What is blockchain? And how does it work? | BTC Direct

What is blockchain?

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“Blockchain... We should do something with that”, said every organisation in 2017 and 2018. Almost everyday a press statement was released about a new blockchain initiative that was started by, for example, a bank. In this article we’ll explain what blockchain is exactly, and if blockchain is able to start an actual revolution. But let’s begin with the history of bitcoin, because bitcoin and blockchain are inseparable.

Blockchain is a small part of bitcoin

In 2008, Satoshi Nakamoto wrote the Bitcoin whitepaper. In this document, he (or she) describes a new currency called bitcoin.

The white paper also describes an accounting system with which you are able to keep track of all bitcoin transactions that are being made, and who owns what. This accounting system consist of loads of ledgers that are kept by all members of the bitcoin network. An important feature of the system is that all these members together decide whether or not a transaction is approved.

The transactions that are made on the network are processed in blocks. This work is carried out by computers called miners. Only if a block contains the correct information from the previous block it is considered valid and added to the chain of existing blocks. Every block has unique numeric characteristics, called a hash. The hash of a previous block is always processed in the next block. This way, a chain of hashes is formed between all the blocks.

This accounting system isn’t actually called ‘blockchain’ in the whitepaper. That term originated much later. Nakamoto doesn’t even emphasize the accounting structure in his paper, it is just one of the many characteristics of Bitcoin.

With this is mind, it’s remarkable that some bitcoin critics say they don’t believe in bitcoin, but do believe in the bitcoin system: the blockchain. After all, a blockchain without bitcoin wouldn’t be the same.

Curious about the white paper?

Read it here

What is special about blockchain?

The blockchain technology, as described by Nakamoto, has a couple of distinctive features.

Blockchain is a public ledger of transactions. It’s also decentralized, so instead of one person or company controlling everything, there are thousand of computers from all over the world that are connected to the network. These computers are called nodes, and each of them have a copy of the current blockchain. Some of these nodes, called miners, process all bitcoin transactions in blocks on the blockchain.

When someone executes a transaction, it is sent to the network and miners carry out very complex algorithms to decide if the transaction is valid. If it is, they add the transaction to the current transaction block and connect it to the previous transaction block. This process is many times safer than traditional databases; that’s because thousands of computers are involved. If you want to hack the network, you will have to hack computers from all over the world simultaneously.

Another benefit of the blockchain technology is that you don’t need to trust one central party anymore, like a bank for instance. Everyone could fulfill the role banks have, since everyone has access to all data. This technology could potentially be useful for multiple purposes, not just bitcoin.

So the blockchain is a distributed and decentralized database in which transactions are being stored. The word ‘ledger’ is often used to make it even clearer. This ledger is shared with all nodes that are connected to the network.

It may sound harder than it really is, here you will find a quick glossary:

  • Ledger: A list or database with information about all blocks
  • Stored: In every block, information (data) is stored. That information could be anything, with bitcoin it’s transaction data.
  • Distributed and decentralized: Normally, a central party is responsible for managing all data. But with blockchain there are thousands of parties that are all responsible and are connected to one another. All these parties have a copy of the same ledger, and receive and update when something changes.
  • Shared with all nodes that are connected to the network: Every computer connected to the network that runs the blockchain owns the same copy of the ledger.

How does a blockchain transaction work?

You could summarize a blockchain transaction in the following steps:

  1. Julia wants to send a transaction.
  2. Julia executes the transaction.
  3. Julia offers the transaction to the network.
  4. A computer (miner) in the network confirms the transaction has been made and approves it if all information is correct.
  5. Julia’s transaction is included in a newly added block that is made for the blockchain.
  6. The updated blockchain is sent out to everyone that is a part of the network.
  7. Done!

What about all those blockchains?

A lot of organizations are experimenting with the blockchain technology, but do these projects meet the requirements of blockchain, or are they more like a regular database?
When a company claims to have started a blockchain project it’s always good to ask the following questions:

  • Is the blockchain you’re working with decentralized?
  • Is it accessible for everyone?
  • Is it distributed?
  • Is there an incentive to keep the network updated and safe?
These questions are important because blockchain is a by-product of bitcoin. Bitcoin is a decentralized peer-to-peer financial network. As you can imagine, it is extremely important that users of a network agree with each other on the state of it, and decide together which transactions are valid. But who determines that?

In a centralized system like our current financial system, we trust third parties to set those rules. When you log into your digital banking environment to check your balance, you need to trust the bank in keeping their ledger up to date which ensures you that the balance shown is accurate. Since your bank’s ledger isn’t publicly accessible this is hard to verify.

In a decentralized system, we don’t want to trust a third party, so a new solution has to be found in order for the network to have consensus. Bitcoin uses a consensus mechanism that’s based on ‘proof-of-work’. Providing proof of work is a process we call mining.

Is it possible to have a blockchain without miners? Yes, but in this situation the term blockchain would be quite misleading. You need to use a different consensus mechanism, and chances are high this mechanism won’t be decentralized. This means all unique and very important features of blockchain, like immutability, permissionless, and openness are now lost. And what’s left is just a regular database with a snazzy name.

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