Why is this significant? Cryptocurrencies are decentralized networks that are based on blockchain technology. To further understand cryptocurrency, it is important to know what blockchain is, and how it works.
What is Blockchain?
Investopedia defines blockchain as a distributed ledger enforced by a disparate (diverse) network of computers. It is a digital ledger (like a book recording) of transactions that is replicated and distributed across the whole network of computers on the blockchain. What this means is, blockchain is a system or form of information recording that makes it hard to hack, cheat, or change the system, because it is spread across a network of computers. Every individual block in a chain (blockchain) keeps a record on the number of transactions in the chain, and every time a new transaction occurs or is created on the chain, it is recorded and added to every participant’s ledger. This decentralised database that is managed by multiple participants is known as Distributed Ledger Technology (DLT).
If a block in a chain is changed (or manipulated with), it would immediately become clear it has been tampered with, because of DLT. For hackers to successfully corrupt a blockchain system, they have to change every block in the chain, across all the distributed versions of the chain. This is why it is very difficult and near impossible for the bitcoin system to be hacked, because tampering with it is really hard. Addition of more blocks further strengthens the ledger’s security. For example, bitcoin, a cryptocurrency, is constantly growing (limit of 21 million). Growth means more blocks are being added to the bitcoin blockchain. This makes the security of bitcoin stronger.
How Does Blockchain Work?
A hash function is fundamental and foundational to how bitcoin works. The job of this program (hash function) is to turn texts into a set of numbers and letters, or a fixed number of characters. This string of numbers and letters is called a hash. A small change in a string of numbers produces a completely new hash. After a record or a transaction is made on the blockchain system, a hash is created, generated from the record of the last hash.
A nonce is a number added after each record. Nonce is designed in a way to end in two zeros, so a generated hash ends in two zeros. Neither people nor computers can figure out nonce quickly, in the case of a possible hack or cheating.
A node is a computer on the blockchain system. So the group of computers or rather, the computer network on a blockchain system are called nodes. Nodes have to approve every transaction on a blockchain. They do this to check the validity of a transaction. After every node has checked a transaction, something like an electronic vote happens, because some nodes might think the transaction is a fraud, while others think it is valid. Each node possesses a copy, their own copy, of the blockchain or digital ledger. If majority of the nodes say a transaction is a fraud, then the transaction does not go through, is blocked, or does not occur. But if a majority of nodes agree that a transaction is valid, it is written into a block.
A block is a spreadsheet like platform that contains the records of approved transactions. A new block is created after a block amasses a certain number of approved transactions. A blockchain is a whole family of blocks. Every ten minutes, a blockchain updates itself, automatically. It does not need any central computer or master to instruct the nodes (computers) to update itself (the blockchain). Once the blockchain is updated, it becomes impossible to change or forge, because it is updated on all nodes (computers) simultaneously.
A wallet is a string of numbers and letters that is basically an address that appears in many blocks within the blockchain, as transactions happen. For example, 18c177926650e5550973303c300e136f22673b74. A wallet’s address is the only thing visible in a transaction. The identities of the people involved in the transaction are not visible. The address of every individual wallet is a public key.
The other thing needed, along with a wallet to carry out a transaction on a blockchain, is a digital signature. A digital signature is a string of random numbers that must be kept private. In others words, a digital signature is a private key. If someone is sending coins to another person, they have to sign the message that contains the transaction with their private key. The use of this system, of two keys, actual is older than bitcoin. Its origins can be dated back to the 1970s.
After the message sends, it is broadcasted to the blockchain network. The stage that follows is the nodes network working on the message to verify the transaction it contains is valid. Once it confirms the transaction is valid, the transaction is placed in a block. What follows is the permanence of the transaction’s information (no information about it can be changed).
If this information article about blockchain and how it works is interesting to you, you should read more about the technology and probably find novel ways it can be applied. Remember, for the management of your digital assets (cryptocurrency), we at Smart Assets are ready to help.