Blockchain: How Does it Work?

A blockchain can be best understood by an analogy of a spreadsheet duplicated many times across networks and mostly computer devices. Holders of this spreadsheet are tasked to regularly update it so that each spreadsheet is in synch with each other and so there is no chance of any discrepancy. That is the basic understanding of how a blockchain works. Information stored on a blockchain should or does not change and whenever there is a new update it is reconciled across all computers within the network. Therefore, a blockchain more so, in relation to cryptocurrencies, comprises a series of a chain of blocks. Important to note that a block refers to all or even some of the transactions recorded within the blockchain network. These transactions are bundled together in the form of a data bundle and each time a transaction is verified they have linked to the previous block hence the name blockchain (block+chain). 

Each block carries a set of previously confirmed transactions. To improve and guarantee the security of this data against any alteration, the blockchain is maintained in the form of a network of computers spread across the world (Gorkhali, Li, and Shrestha, 2020). Hence, achieving the much-needed feature namely decentralization where each participant’s computer (node) has access and maintains a copy of the entire network’s blockchain data. A node is any computer participating in a blockchain network. The nodes communicate with each other to ensure they are operating and agree on the integrity of all transactions per block. 

Blockchain transactions are meant to follow a peer to peer (P2P) model within the global network. Blockchain application in developing Bitcoin achieves significant features of the cryptocurrency because of attaining decentralization. Bitcoin operates as a digital currency that is censorship resistant, borderless, and permission-less (Binance Academy, 2020). Blockchain systems by design should be trust-less meaning they do not require any form of trust. In the end, eliminating the single authority of control as in the case with Bitcoin. 

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Almost all blockchains do have an essential process at the core known as mining and it utilizes hashing algorithms to initiate this process. For instance, the Bitcoin blockchain operates by use of the SHA-256 algorithm (Anascavage and Davis, 2018). It entails processing an input of any length and creating an output of equal length known as “hash” and in the case of Bitcoin, it’s made of 64 characters or 256 bits (Binance Academy, 2020). Hashing a block refers to the computational process which involves participants engage in a sort of competition to solve a set of difficult puzzles. 

Therefore, the mining process will always give the same output for the same input irrespective of the number of times a process is repeated. Noteworthy, if any change is effected into an input it will also change the output completely. Consequently, leading hash functions especially in the crypto universe to be deterministic even though a lot of them by design is structured as a one-way hash function (Drescher, 2017). This means it is impossible to discern an input from output, even if one applies guessing the chances of getting it right are extremely low. Significantly, this feature is one of the reasons that make the Bitcoin blockchain highly secure. 

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An example of Blockchain transaction using Bitcoin

Think of two individuals namely Ann and Ben and both hold bitcoin balances. Assume Ann owes Ben 4 Bitcoins, and she needs to pay her debt. 

The transaction process starts with Ann broadcasting a message of the transaction to all miners in the Bitcoin blockchain network in the form of initiating the transaction in her wallet. This is done by Ann sending the miners, Ben’s address, the amount in Bitcoin she wants to send, her digital signature, and public key essential to show that she owns the Bitcoins she is about to send to Ben. Using the digital signature, which is made of Ann’s encoded private keys, the miners can validate that indeed Ann owns the Bitcoin under the transaction. 

So, How Does Mining Work?

The next step is miners validating the transaction and adding it to a block undermining during that particular time along with other transactions and they attempt to mine the block. Hence, orchestrating the next step which is mining where the block is put through the SHA-256 algorithm. The outcome needs to be an output that begins with a specific amount of “0” s for the transaction to be identified as valid. The length of “0” s needed will vary depending on the difficulty level during the mining process as this fluctuates depending on the amount of computing power available on the Bitcoin blockchain network. 

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The output expected should have the desired number of “0”s as defined in the beginning, hence must add what is known as a “nonce” into every block during the mining process and this should be done before running it through the SHA-256 algorithm. Remember, it’s not possible to guess and any small change in input results in a complete change of the output, therefore, miners choose random nonces until they are lucky to land a valid output hash. 

Upon successful mining of a block, miners then broadcast to the network of miners the newly mined block, who then verify that the block is valid before adding its copy to the blockchain and if valid, it’s linked to the previous block marking the transaction as complete. Important to note miners need to include an output has that belonged to the previous block which is a mechanism of linking old blocks to the new ones which is the essence in the building of a chain of blocks hence the name blockchain. this is essential because it bolsters the trust system integrated into a blockchain system. It is after all blockchain confirmations that Ben will receive the 4 Bitcoin from Ann less the transaction fee paid to miners. The timeframe for blockchain confirmations or adding a new block height in the case of Bitcoin takes approximately 10 minutes. 

Each miner participating in a blockchain network owns a copy of the blockchain installed on their computer device. All of them trust that whichever blockchain with the most computational power is dedicated to it forms the longest blockchain. in the event a miner feels malicious or wants to orchestrate an attack in the form of altering a transaction in a block, this means the output hash will also change. Eventually, because output has been added from the previous block, it means this will affect all other previous blocks. However, with the use of computational power dedicated to mining each block, and the connection of all blocks to each other, the malicious miner will have to redo all the work of all other blocks for every miner in the network to accept changes (Gorkhali, Li, and Shrestha, 2020). This makes it very difficult especially in open and public blockchains because of the huge computational power required to facilitate such a process and lobbying for consensus within the network which may be a tall order to achieve. In a blockchain, such an attempt if possible, would require the support of more than 50 percent of the network’s computing power, and it’s very unlikely to achieve to orchestrate what is known as 51% attack (Binance Academy, 2020).

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Next, read THIS and learn about the history of blockchain.

Learn about the global importance of Bitcoin HERE.


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References

Anascavage, R., & Davis, N. (2018). Blockchain technology: A literature review. Available at SSRN 3173406.

Berentsen, A., & Schar, F. (2019). Stablecoins: The quest for a low-volatility cryptocurrency. Fatas A.(a cura di), Economics of Fintech and Digital Currencies, 65- 71.

Binance Academy. (2020, October 21). What Is Blockchain Technology? The Ultimate Guide. Retrieved December 12, 2020, from https://academy.binance.com/en/articles/what-is- blockchain-technology-a-comprehensive-guide-for-beginners#other-consensus- algorithms

Drescher, D. (2017). Blockchain basics (Vol. 276). Berkeley, CA: Apress.

Ethereum.org (2019, September 1). Ethereum Foundation. Retrieved December 12, 2020, from https://ethereum.org/en/foundation/

Frantz, R. (2013). Frederick Hayek’s behavioral economics in historical context. In Hayek and behavioral economics (pp. 1-34). Palgrave Macmillan, London.

Gorkhali, A., Li, L., & Shrestha, A. (2020). Blockchain: a literature review. Journal of Management Analytics, 7(3), 321-343.

Gupta, S. S. (2017). Blockchain. John Wiley & Sons, Inc.

Maxwell, D., Speed, C., & Pschetz, L. (2017). Story Blocks: Reimagining narrative through the blockchain. Convergence, 23(1), 79-97.

Nofer, M., Gomber, P., Hinz, O., & Schiereck, D. (2017). Blockchain. Business & Information Systems Engineering, 59(3), 183-187.

Puthal, D., Malik, N., Mohanty, S. P., Kougianos, E., & Das, G. (2020). Everything you wanted to know about the blockchain: Its promise, components, processes, and problems. IEEE Consumer Electronics Magazine, 7(4), 6-14.

Nakamoto, S (2008).  Bitcoin: A Peer-to-Peer Electronic Cash System Retrieved from https://bitcoin.org/bitcoin.pdf

Schedlbauer, M., & Wagner, K. (2018). Blockchain beyond digital currencies-a structured literature review on blockchain applications. Available at SSRN 3298435.

Shanaev, S., Sharma, S., Ghimire, B., & Shuraeva, A. (2020). Taming the blockchain beast? Regulatory implications for the cryptocurrency Market. Research in International Business and Finance51, 101080.

Tama, B. A., Kweka, B. J., Park, Y., & Rhee, K. H. (2018, August). A critical review of blockchain and its current applications. In 2017 International Conference on Electrical Engineering and Computer Science (ICECOS) (pp. 109-113). IEEE.

Xu, M., Chen, X., & Kou, G. (2019). A systematic review of blockchain. Financial Innovation, 5(1), 27.

Yli-Huumo, J., Ko, D., Choi, S., Park, S., & Smolander, K. (2016). Where is current research on blockchain technology?—a systematic review. PloS one11(10), e0163477.

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