So far we’ve learned about blockchain’s key features and some of its uses. But we haven’t really delved into how it actually works. Our post today will explore how blockchain technology works. Hopefully, you’ll find it every bit as interesting as I do.
Blockchain technology essentially works on three main principles. The principles are: 1) Cryptographic keys, 2) a peer-to-peer network that has access to a public ledger and 3) an ecosystem that is built on incentives to securely and transparently manage transactions over the network.
Picture two people who wish to transact with each other. The most common and secure way is a physical exchange, right? Security is one of the biggest challenges when it comes to transactions over the internet. That’s where cryptography keys come in.
In the same scenario, both individuals own a private key and a public key. The combination of the two creates a secure digital identity reference for its owner. Similar to an actual signature, this digital identity reference represents as a form of consent and authority when used.
But just having cryptographic keys as authenticated identities is not enough to ensure transparency, which brings us to the next point,
A peer-to-peer Network
Transactions over the internet means that you’re not able to see, or at least verify the other person’s actions. Hence, a neutral third party that can oversee and verify both parties. In this case, it’s either the banks or payment gateways that act as agents to carry out transactions.
Blockchain technology eliminates the need for third party intervention. We know that the ecosystem is made up of a large network of computers. Furthermore, it continually grows as more people join the network. The idea of a peer-to-peer network is that instead of one intermediary, there is a large pool of validators that reaches a consensus to validate a transaction.
Think of it in terms of witnesses. One witness is insufficient to verify that a crime happened. But if there were a lot of witnesses at the location, you can be sure that a crime did happen. In this case, instead of eye witnesses, blockchain uses mathematical verification. Which is a whole lot more reassuring, if you ask me.
What is worth noting is that the larger the size of the network, the more secure it is. To date, bitcoin is secured 3,500,000 T/Hs, which simply means that you need a lot of computing power to crack the hash code. You can learn more about what hash means from our post here.
Another important point here is that the network share equal access to a public ledger. Moreover, this ledger records all transactions that ever happened in the blockchain and every computer, even new ones that join the network will have a copy of this ledger.
So when you combine the cryptographic keys and the network together, you will get a secure digital interaction that is recorded in the public ledger. The figure below shows how transactions happen in the network.
As you can see from the flowchart, the process is pretty straightforward. Let’s say a transaction occurs between a merchant and a user. The merchant sends or announce his public key to the user. Then, the user will create a transaction using their private key and attach it to the merchant’s public key. The transaction joins other transactions flooded into the blockchain network to form a block.
The last process in the transactions makes up the healthy ecosystem. In order to validate the transaction, there must be a consensus from the network. This is where mining comes in. We’ve created a series where you can learn about mining, and you can read it here.
Here, the goal is twofold. First, miners gets incentives to verify transactions. The second goal is to eliminate the possibility that the same cryptocurrency is in another transaction at the same time. The network creates and maintains a history of transactions that continually reconciles over time.
Simply put, what miners do is solve complex mathematical problems to confirm and relay transactions. As a result, they will be rewarded for every problem they solve. The basic economic theory of self-interest applies here in order to sustain the whole ecosystem. It’s a win-win situation for all parties.
So here we’ve learned the three principles that make blockchain technology work. They are very important in ensuring that blockchain is secure, transparent and maintain its integrity. You can go to our post here in case you need a refresher on its features.
See you next time!