Blockchain technology is the key innovation that powers cryptocurrencies like Bitcoin, Ethereum, and Dogecoin. But what exactly is blockchain and how does it work?
What is Blockchain Technology?
Blockchain technology is a type of shared database that differs from a typical database in the way it stores information; blockchains store data in blocks linked together via cryptography. Different types of information can be stored on a blockchain, but the most common use for transactions has been as a ledger. In Bitcoin’s case, blockchain is decentralized so that no single person or group has control—instead, all users collectively retain control. Decentralized blockchains are immutable, which means that the data entered is irreversible. For Bitcoin, transactions are permanently recorded and viewable to anyone.
How Does Blockchain Work?
A blockchain consists of programs called scripts that conduct the tasks you usually would in a database: Entering and accessing information and saving and storing it somewhere. A blockchain is distributed, which means multiple copies are saved on many machines, and they must all match for it to be valid. The blockchain collects transaction information and enters it into a block, like a cell in a spreadsheet containing information. Once it is full, the information is run through an encryption algorithm, which creates a hexadecimal number called the hash. The hash is then entered into the following block header and encrypted with the other information in the block. This creates a series of blocks that are chained together.
Transactions follow a specific process, depending on the blockchain they are taking place on. For example, on Bitcoin’s blockchain, if you initiate a transaction using your cryptocurrency wallet—the application that provides an interface for the blockchain—it starts a sequence of events.
Your wallet creates a transaction message that includes the amount of Bitcoin you want to send, the address of the recipient, and a digital signature that proves your ownership of the Bitcoin. This message is then broadcasted to the Bitcoin network, where it is verified by other nodes (computers) running the same software. These nodes check that you have enough Bitcoin to make the transaction and that you have not spent it before.
Your transaction is added to a pool of unconfirmed transactions, where it waits to be selected by a miner—a node that uses its computing power to solve complex mathematical problems and create new blocks. Miners compete with each other to be the first to create a valid block that includes your transaction and others from the pool. The first miner to do so receives a reward of newly created Bitcoin and transaction fees.
The more blocks are added after your transaction, the more secure it becomes. Typically, six confirmations are considered enough to ensure that your transaction is irreversible.
What Are the Applications of Blockchain Technology?
Blockchain technology is not limited to cryptocurrency use cases. It can be used to make data in any industry immutable—the term used to describe the inability to be altered. Because there is no way to change a block, the only trust needed is at the point where a user or program enters data. This aspect reduces the need for trusted third parties, which are usually auditors or other humans that add costs and make mistakes.
Some examples of blockchain applications beyond cryptocurrency are:
– Smart contracts: These are self-executing agreements that are stored on a blockchain and executed automatically when certain conditions are met. Smart contracts can be used for various purposes, such as escrow services, insurance claims, supply chain management, voting systems, and more.
– Non-fungible tokens (NFTs): These are unique digital assets that represent ownership of something intangible, such as art, music, collectibles, or even tweets. NFTs are created and traded on blockchains that support them, such as Ethereum or Binance Smart Chain.
– Decentralized finance (DeFi): This is an umbrella term for financial services that are built on blockchains and operate without intermediaries or central authorities. DeFi applications include lending platforms, exchanges, stablecoins, prediction markets, and more.
What Do I Need to Study to Understand Crypto?
Blockchain technology is the foundation of cryptocurrencies and many other innovative applications. It is a secure and transparent way of storing and transferring data that eliminates the need for intermediaries and enhances trust. By understanding the basics of blockchain technology, you can better appreciate the potential and value of crypto and its future impact on the world.
