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How Does Blockchain Technology Work?

If you have followed the recent surge in the price of bitcoin, even starkly, you may have come across the term “blockchain”- the record-keeping technology of cryptocurrencies. Since 2009, this technology has received growing interest in the general public discourse.

As open-source technology, blockchain offers an alternative to the traditional form of intermediary-based financial transactions.

The intermediary is replaced by the collective decentralized verification ecosystem, offering a great degree of traceability, speed and security. This new form of digital record-keeping could revolutionize our society in ways we had not thought of before.

How Does a Blockchain Work?

Let me give you an analogy of how blockchain works: suppose I (a “node”) have a record of a financial transaction on my computer (a “ledger”). Ten government accountants (call them “miners”) have the same file on theirs as well (so it’s “distributed”).

When I make a financial transaction, my computer emails each accountant and informs them. These accountants then rushed to be the first to check whether my transaction was legible. And the first one to validate the transaction sends out the logic for verification to other accountants.

Once the other accountants agree with the verification logic, it gets updated on my and other accountants’ computers. The accountant who validates a transaction will earn a small amount for his/her efforts. This process is known as blockchain technology.

Blockchain is a decentralized, distributed public digital ledger consisting of records called blocks – linked to one another using cryptography.

Each block contains a cryptographic hash of the previous block, a timestamp, and transaction data. Anyone with internet access can look at the information within: it is open to everyone.

Everyone has collective ownership of the record, but nobody (really) owns it, controls it, and manipulates it.

It is maintained by thousands of computers located worldwide in a distributed network. Anyone can add their computers to this network. In return, you receive payment for the service you provide. All the information in the record is permanent – and cannot be changed.

All the computers on the network keep a transaction record to ensure this. If you want to hack the system, you would have to hack every computer on the network.

New information can only be added to the system when all the computers signal their approval, which they do once they are satisfied with the proof of logic. 

How does one use blockchain?

Suppose I go to a candy store and buy chocolates. I pay the shopkeeper a sum of money in return for the transaction. It is a direct transaction where the two parties exchange values. Now, I have some money in my digital wallet.

To spend that money, I will have to go through a middleman – in this case, a bank, PayPal, or a credit card company. For decades, computer scientists have been finding ways to replicate the direct, frictionless cash transaction digitally.

As early as 1982, cryptographer David Chaum proposed a blockchain-like protocol with “computer systems established, maintained, and trusted by mutually suspicious groups.”

But the first blockchain was conceptualized by an anonymous entity (a person or a group of people) known as Satoshi Nakamoto in 2008. Nakamoto wrote: 

A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending. We propose a solution to the double-spending problem using a peer-to-peer network. The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work. The longest chain not only serves as proof of the sequence of events witnessed but proof that it came from the largest pool of CPU power. As long as most CPU power is controlled by nodes not cooperating to attack the network, they’ll generate the longest chain and outpace attackers. The network itself requires minimal structure. Messages are broadcast on a best-effort basis, and nodes can leave and re-join the network at will, accepting the longest proof-of-work chain as proof of what happened while they were gone.

(Nakamoto 2008)

Instead of a bank or a financial intermediary to process and maintain the transaction and the record, Nakamoto proposed the same work to be processed by thousands of computers distributed across the bitcoin network in an open-sourced collaboration.

The payment information – the wallet address, the amount, and the time – is added to the collective database known as the chain of information.

Money requires trust. Over many centuries, this trust was legitimized by sovereigns, treasuries, and the banks in god’s name. The emergence of democratic institutions worldwide transferred this legitimacy to the government.

It works transparently by the mathematical and cryptographic proof that has removed the need for that trust. It has enabled people to spend their digital cash directly without needing a middleman. The first blockchain was a database on which every Bitcoin transaction was stored. 

What is the purpose of blockchain?

Blockchain is an open-source distributed database using state-of-art cryptography that facilitates collaboration and transparency in all transactions.

Don Tapscott, co-author of the Blockchain Revolution: How the Technology Behind Bitcoin is Changing Money, Business and the World, thinks the “blockchain is the biggest innovation in computer science – the idea of a distributed database where trust is established through mass collaboration and clever code rather than through a powerful institution that does the authentication and the settlement.”

Blockchain and Financial Systems

Blockchain technology will revolutionize the financial system soon. As more and more countries and financial institutions have realized that banning a decentralized digital currency is incomprehensible, they are moving towards regulations – thereby reaping the benefits of this technology.

Blockchain and Data Decentralisation

Traditionally, data was stored within a relational, centralized database – an advanced Excel spreadsheet. These databases have been vulnerable to hacks, manipulations, and data thefts.

With blockchain technology, there will be no centralization, no data manipulation, and reduced data redundancy to a new level. You can send digital money to anyone, anywhere, without waiting for days for the receiver to receive the payment.

Blockchain and Digital Payments

In February 2021, MasterCard announced that it would provide its merchants with an option to receive payments in cryptocurrency later this year. The company also holds a patent application describing a blockchain-based database capable of instantaneously processing payments.

The financial services industry is up for disruption. Several banking institutions have adopted this technology for quick transactions, database maintenance, and financial transparency. 

Blockchain and Digital Health

The rise of digital health – the use of information and communication technologies in medicine – has also significantly boosted blockchain technology. Blockchain will make it easier to treat health problems by radically improving the accuracy and availability of historical data on patients.

By creating an accessible, permanent blockchain record owned by you, you could instantly store information about your ailments, allergies, and lifestyle choices. It will enable doctors to diagnose and treat their patients better.

Blockchain and Health Data Security

Another reason for healthcare providers to turn to blockchain technology is security.  A recent report published by Risk Based Security revealed that the healthcare industry faced 484 hacks in 2020, accounting for 12% of all last year’s breaches.

With blockchain technology, patients, doctors, and healthcare providers will securely access the information. Factom, a health-focused company, helps store digital records that can be accessed only by hospitals and healthcare administrators.

Blockchain and Real Estate

The property market is a pretty messy business. It would take months of paperwork for one to buy a house. This tends to happen due to a lack of trust between different entities. With blockchain smart contracts, this laborious task of property transfer has become more straightforward and transparent.

In the United Kingdom, a company called ClickToPurchase has used this technology. According to Gartner, blockchain technology has already passed the peak of the hype cycle. And it has entered a period of disillusionment that enables the usage of blockchain technology in our everyday life.

The social impact of blockchain technology has already begun. It may just be about time we see a society based on the revamped social contract – based on collaborated ownership. But it is still a long way to imagine blockchain technology becoming a part of everyday life. 

Picture: Aman Mishra on Medium

This website and the newsletter (fuzzy notes) have been a labour of love. While they are free to access (and will continue to be free), they are not free to create. I spend significant time researching, writing, and proofing every article I publish here, apart from all the logistical aspects of buying and managing the domain and hosting plans. Each article is written meticulously to help fellow readers (such as yourself) get the best knowledge, which is also witty and articulate in this outlook. You may reach out to me at [email protected] (and tell me what you liked about the essay you may have just read or if you want me to write on anything you wish to read). If you have benefitted from reading articles on my website and the newsletter, consider buying me a coffee (as a token of love and appreciation ♥). If you cannot do so now, it’s okay! (understandably, each of us has our problems to deal with every day.) You can still do something else: share the article with someone who may like it.

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