Learn Blockchain Basics: How Does the Blockchain Work?

Anybody who’s read anything about cryptocurrency has heard the word blockchain in some capacity. But if you’re like a lot of people, you might find the topic confusing. It can be difficult to learn anything about cryptocurrency if you don’t understand the basic terminology and blockchain applications.

At Addition Financial, we believe that it’s essential for our valued members to learn blockchain basics. There’s a lot of evidence that blockchain is the future. So, with that in mind, here’s what you need to know about how blockchain technology works.

What is a Blockchain?

Let’s start with a basic definition of a blockchain because that will be the foundation for everything else we talk about in this post. Simply stated, a blockchain is a database – and as you already know, a database is a collection of knowledge typically stored on a computer or network.

Another way of thinking of a blockchain is that it is a distributed ledger that records transactions and data. Unlike a typical computer database that might store data in rows and columns, the blockchain stores data in blocks. Each block is attached to the previously-created block, and the accumulation of blocks is referred to as a blockchain. We’ll get into more detail about how blockchain technology works later.

What Are the Main Blockchain Terms?

The explanation of how blockchain technology works involves learning a number of new terms. Here are the important terms you need to know with a brief definition of each. 

Block

A block is an entry in a digital ledger. The block contains data. Once the block is full, its contents are verified and it is added to the blockchain.

Blockchain

The blockchain is a digital distributed ledger where the data is shared among multiple computers or groups of computers. This differentiates it from a traditional database or ledger because it’s not stored on a single computer or server. The information is shared.

Node

Node is the term used to describe a single computer or a computer network on the blockchain. The nodes play an important role in maintaining the security of the blockchain.

Decentralization

Decentralization means that the data on a blockchain is not centralized. This idea applies to cryptocurrency as well. Whereas the US dollar is a fiat currency, meaning that it’s controlled by a central authority, cryptocurrency is digital currency controlled by the nodes in the blockchain.

Hash

A hash is a digital fingerprint that identifies each block in the chain. When a new block is added, it gets a unique hash that is added to the hash of the previous block.

How Does Blockchain Technology Work?

Now that you have some basic terms to work with, let’s get into how blockchain technology works. The purpose of blockchain technology is to create a system to store data and transactions that is secure and difficult to hack. Compared to a centralized database which could be easily compromised by a determined hacker, hacking a blockchain is far more difficult.

When new data needs to be added to the blockchain, it is put into a block. The block must then be verified. One of the reasons that blockchains are so secure is that any new data being added must be agreed upon to be accurate by a majority of nodes. That means 51% of all computers and computer networks that hold the distributed ledger must agree to add the block to the chain.

The information in each block is verified by a process known as mining. We’re not going to get into detail about that process, but it involves one or more nodes working to solve the hash that’s been assigned to the block. The first node to accomplish the task gets credit for verifying the block and is often rewarded with cryptocurrency.

Once the new block is added to the chain, it cannot be changed unless the majority of nodes agree to do so. If one node were to attempt to change a block, their copy of the distributed ledger would not match the rest of the chain. The discrepancy would be easy to spot and correct.

What is the History of Blockchain?

While most of us only started hearing about blockchain recently, the history of the technology goes back to 1982. A cryptographer named David Chaum wrote a dissertation about the idea of data storage among “mutually suspicious groups.” Two other men, Stuart Haber and W. Scott Stornetta, expanded on the idea in 1991 when they wrote about establishing a system that would protect document timestamps from tampering.

The big splash for blockchain occurred in 2008 when someone published a white paper under the pseudonym Satoshi Nakamoto. Nakamoto, whose identity is still unknown, improved on the technology of hashing. The advances in the white paper made it possible to timestamp blocks without requiring the signature of a trusted party and introduced parameters that stabilized the rate of blocks being added to the chain.

In 2009, Nakamoto established the very first decentralized blockchain for use with Bitcoin. By 2014, the size of that chain had grown to 20 GB. As of April 2022, the blockchain for Bitcoin contains 389.72 GB of data. 

What Problems Does Blockchain Solve?

One of the most interesting things about blockchain technology is that it solves a myriad of problems that exist as the result of our increasing reliance on technology. With many businesses storing their data online, the danger of that data being compromised is real and concerning.

The fact that security concerns are so widespread explains why virtually every industry is interested in the potential for blockchain technology to help them solve some of the problems they face. Here are some of the problems that blockchain technology can address:

  • Security – As you now know, hacking a blockchain is extremely difficult and would be expensive. While blockchains are decentralized and currently unregulated, the chains regulate themselves. Because a hacker would need to compromise 51% of the nodes in a chain to alter its data, blockchain technology can be used to protect data anywhere it exists.
  • Transparency – Blocks in a chain cannot be altered after they are added without a consensus. That means that it’s easy to track the history of any transaction. It also makes it possible to verify the accuracy of data without accessing it directly. 
  • Risk Control – Any financial transaction involves some risk because banks and other entities must usually entrust their money to third parties. With blockchain technology, it’s possible to conduct peer-to-peer transactions without intermediaries.
  • Accountability – Using blockchain technology to create a smart contract would ensure that deliverables are completed automatically and at the agreed-upon time. A smart contract is not a legal contract, but rather a piece of data script or software code that is triggered by a specified event.
  • Speed – With any centralized system, speed can be an issue. For example, financial transactions in the US must go through the Federal Reserve, which is open only during specific hours. Blockchain technology would make it possible for entities and individuals to make instantaneous transfers of money and information.

Even with only an understanding of blockchain basics, it’s easy to see that decentralized ledger technology could be applied in a variety of ways, including protecting a digital asset or storing private information.

What is the Future of Blockchain?

The future of blockchain is nearly limitless. As we mentioned above, many industries have an interest in exploring what blockchain technology can do for them. 

A private blockchain network could be used to protect data or facilitate its sharing within an organization. For example, it could be used to store personal medical information for healthcare providers to share to better treat their patients.

A public blockchain network could be used to speed the delivery of government services that sometimes get bogged down in red tape. With secure data storage and the immediacy with which data and money can be transferred, much of the slowness in government could be resolved with the adoption of blockchain technology.

Government use of blockchain is already happening around the globe. In Australia, work is underway to use blockchain technology for digital voting because it offers a way to maintain the integrity of elections while making it easy for citizens to vote. Estonia is considered by many to be the most digitally advanced country in the world. It adopted blockchain technology in 2012 and has used it to streamline everything from voting to filing taxes to storing medical records.

One of the major criticisms of blockchain is that it requires the use of enormous amounts of energy to verify blocks in the chain. It’s reasonable to expect that there will be some efforts to use blockchain technology to help the environment in ways that may offset the issue. For example, companies could acquire crypto tokens to prove that they have complied with environmental regulations.

A related development could be that the technology to verify blocks could change from using proof-of-work algorithms, which require a lot of energy, to proof-of-stake algorithms, which are more energy efficient.

Blockchain technology has the capacity to revolutionize the way we do almost everything, including managing and exchanging money and tracking investments. As a financial institution, we are interested in seeing where it goes and looking forward to helping our members navigate the world of digital transactions.

Do you need help investing your money? Click here to learn about Addition Financial’s MEMBERS Financial Services program.

The content provided here is not legal, tax, accounting, financial or investment advice. Please consult with legal, tax, accounting, financial or investment professionals based on your specific needs or questions you may have. We do not make any guarantees as to accuracy or completeness of this information, do not support any third-party companies, products, or services described here, and take no liability or legal obligations for your use of this information.