Blockchains are “distributed ledgers”. In Layman’s terms, they store digital data. Each participant gets a copy of the data, and the opportunity to confirm new data. If someone wants to manipulate this data for nefarious purposes, they would have to coerce every participant—something that’s very unlikely to happen. Every member works to keep everyone else honest.
Let’s illustrate by contrasting a blockchain with a bank.
Your bank maintains a central database (a “ledger”) of all their customer details. This may store account numbers, balances, transactions, and more. Whenever you interact with your account (such as by withdrawing money or making a transfer), your bank updates its records.
Only the bank has access to the ledger, so if they decide to make a change (even one that’s wrong), there’s not much you can do change it, short of making a complaint.
Now imagine if a hacker gained access to this database. They could change balances, delete transactions, and more. Your bank may be able to restore the data from backups, and there may be many databases serving this data, but it’s still controlled by one central entity.
Distributed ledgers are much smarter. Rather than having one person or company with the sole responsibility of the data, many people have copies of a distributed ledger, and there are often few restrictions on who can join.
Each user (known as a “node”) stores a copy of the data—all the way from the beginning of the ledger until now. The whole lot. For every transaction, several nodes verify it, and then all nodes update their records so that everything stays up to date and in sync.
Each new transaction gets bundled up with many other transactions into a “block”. These blocks provide some serious benefits. There’s no centralized authority that can manipulate the record. If a hacker or nefarious node started changing records in one ledger, all the other nodes would reject it since the new records would not match the data stored by everyone else.
The only way to manipulate data is for every single node to collude together, which is unlikely. In the case of Bitcoin, there are roughly 10,000 different Bitcoin nodes spread out across the whole world as of this writing.
This is why blockchains are so exciting. Almost anyone can join, although restrictions do exist at times, such as with a private blockchain. Nobody can manipulate the records, and it’s very hard for governments to stop. Your bank could mismanage your funds, go bankrupt, get bailed out by the taxpayer, or forced to close by the government. If any of these things happen, you’re unlikely to see your money again.
Blockchains such as Bitcoin are very hard to block or stop. With no central owner, who can governments chase? Nobody can steal your funds, and internet firewalls struggle to block thousands of different nodes.
Bitcoin launched with the following text embedded into the first block:
Chancellor on brink of second bailout for banks
This quote is from a headline published by the times on 3 January 2009. It refers to a decision by the UK government to prop-up the banks (again) following the 2008 financial collapse. It highlights that Bitcoin was perhaps designed to fix the broken monetary system that is fiat currency.
Finally, it’s worth discussing data vs. money. The vast majority of blockchains store their own currency as data. Like numbers on a spreadsheet indicating how many Bitcoins you, I, and every other Bitcoin user owns. Blockchains don’t have to store monetary details. They can store anything you like. Land registry records, shoe sizes, voting details. There’s no limit to what a blockchain can store.
Blockchain Validation: Public and Private Keys
As you saw above, a blockchain is a decentralized store of data, and the most common type of data stored is financial records—transactions and account balances.
If I send Gavin one BTC, I’m telling every node that’s what I’m doing, and they all record the transaction if it’s allowed. By checking the ledgers, nodes may refuse the transaction if I don’t have enough Bitcoin to send, or if I’m not the account holder.
Each transaction must pass validation, and that’s where blockchain technology becomes a bit more complicated. Every blockchain “wallet” (think of this as a blockchain bank account) has a public key and a private key.
The public key isn’t sensitive, but the private key is. Only the true account holder should have access to the private key (and if anyone gets hold of it, your account could get taken over). If you want to keep your coins super safe, then you should look into our suggestions for the best cryptocurrency cold wallets.
When sending Gavin the one BTC mentioned above, my wallet presents the public key along with a digital signature. This digital signature is unique and is only generated with the private key. By using the signature and public key, other nodes can verify that this is a legitimate transaction, all without ever revealing the private key.
This is a simplified example—the cryptography behind the public/private key system is much more complex. Public and private keys aren’t numbers like bank accounts. Rather, they use Secure Hash Algorithm 256 (SHA-256) and RACE Integrity Primitives Evaluation Message Digest 160 (RIPEMD-160).
Never heard of these algorithms? No worries. You don’t need to understand them in-depth to use cryptocurrencies. Know that these algorithms run the internet as we know it, encrypting web pages through SSL and TLS and more. In the future, newer or better encryption algorithms may exist.
All this encryption and verification comes at a cost. Every node needs a lot of computing power to verify all the transactions that ever happen and update its ledger.
This is where mining comes into play: users can earn small transaction fees as payment for verification.
By running the ledger this way, miners running nodes get paid, and every transaction gets verified. It’s an elegant system.
But it’s not all perfect.
During periods of high transaction demand, the fees can go up. If there aren’t enough nodes to go around, users can actually pay more to get their transactions processed sooner than others, and miners end up favoring the higher-paying transactions. Those who pay lower fees will still get processed, but at a much slower rate—unless the fee is too low, in which case nobody will bother verifying the transaction.
Aside from transaction fees, miners can also get paid in shiny new Bitcoins. By paying miners a fraction of a BTC on top of the transaction fee, new Bitcoins are drip-fed into the market. These unmined Bitcoins get more difficult to mine as time goes on, until one day there won’t be any unmined coins left, and miners will only get paid in transaction fees.
When Is a Blockchain Not a Blockchain?
While many blockchains only store transaction details, it’s possible to store all kinds of data on a blockchain: medical records, secure messages, smart contracts, and more.
It’s also possible to build your own blockchain, even one that’s private—provided you have enough nodes to run it. You could remove encryption, changes the rules, or centralize it.
Many would argue that these changes would mean the system is no longer blockchain, but therein lies the problem: with no formal specification or definition of “blockchain”, there’s no governance of the word. Some blockchain projects exist to scam people. Other blockchain projects piggyback off the blockchain name, using it to boost their bottom line with no real innovation.
There’s no agreement on these matters. We would argue that the traditional Bitcoin model is the best way forwards: a public blockchain, accessible by all, and not centralized. What do you think?
Now take a look at how tech companies are shaping blockchain.
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