April 25th, 2018
Blockchain technology is rapidly growing in importance and it’s easy to see why. From the hype around digital currency in 2017, to the increasing adoption of blockchain solutions in business in 2020, this decentralized technology is rapidly growing in importance. So while blockchain may operate largely in the background, whether you are new to bitcoin and digital currency or an established crypto exchange user, it’s worth knowing a little about how it works, including how & where blockchain is stored.
The blockchain, is at its core simply a database for storing information. One key difference with blockchain technology however over a conventional database is that rather than the database being controlled by a central authority like a Government or a bank, the database is ‘decentralized’ in that it is effectively owned by the network of users. As a result of this architecture, a blockchain is able to provide a shared public record of the ownership of any asset, tracking changes in such a way they are visible to anyone with access to the blockchain. As such a decentralized database operates according to the rules of the network, which is why blockchain ‘governance’ is so important to their success, and why community feedback is key, especially to the success of public ‘permissionless’ blockchains.
When a new computer, or ‘node’ to use the technical jargon, joins a blockchain network, it can start to make transactions. Typically that decentralized network will comprise millions of other computers around the world linked together in what’s called a ‘peer-to-peer’ network. Fundamental to how the blockchain works is that whenever a transaction takes place, the details of that transaction appear on the network so that all users each have an updated record. A second key feature is that any data added to the blockchain must be verified by the network. And because blockchains are decentralized, with no single point of failure unlike traditional databases, then computer ‘hackers’ find it very much harder to disrupt or change the data held on the blockchain.
The term ‘blockchain’ derives from the way in which transactions are linked together one block at a time, which is essentially how all new information is added to the database. By this block-by-block process, the blockchain is an ‘immutable record’ – in other words it’s an accurate record of who exactly owns what on that network – which cannot be altered. And with public blockchains while the data is public, who is actually making the transactions is private, so it’s anonymized in that way too.
Digital currencies are all made out of blockchain; it’s the underlying technology behind most cryptocurrencies. The blockchain is a huge database storing all information. Imagine a large Excel spreadsheet where entries can be made by all users and it is instantly updated on all systems. The blockchain stores all details about digital currency transactions ever made. In the case of bitcoin this includes:
As an example, here are different digital currency addresses or account numbers. We are assuming each address had 5 BTC to begin with. The best thing about this concept is that anyone within the network can calculate the balance just by reading the transactions:
1FJJgwoa47aBpv84euSLreFmJPwBdZy has 5-0.01 = 4.99 BTC
35cVF6hZwXF33yS3jhoQRt1gzZhxM has 5–4.9 = 0.01 BTC
1JN95wW66Pone6n4f1giFZNqCu64 has 5–1.245=4.875 BTC
1737a36vF46rGXQPGLMJTcWsw2y has 5+0.01+4.9=9.9 BTC
1KJDDF54pH65qicuyCK74Af7Wtpp has 5+1.245=5.12 BTC
In simple terms bitcoin is built upon a blockchain, which functions as the digital currency’s shared ledger, “a database that is consensually shared and synchronized across multiple sites, institutions, or geographies, accessible by multiple people,” according to Investopedia. Think of blockchain as similar to a computer operating system, such as Microsoft Windows or MacOS, and bitcoin itself as just one application that can run on that operating system.
A good example of how blockchain works is provided by car leasing companies, as illustrated in this IBM case study which clearly outlines its benefits: “A significant challenge faced by today’s car leasing networks is that even though the physical supply chain is usually integrated, the supporting systems are often fragmented.
“Each party within the network maintains its own ledger, which can take days or weeks to synchronize. By using a shared ledger on a blockchain network, every authorized participant can access, monitor, and analyze the state of the vehicle regardless of where it is within its life cycle.”
Illustration from ‘Blockchain for Dummies’ IBM Third Edition, 2020, Manav Gupta
How the Blockchain Builds Trust
The blockchain is a decentralized concept which is completely different from traditional systems, as there is no single authority or organization taking control of the system. What this means practically is that the blockchain is highly effective for building trust. The original developers of bitcoin wanted a means to distribute currency anonymously, independent of any government structure. To use the jargon word it is “trustless” in that the system was designed so that nobody has to trust anybody else in order for the system to work!
The key features of the blockchain can be boiled down five key characteristics:
1. Distributed and sustainable: The blockchain is shared, updated with every transaction, and therefore what’s on the blockchain is updated as it’s used. And because it’s not owned or controlled by anyone, the blockchain doesn’t need to depend on any single individual or organisation for its continued use and development.
2. Secure, private, and immutable: Built-in permissions and the use of cryptography (code for protecting information in computer systems) helps prevent unauthorized access to any given network and to ensure that the participants are who they claim to be. Confidentiality is maintained through a combination of cryptography plus data access rights, to give users selective access. After signing up, users aren’t able to tamper with any record of the transaction.
3. Transparent and auditable: Because blockchain users all have access to the same data, they can validate transactions and verify identities or ownership without the need for third-party intermediaries or a controlling central authority.
4. Consensus-based: All users of a blockchain network must agree that a transaction is valid. This is achieved through the clever use of what’s called ‘consensus algorithms’. As a result, blockchain networks can decide how exactly each transaction can take place.
5. Organised and flexible: Blockchains can set up with business rules and ‘smart contracts’ (automatic software that execute based on one or more conditions – see below) built into the platform. As a result these networks can support end-to-end business processes and a wide range of activities from supporting global logistics management, to helping consumers with automated flight insurance if your flight is disrupted.