Market Basics

How Does Blockchain Work?

What is Blockchain Technology?

A blockchain is a record-keeping technology, often thought of as a digital ledger. The name blockchain comes from the ledger’s structure and how it records and stores data. When a digital transaction first hits a blockchain ledger, the data begins a short but complicated process of becoming part of a verified block. The words block and chain were initially separated when pseudonymous developer Satoshi Nakamoto launched the Bitcoin blockchain in January 2009. Eventually, block and chain were combined into a single word as the technology rose to become global renowned in 2017. This article delves further into blockchain operations – how blocks record transactions – and how blocks connect to create a chain.

How Does Blockchain Work?

Those new to the crypto industry often mistake blockchain with bitcoin, the popular cryptocurrency. There is sufficient reason for the confusion. Blockchain was initially launched as a database to underpin Bitcoin. But the two are not the same. It is best to think of blockchain as an operating system, like Microsoft Windows or macOS, while cryptocurrencies are just one of many applications that can run on it.

What Data Does Each Block Record?

Each block on a blockchain holds tens or even millions of digital transaction records. More specifically, each electronic transaction record held by a block typically contains:

• The date, the unit amount, the encrypted IDs of the transaction participants, and a timestamp to keep all records sequential and organized chronologically.
• A unique code that distinguishes each transaction from another that is called a hash. Hashes serve as a digital fingerprint for each transaction ever recorded in a block

What is a Hash Function, and How Are They Created?

Computer scientists and engineers use a computer-based cryptographic tool called a secure hashing algorithm (SHA) to create fixed-length unique hashes. Hashes are critical to blockchain security measures because they encode the majority of sensitive information on the network. When an SHA hashes any given set of data, the algorithm will generate one unique hash of a set length. An SHA-256 algorithm, for example, will output a unique 64-character string of letters and numbers, no matter the size of the input (as shown below):

Hashing Input #1: 18 characters
Los Angeles Lakers
Hashing Output #1: 64 characters 73aeb6743ec2d2e1dcebd05ec2b474be8d04fa93b752eecbd3e0a71bee06a896

The Bitcoin blockchain uses a combination of SHA-256 (64-character strings) and SHA-512 (128-character strings) to encrypt data. The higher the SHA number – generally, the more complex and secure the hash. SHAs are also one-way cryptographic hash functions. It is an essential distinction because one-way codes are incredibly difficult to solve or revert. After all, the hashing output is orphaned and has no other relationships.

How are Blocks Formed?

After a Bitcoin transaction or transfer from one address to another is requested, the record moves to a pool of unconfirmed transactions on the Bitcoin blockchain. At this point, the network must verify with multiple network participants that previous transactions match. The responsibility for this work falls on the network participants or nodes who maintain and operate the blockchain. Particular network participants called mining nodes or miners are responsible for verification, better known as mining, in some blockchain protocols.

What is Crypto Mining?

As we detailed in the previous article, the most significant difference between blockchain and traditional databases is distribution. On a distributed public blockchain, usually, no single actor, computer, or organization is in control . A public blockchain is instead updated communally by hundreds sometimes millions of network participants of nodes – eliminating the need for a centralized intermediary. The collective nature of blockchain has brought comparisons to Wikipedia, which relies on a network of contributors rather than a single author. Three different network forces come together to maintain and secure a blockchain:

1. Network Node operators, miners, validators and or stakers, who maintain the security of the network and maintain the history of all the transactions
2. Developers who write the code to maintain, enhance, and build on top of the network
3. Organizations and others that use the network

If a developer creates something not accepted by the users of the network, they will refuse to run the new code. The network’s distributed nature helps to limit the ability for a single person, entity, or even group of people to make changes that are not accepted by the majority. For example, if miners and developers collude, they can drive away the users.

Mining is a critical part of the transaction approval and block formation process in many blockchains. Crypto blockchain miners follow a specific agreed-upon protocol for adding new blocks of transactions to the blockchain. Miners first select unconfirmed transaction records from the network mempool and start a competition to be the first to solve a math calculation and ultimately form those transactions into a new block. Several miners will choose the same unconfirmed transaction and compete to create the block first.

Next, all competing miners use software and computing power to solve a computational problem unique to the new block. This exercise, which is a computer-based mathematical puzzle, is called a proof of work. The first miner to solve the computational problem within the time pre-determined by the code will receive an eligible signature in hashed form. This signature is required to validate a new transaction to the block. With the help of other nodes, the winning miner or group of miners will broadcast this hashed signature and the updated block to the network.

Although many crypto users think of blocks as holding just one transaction, that is not necessarily the case. A single block on the Bitcoin blockchain, for example, can store ~1 MB of data. Depending on the transaction’s size, this means a single block can house hundreds or millions of transactions under one roof.

How do Verified Blocks Link to Form the Chain?

After a block is verified, it will hold its unique block hash and the previous block hash, as shown below.

The previous block hash is the connection point that links the blocks together and prevents blocks from being altered. It also prevents a rogue block from being inserted between two verified sequential blocks. With this protocol, each subsequent block confirms a sequence of transactions and strengthens the previous block’s verification – reinforcing the chain. This write-once and append-many framework has earned blockchain the reputation of being tamper-resistant and an unchangeable record of verified transactions, each timestamped and linked to the previous one.

Three Takeaways:

1. Blocks are a digital record consisting of transactions and containing unique codes called hashes that distinguish each transaction and each block.
2. Most blockchains can only be updated by consensus from the network participants who maintain and operate the system.
3. After a new block is verified, it is linked sequentially to the chain using the previous block hash.