Blockchain Explained

An unavoidable consequence of our time is that an understanding of how technology works, and at the very least what it does and how to use it, is critical to running a dynamic business. In this 3-part series, we look at Blockchain, the ledger system that underlies bitcoin, which has been tipped by many to have the capacity to change the world. Of course, the ability to instantaneously and securely make payments and transfer data does seem too good to be true.

So our first instalment of this series is what is blockchain? And how does it work?

The idea of blockchain was first described by Satoshi Nakamoto in a 2008 essay.

[1] This paper envisioned ‘a purely peer-to-peer version of electronic cash [that] would allow online payments to be sent directly from one party to another without going through a financial institution’. This is essentially what blockchain facilitates, a software that stores and transfers value or data across the Internet.

Blockchain is a peer-to-peer ledger system residing in the cloud, which records electronic currency transactions, like bitcoin. The system is completely decentralised, meaning that transactions are verified and authorised by other nodes (computers) in the blockchain network. Essentially then, the blockchain ledger is maintained by a group of strangers. However, it is the complex digital security system embedded in blockchain which compensates for this lack of relationships and negates the need for trust.

Users of the blockchain log in and add virtual funds to their ‘virtual wallet’ (‘real money’ cannot yet be used). When one person or business transacts with another, the transaction is given a unique digital signature, called a public-encryption key. This is shared with the whole network and is used by other nodes to check the legitimacy of the transaction and the payer’s ownership of the currency. This public key is generated out of the user’s private key, which is unique to each user and can be used to unlock funds, which have been sent to them. Once the transaction has been verified, the data from the transaction is bundled together with other transactions that occurred at the same time and recorded as a block. Blocks cannot be altered, and therefore transactions cannot be reversed.

While it may sound complex, this whole process takes around 10 minutes on average, allowing the quick and secure interchange of cryptocurrency and/or data between parties. The electronic record, which the blockchain creates, is powerful, as it allows the ownership of digital currency and assets to be permanently tracked. For bitcoin this has massive implications, as each bitcoin has its own unique code. Therefore once the bitcoin is recorded in the blockchain its ownership cannot be contested.

While the bitcoin blockchain is public/‘permissionless’ (accessible to all), private/‘permissioned’ blockchains can also be created and there is no doubt that the capabilities of blockchain are still being discovered and tested Soon blockchain will be used for more complex online transactions, such as smart contracts, crowdfunding and auctions. More on that in our next blog.