How Does Blockchain Works?

Though blockchain technology is commonly associated with cryptocurrencies — such as Bitcoin and Ethereum, it has the potential to do far more than simply power digital currencies. A decentralized ledger system is a DLT that allows for transactions made among a network of computers in a way that is both secure and immune to tampering. In this article, we will discuss the basic concepts behind it that makes blockchain work, what constitutes a blockchain and the consensus mechanisms and security features associated with blockchain.

Understanding Blockchain Technology

Definition

Blockchain technology is an immutable shared ledger that makes it easier to track assets and record transactions in a business network. Each block contains a timestamp, transaction data, and a cryptographic hash of the previous block.

Key Components

1. Blocks: Data containers that hold transactional records.
2. Transactions: Digital interactions between parties recorded on the blockchain.
3. Hash Function: A type of crypto algorithm that takes an input and turns it into a fixed-length alphanumeric string.
4. Decentralization: There is no central authority, the data is distributed across various nodes in a peer-to-peer network and is verified by multiple nodes.
5. Consensus Mechanism: A protocol used to make sure that nodes agree on the validity of transactions and the state of the blockchain.

How Blockchain Works

Transaction Process

1. Transaction Initiation: A user begins a transaction by signing it digitally and broadcasting it on the network.
2. Transaction Verification: Nodes within the network validate the transaction as legitimate and that the user has funds.
3. Block Formation: Miners or validators group valid transactions together forming a block.
4. Block Hashing: This takes the blocks header (trans. data and ref. to the previous blocks hash), and runs the header and runs it through a hash function.
5. Consensus: Miners compete to solve a cryptographic puzzle (proof-of-work) or stake tokens (proof-of-stake) to add the block to the blockchain.
6. Block Addition: When consensus is achieved, the new block is added to the blockchain and the transaction is confirmed.

Decentralization and Security

1. Peer-to-Peer Network: Blockchain functions on a peer-to-peer network so no single point of failure exists.
2. Immutable Ledger: A cryptographic hash of the previous block is contained in each block, so changing old transactions is very difficult.
3. Consensus Mechanism: This ensures that the network of nodes agree on the validity of the transactions — making sure that the blockchain is the correct form of the data.
4. Encryption: Transactions are encrypted and later verified by public-key cryptography.

Types of Blockchain

Public Blockchain

• Public & Permissionless — Open for anyone, secure for all participants, and transparent, allowing anyone to take part, access transactions, and help secure the network.
• Examples: Bitcoin, Ethereum.

Private Blockchain

• Limited to only authorized participants providing greater governance of access, permissions, and data privacy.
• Examples: Hyperledger Fabric, Corda.

Consortium Blockchain

• Shared by a consortium of organizations, between decentralization and control.
• Examples: R3 Corda, Enterprise Ethereum Alliance.

Applications of Blockchain

Cryptocurrencies

• Cryptocurrency for example Bitcoin or Ethereum allows payments without going through any third party.

Smart Contracts

• Contracts that are automatically executed with specific terms and conditions on the blockchain.

Supply Chain Management

• Continuously joined supply chains that transparently link trusted endpoints from end to end.

Healthcare

• Privacy of data while making it shareable, standards-health records.

Identity Management

• Decentralized, secure identity solutions: To provide secure and decentralized authentication and verification solutions around digital identity.

Challenges and Limitations

Scalability

• Increased transaction volume slows down full nodes, congestion the network and therefore the time it takes transactions to complete.

Interoperability

• No standards & no interoperability between the blockchain networks/protocols are supported.

Regulatory Uncertainty

• Advances in regulation globally and increasing challenge of compliance across regions.

Energy Consumption

• Proof-of-work consensus mechanisms, on the other hand, are resource and energy-starved.

Conclusion

Blockchain elevates the nature of data storage, verification, and transactions to be trustless, transparent, secure, and decentralized of transactions. Transactions will be decentralized via the blockchain, which could turn industries like finance, supply chain, healthcare, or identity management completely on their heads. But there are still a number of scalability, interoperability, regulatory, and energy consumption challenges that must be overcome in order for more decentralized solutions to take off and fully harness the power of blockchain.