Since it reached worldwide fame in 2017, the blockchain has been portrayed as a miracle solution to all of the world’s problems: finance, energy, storage, supply chains, democracy, every current issue seemed to have found a solution through this miraculous technology. Now that the 2018 bear market has cooled down the fervor and killed the hype, let us examine, in simple terms, how a blockchain works and what makes it different from existing storage mechanisms.
What is a blockchain?
A blockchain is a database. It stores data. Specifically, it’s a database designed for storing cryptocurrency transactions, such as “Alice sends 10 bitcoins to Bob. Signed: Alice”, or what is commonly called a ledger. Now, this is a simple transaction, but a blockchain may store more complex ones, such as conditional transactions, calls to smart contract functions, or just for storing data.
What makes it different from a standard database?
Well, first of all, anyone can write to a blockchain. There are no permissions, no limitations, no identified users. The only rule for writing data to a blockchain is that a new transaction including a digital signature is needed to move a record from one owner to another.
In order to sign a transaction, a user needs a private key, which is a piece of cryptographic information typically stored in a digital wallet.
In accounting information systems, one must take care to prevent double spending, that is to prevent someone from sending the same asset to two different people; that is why double-entry bookkeeping is so important. A blockchain automatically takes care of these issues, by offering a guarantee that no double-spending is possible.
In general, in order to make sure that no double-spending happens within a financial system, a central entity that controls each and every account on the system is needed. This is usually called a clearinghouse. And the keyword here is central. Contrarily, one of the main features of a blockchain is that it is totally decentralized: there is no single actor within the system that controls all the accounts or is able to delete or modify any single transaction.
How can we verify that all transactions within a blockchain are genuine without a central authority?
By using a system of volunteers. Each of those volunteers uses computers running automated software, which will examine incoming transactions ready to be stored in the blockchain. If they detect fake or invalid transactions, they will discard them.
These volunteers are called miners, and the valuable work that they provide for maintaining the system and discarding invalid transactions is rewarded through monetary creation and transaction fees paid by whoever created the transactions to be included in the blockchain.
Miners store transactions in blocks. Each block is a list of transactions that have been thoroughly verified and includes a cryptographic hash, a unique digital footprint that represents the information contained within the block and guarantees that it has not been tampered with. The rules of a blockchain make it extremely time-consuming to create a valid hash, while it is trivial to verify its validity.
So why is it called a blockchain?
Each block also contains the hash of the previous block, which means that they are all linked together, forming a chain of blocks. Hence the name blockchain.
In order to modify one single transaction within a given block, one would have to regenerate the hash of the block, as well as all the hashes of the following blocks, which is extremely expensive and time-consuming. This is why the blockchain is often considered immutable: whatever has been written in a blockchain will never be deleted or modified.
What happens to a block once it has been generated?
It is sent to about 10 000 machines over the Internet, called the nodes of the network. This makes the blockchain extremely secure and resistant to censorship: as long as at least one of these machines remains available, the blockchain keeps working and ready to be used.
As a summary, it may be said that “a blockchain is a decentralized, distributed ledger that can record lists of transactions as blocks in a verifiable and permanent way”. That’s what makes it different from a regular database, and gives it value over different storage and wealth management systems.
Are blockchains going to replace current databases?
Certainly not. They have severe limits and disadvantages: blockchains are very slow and inefficient; each transaction has to include a fee, paid by the sender; and all the information stored in a blockchain is public, which may be considered a liability, especially in corporate environments. But blockchains do solve a host of issues with current storage systems, and we believe their usage will increase tremendously over the coming years.