Blockchain Explained

Blockchain technology has captured the imagination of the computing world since 2008 when the debut of bitcoin brought its underlying technology to the forefront. In fact, Fortune magazine says blockchain “will change the world.” But what is blockchain technology exactly? See our “Blockchain Explained” video tutorial,  and here we’ll recap everything covered in the video. We’ll be discussing:

  • What is blockchain?
  • What is bitcoin?
  • Blockchain’s features, including public distributed ledger, hash encryption, proof of work and mining techniques (how miners make money)
  • The fields that use the blockchain

Let’s dig in!

Before Blockchain

Let’s take a look at how typical transactions used to happen before blockchain. For our first example, we’ll use a property transaction. In the past, when two people conducted a high-value transaction such as a buying and selling a property, an intermediary such as a broker was always involved. The broker would facilitate the transaction between the buyer and the seller, and would manage all the documents involved, such as land records. In this scenario, however, things can go wrong. For example, the broker could have made alterations to the data, or could have made an error in the documents and records involved. Because this is such a high-value transaction, if an error is made, both the buyer and seller can suffer huge losses.

Now let’s take another example: a banking transaction. If a sender wants to send money to someone, typically today the sender would rely on a bank. You as the sender would transfer money to a centralized bank, which you trust would get the money to the receiver, and the bank charges a commission. But several things can go wrong here. Either your account or the receiver’s account could get hacked, the bank could be having technical issues, or you could have exceeded your transfer limits for the day.

But today, with cryptocurrency, we can do these transactions with lower transaction costs compared to what banks charge, and the technology is available 24/7. Blockchain technology has therefore reduced the need to be dependent on intermediaries, has reduced the transaction costs, and reduced transfer limits to none.

The Birth of Blockchain

In 2008, a person or group of individuals going by the name Satoshi Nakamoto produced a white paper that introduced a currency called bitcoin that would change the lives of people around the world who were dependent on banks to make any financial transaction. Satoshi Nakamoto introduced a democratic currency that allowed transactions across geographic regions with low transaction fees. This solved several of fiat currency problems. What is fiat currency? Fiat currency is a legal tender as declared by a government but isn’t backed by a physical commodity, such as gold or silver. Some of the problems with fiat currency that bitcoin solved are:

  • Bitcoin is accessible to anyone
  • Transactions are protected using cryptography
  • The system is decentralized—the participants in the network take care of the transactions and ensure the integrity of the network
  • User anonymity is assured

And as its underlying technology, bitcoin uses blockchain. This is the heart of our “Blockchain Explained” tutorial.

Before we discuss the key features of the blockchain, first let’s define “bitcoin.” As of today, about 16.5 to 17 million bitcoins have been mined (we’ll discuss mining below) and are available for transactions.

Public Distributed Ledger

A public distributed ledger is a collection of digital data that is shared, synchronized and replicated around the world, across multiple sites, countries and institutions. Now let’s consider a blockchain that can be accessed by anyone in the network around the world. If someone tries to alter data in one of the blocks, everyone in the network can see the alteration, because everyone in the network has a copy of the ledger. In this way, data tampering is prevented.

Hash Encryption

Blockchain uses cryptography (see definition of “cryptography” above) to ensure that all the data in the blocks is kept secure from unauthorized access and is not altered. Blockchain uses SHA-256 for encryption. SHA-256 is one of the strongest hash functions available. This cryptographic hash algorithm generates an almost unique 256-bit signature for a text. Blockchain also uses digital signatures to validate users.

Each user has a public and private key. The public key is used to uniquely identify the user, and the private key gives the user access to everything in the account. In the process from the sender’s side, the sender’s message is passed through a hash function, then the output is passed through a signature algorithm with the user’s private key, then the user’s digital signature is obtained. In the transmission, the user’s message, digital signature and public key are transmitted.

In the process on the receiver’s side, the message is passed through a cryptographic function to get a hash value, then that hash value is compared with the hash output obtained by passing the digital signature and public key through a verification function.

As mentioned, each block in a blockchain uses SHA-256 to encrypt and therefore secure the data. Every block has four fields: 

  • Previous hash—this field stores the hash of the previous block in the blockchain
  • Transaction details—this field contains information regarding several transactions
  • Nonce—this field contains a random value (the nonce value) whose sole purpose is to act as a variate for the hash value
  • Hash address—this field contains the unique identification of the block; it is a hex value of 64 characters, both letters and numbers, obtained by using the SHA-256 algorithm

The first three values (previous hash, transaction details, and nonce) are passed through a hashing function to produce the fourth value, the hash address of that particular block. 

Proof of Work

Bitcoin uses a proof-of-work system. What is proof of work? It is a piece of data that’s very hard to produce (meaning it takes a lot of time or costs a lot of money) but can be easily verified by others, and it satisfies certain requirements. With bitcoin, proof of work is a competition among miners who want to add a block to the blockchain—meaning they have to find the nonce value for the block by solving a mathematical puzzle. Once a miner discovers a nonce value, he or she spreads the word throughout the network, and if other miners validate the claim, the miner is rewarded with 12.5 bitcoins or another form of compensation. Finding a nonce value also adds that block to the blockchain.

Choosing a nonce value is the primary objective of miners. They have to find a value that is less than the target value. If they find a value greater than the target, then their mining effort is rejected. But if they are able to successfully generate a hash value using the nonce that is less than the target value, then their effort is accepted. This is where the entire computational power of the miner is used—to generate the hash value.

Finding a nonce value requires a lot of time, money and resources. When the nonce value is found, the miner spreads the word about finding this value, other miners attempt to validate the claim, and if it’s verified, the miner gets the reward. So a miner is rewarded for being the first one to find the nonce, and that adds a block to the blockchain.

As mentioned, as of today, the reward is 12.5 bitcoins. Every four years, the amount of bitcoin a miner can earn is reduced by half. Mining is the only way new bitcoins can be generated, and it ensures that there’s a limit to how many bitcoins can exist in the market.

Other Fields That Use Blockchain

The financial services industry is an obvious field that uses blockchain technology extensively, but it’s not the only one. Forbes mentions healthcare, crowdfunding and ride-sharing in its article “Eight Ways Blockchain Will Impact the World Beyond Cryptocurrency.” Let’s look at a few other fields.

Travel

Blockchain technology can be used for things like:

  • Tracking luggage, especially with multiple flights in one itinerary and international flights
  • Identifying passengers, saving time and reducing lines and wait times
  • Making and accepting payments for services

Music

The rise of digital music has posed problems regarding issues like piracy and artist compensation. Blockchain can:

  • Help prevent piracy (illegal sharing) of music files
  • Be used to compensate artists for purchased songs and albums

Cyber Security

Even a giant company like Lockheed Martin is using blockchain in its cyber security efforts. Blockchain can:

  • Help secure sensitive data, thanks to its cryptography feature
  • Eliminate the need for passwords, because users and devices can be authenticated using the public and private keys

Human Resources

Blockchain technology is a natural fit for improving time-consuming and costly HR procedures. For example, it can:

  • Eliminate the need to run individual verification checks on potential employees—blockchain transactions can store data regarding identity and employment history
  • Track payments and expenses, making things like paying taxes much easier for both employers and employees

Want to Learn More About Blockchain?

We hope you have enjoyed this “Blockchain Explained” tutorial. However, it’s only a start—and as we’ve seen, many industries and individual companies are poised to start using blockchain technology, if they haven’t already. Get a full introduction to blockchain in Simplilearn’s Blockchain Basics course, or take the Blockchain Certification training to further your career even more!
 

About the Author

Rahul VenugopalRahul Venugopal

Rahul Venugopal is a Senior Product Manager with over six years of experience in Digital Marketing, Growth Hacking, and Mobile-App based marketing. He specializes in Online User Behaviour Analysis and Creative and Campaign Optimization.

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