How Does Blockchain Technology Work?

Blockchain technology is a complex subject. Learning about its complete potential could form the basis of a lifetime endeavor. Most people are content with a basic understanding that helps them relate blockchain technology to the creation and management of cryptocurrency. For these individuals, a little information about the three core components of a blockchain is enough.

All blockchains share three core components. These are cryptographic keys, distributed networks, and network servicing protocols. Together these components provide security, access, and somewhat autonomous management of the blockchain. None of these components is new, but combining them to create a blockchain is innovative. Let’s take a closer look at each aspect of blockchain technology.

Cryptographic Keys

The Internet can be seen as a digital world where transactions are always taking place between parties. These transactions don’t always have to involve money; an email sent between two people can be viewed as a transaction. As long as there have been digital transactions there have been efforts to secure those transactions. People want to know that an intended party receives that transfer of email or money, and they do not wish to make the business of the transaction available to everyone.

Cryptography is a factor that enables secure transactions between two parties or individuals. Cryptography is far older than the Internet. It is at least thousands of years old. By definition, cryptography is the use of codes and ciphers to protect sensitive data. It came into massive popularity during World War II when Germany used the Enigma machine to send coded messages to its field commanders. The Allied forces were able to break the Enigma’s unique form of cryptography with the assistance of Alan Turing, a man who many regard as the forefather of what came to be known as the Internet.

Blockchains employ the use of cryptographic keys to allow individuals to complete secure transactions. This happens by virtue of a set of public and private cryptographic keys. Each individual that participates in a blockchain transaction has their own set of cryptographic keys. It is the possession of these keys that establishes a secure digital identity.

When the keys are used together to conduct a transaction, this establishes a form of digital consent. The keys create a digital signature that helps to establish ownership of the money or other items being exchanged.

To demonstrate how powerful this one component of blockchain technology is, think about the old days of writing a check to pay your monthly electric bill. You would write and sign the check and send it to your utility company. The utility company would then deposit the check to its own account. Once someone verified that you signed the check and that you had money in your account, the transaction would be completed. Clearing a check could take more than a week, and it was also possible that someone could steal your checks and forge your signature.

Cryptographic keys can accomplish the same types of transactions in a matter of seconds or minutes while using cryptography to protect the assets of those involved by creating a unique digital signature that cannot be used or stolen by someone else. This is a very good, if basic, way to understand the cryptographic key component of blockchain technology.

Distributed Networks

A secure digital transaction involves more than just establishing ownership and digital signatures through cryptographic keys. There has to be some way to preserve a record of the transaction ever taking place. In other words, someone has to validate the transaction and make a lasting record of it. This is where distributed networks become a part of the blockchain technology picture.

A distributed network can be defined as a computer network that is spread over multiple other networks. The main network serves as a hub of data communication, and the hub can be managed by the other networks individually or in cooperation with one another. This is what gives the blockchain its designation as a distributed ledger.

The true value of a blockchain like the one that supports Bitcoin is in its ability for validators to reach an agreement about what is taking place on the network. This agreement is called a consensus, and the consensus is needed to add blocks of transactions to the ledger.

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The size of a network is directly related to its security. Bitcoin’s network is massive. It is larger than the networks of the 10,000 largest banks in the world combined. The network serves to create and maintain a system of record when used in combination with the cryptographic keys. Once a transaction is initiated, the transaction is recorded in a block that is broadcast to the entire network. This makes it virtually impossible for someone to create a false transaction.

Network Servicing Protocols

There must be certain protocols in place to insure that the network is serviced and correctly maintained. Large networks require the participation of nodes, or other computers, to service the blockchain. An obvious problem would be getting people to participate in such an endeavor that requires lots of computer resources.

Most blockchains offer an incentive to those who are willing to help service the network. This process of incentivized compensation is known as mining in most blockchain platforms. When one agrees to share their computer processing power with the network, there is the possibility of reward. Miners are tasked with solving complex mathematical equations to verify transactions. The first miner to complete the equation is rewarded with digital tokens.

There are a few different protocols when it comes to servicing a blockchain network. One of these is known as Proof of Work. Another is called Proof of Stake. Proof of Work is the protocol that is associated with the Bitcoin blockchain. It requires the aforementioned solving of equations. Those on the network must also reach an agreement that the process has been completed successfully. This is the consensus that we spoke of earlier.

Some blockchain platforms like Ethereum have sought to improve upon the management of networks with concepts such as Dapps and a DAO, or Decentralized Autonomous Organization. The goal is to eventually create blockchains and applications that would not require the oversight or management of third parties.

Understanding these three basic components of blockchain technology will open a up a world of understanding that you can enhance through your own research. These components are the foundation on which all else is based.

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