technology champions the seamless transfer of digital assets and transaction data between divergent blockchain networks. By bridging the gaps between individual blockchain systems, interoperability exponentially broadens the spectrum of potential blockchain applications, fostering unprecedented avenues for innovation.

How do Different Industries use Blockchain?

Blockchain technology, ever since its inception, has seeped into numerous sectors, transforming traditional business networks into more transparent, secure, and efficient systems. Financial institutions were among the first to harness the potential of blockchain, primarily the blockchain from bitcoin, for digital currency transactions. Here, the bitcoin transactions were validated and recorded on an immutable ledger, effectively reducing transaction fees and streamlining payment processing. But the applications of blockchain extend far beyond digital currencies. The supply chain industry, for instance, leverages blockchain networks to trace the journey of products, ensuring transparency and authenticity. Every transaction record includes details from production to delivery, offering real-time tracking on a shared ledger, which cannot be altered due to the blockchain’s immutable nature.

Furthermore, industries requiring secure data storage employ private blockchains for their operations. These private blockchain networks offer enhanced security features, with access restricted to specific network participants, ensuring data integrity. On the other hand, public blockchains, like the bitcoin blockchain, are decentralized blockchains that anyone can join. This decentralization eliminates the need for a central authority, making transactions transparent and direct. Consortium blockchains, a hybrid between public and private blockchains, are gaining traction, especially in sectors that require a blend of transparency and privacy, such as joint ventures among competitors or cross-industry collaborations.

Smart contracts, another facet of blockchain technology, have revolutionized sectors like real estate and legal. These self-executing contracts with the terms of agreement between buyer and seller being directly written into lines of code are executed automatically once conditions are met. This automation not only reduces the potential for human error but also speeds up processes and reduces costs. Storing data, especially in healthcare, has also seen a transformation. Patient records, stored on the blockchain, can be accessed online by authorized personnel, ensuring data integrity and security. Furthermore, the blockchain protocol ensures that every subsequent block has a reference to the previous block, reinforcing the security of the entire blockchain.

Traditional databases, used in various industries, are now being supplemented or even replaced by distributed ledgers, offering higher transparency and security. Especially in areas like document timestamps or recording transactions related to the assets, the advantages of blockchain are palpable. Blockchain also facilitates reduced transaction fees, which is particularly beneficial for businesses that conduct transactions frequently. Industries that rely heavily on certifications, such as diamond or luxury goods, use blockchain to validate the authenticity of their products. Blockchain applications in these sectors ensure that every product can be traced back to its source, thereby reducing counterfeits.

In essence, whether it’s integrating smart contracts for seamless transactions, employing private blockchains for secure data storage, or leveraging public blockchain networks for enhanced transparency, industries across the board are harnessing the power of blockchain to drive efficiency, security, and transparency in their operations. As blockchain technologies continue to evolve and adapt, their footprint across diverse sectors is only set to expand.

Private Transactions

The heart of the financial realm beats for transparency and efficiency. As financial industries, especially banks, seek progressive approaches, blockchain has surged forth as a viable solution. Its decentralized ledger—stored on the blockchain—safeguards transactions, ushering a new era where peer-to-peer transactions eliminate traditional intermediaries. Through this, blockchain accelerates transaction settlements and provides an unmatched privacy level. The blockchain protocol at work facilitates this privacy, making the business network more reliable. Financial institutions have realized that the blockchain based distributed ledgers offer tremendous promise for payment processing, reducing transaction fees and enhancing transaction record-keeping.

Supply Chain

Across the industrial spectrum, the significance of a transparent and efficient supply chain cannot be overstressed. From agricultural practices to pharmaceutical productions, and high-end luxury goods crafting, blockchain technologies are being harnessed. Storing data pertinent to products at every step of their journey on the blockchain ensures real-time location tracking and product genuineness. Supply chains integrated with blockchain can pinpoint inefficiencies in real-time, leading to immediate corrective actions. This blockchain implementation in supply chain management guarantees that every transaction record includes detailed, immutable, and shared ledger entries, optimizing every step of the supply chain process.

Technology Cost

A venture into blockchain integration entails an upfront expenditure, encompassing technological set-up and workforce training. However, the realm of blockchain offers long-term boons, transcending the initial expenditure. Reduced transaction fees, diminished error margins, and a drastic plunge in fraudulent activities make a compelling case for the integration of blockchain technologies. Businesses, regardless of their operational domain, are meticulously weighing these immediate costs against the plethora of long-term benefits offered by the blockchain systems to determine the pragmatic feasibility of blockchain integration.

Property Records

Delving into real estate and governmental operations, the significance of incorruptible property documentation is paramount. Here, blockchain applications rise to the occasion, providing an infrastructure where property records are safeguarded in an immutable ledger. Every property transaction becomes transparent, with the transaction ledger accessible for verifications. This alleviates bureaucratic hiccups associated with property ownership, transaction record verifications, and transfer processes.

On What Level can Crypto Market Makers Utilize the Blockchain Technology?

Crypto market makers, pivotal in shaping the liquidity landscape of digital assets, leverage the multifaceted architecture of blockchain technology to enhance their operational efficiency and impact on the crypto ecosystem. By utilizing the base layer for securing transactions, the protocol layer for implementing trading rules, and the application layer for user interaction, they ingeniously orchestrate liquidity across various platforms. Advanced usage includes smart contracts for market making and decentralized finance (DeFi) protocols to ensure seamless trade execution and liquidity provision. At Orcabay, the utilization of such advanced blockchain techniques has enabled the reduction of slippage in high-volume trading periods, demonstrating the tangible benefits of these sophisticated strategies. Such multifaceted approach not only solidifies the role of crypto liquidity providers within the crypto ecosystem but also underscores the transformative potential of blockchain technology in creating more efficient and responsive financial markets.

What are the Benefits of Blockchain Technology?

The digital evolution ushered by blockchain technology is multifaceted. Transparency remains a cornerstone, with every transaction processed being recorded on the shared ledger that the entire blockchain community can independently verify and audit. The security features intrinsic to the blockchain systems ensure that each transaction is encrypted, linked to the previous block, making any unauthorized alterations a Herculean task. This very nature of storing transaction data in subsequent blocks on the blockchain guarantees security. Furthermore, the cost-effectiveness of blockchain is undeniable. The elimination of intermediaries in many blockchain applications, especially in financial assets management, leads to a significant reduction in associated costs.

First Generation – Bitcoin and Other Virtual Currencies

Tracing the genesis of blockchain technology, the digital landscape was graced with Bitcoin—the harbinger of digital currency. The underpinning technology—blockchain from bitcoin—set forth a decentralized alternative to conventional currencies. Its design ensured peer-to-peer transactions, bypassing the central authority. Each of these bitcoin transactions gets recorded in the bitcoin blockchain, ensuring that the entire process is transparent and free from any single entity’s control. The success of Bitcoin highlighted the potential of blockchain technologies and led to its diversified applications.

Second Generation – Smart Contracts

Delving into the evolution of blockchain technology, we’re ushered into its second generation, marked by the advent of smart contracts. These aren’t contracts in the traditional sense; rather, smart contracts epitomize a convergence of contract stipulations and code. Essentially, they’re self-executing contracts, where conditions and outcomes are written into lines of code. The beauty of a smart contract lies in its automation. When predetermined conditions are satisfied, actions are executed automatically, negating the need for intermediaries. This not only accelerates processes but also reinforces trust, as the code ensures unerring adherence to contract terms.

What are AWS Blockchain Services?

In today’s dynamic technological milieu, Amazon Web Services (AWS) has unfurled blockchain services designed to simplify the creation and management of a scalable blockchain network. Eschewing the complexities of establishing a network from the ground up, AWS caters to both private blockchain networks and public ones. Their services not only offer seamless integration and scalability but also reinforce security. Such initiatives by tech behemoths underscore the growing importance and versatility of blockchain technologies.

Disadvantages of Permissioned Blockchain

Permissioned blockchain networks, a subtype of private blockchains, allow validation of transactions only to certain individuals or entities. While this can provide a higher level of security and control, it also comes with limitations. One major drawback is that it lacks the full transparency offered by public blockchains. Furthermore, since a limited number of participants can validate transactions, it may not capitalize fully on the decentralized nature of blockchain network.

Bitcoin Network

Bitcoin network, a marvel in the world of decentralized blockchains, underpins the Bitcoin cryptocurrency. This network, operating on a public blockchain ledger, hinges on “miners” who validate and record transactions. Their reward? Bitcoin. This decentralized nature ensures that no single entity or central authority exercises control. Transactions remain transparent, direct, and secure.

Summary

Blockchain technology has undeniably revolutionized the digital landscape, offering transformative solutions across a plethora of industries. From its nascent stage as the underlying framework of the bitcoin blockchain, where it processed digital currency transactions with unmatched transparency and security, its applications have burgeoned manifold. Financial institutions, for instance, have adopted blockchain networks for seamless payment processing, benefiting from reduced transaction fees and enhanced efficiency. Supply chain management, another critical industry, has harnessed the blockchain’s shared ledger feature, ensuring every transaction record is transparently and immutably logged, thus guaranteeing product authenticity from origin to endpoint.

One of the standout features of blockchain technology is the capability to create smart contracts. These digital contracts, self-executing in nature, automate and streamline processes in industries like real estate, legal, and even entertainment. The distinction between public and private blockchains underscores the technology’s adaptability. While public blockchains offer decentralized solutions with no central authority and are open to all, private blockchains emphasize data security, granting access to select network participants. Consortium blockchains, striking a balance between the two, cater to specialized collaborative endeavors.

The inherent security features of blockchain, including its immutable ledger where every block references the previous one, ensure data integrity. Traditional databases, once the mainstay across industries, now find themselves juxtaposed against the advantages of distributed ledgers, especially when it comes to recording transactions or managing digital assets. The blockchain protocol, with its capability to validate and securely store transaction data, offers a fortified alternative to conventional systems.

Disclaimer: The information provided in this article is for informational purposes only and does not constitute financial, investment, or other professional advice. All opinions expressed herein are solely those of the author and do not represent the views or opinions of any entity with which the author may be associated. Investing in financial markets involves risk, including the potential loss of principal. Readers should perform their own research and consult with a licensed financial advisor before making any investment decisions. Past performance is not indicative of future results.