What is Blockchain Technology and How Does It Work

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There is a technology trends that could prove even more tectonic and enduring than cloud computing: blockchain . While the cloud challenges the way we build software and changes the way we operate business, blockchain technology potentially alters the way we think about and process transactions itself. Beyond serving as the foundation for cryptocurrency, blockchain could fundamentally influence how we propose and record deals.

Much has been made of the revolutionary nature of blockchain and cryptocurrencies and, really, it is something subject to hype. However, when contemplating how current technological developments could influence the future, it is difficult to identify another creation with more possibilities of impacting the evolution of the market.

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The Truth About Blockchain technology

Building distributed software systems is hard. At the core of this difficulty is data: protecting it, making it available, storing it. Although much of the difficulty comes from humans trying to fool the system, there is also an inherent objective difficulty in overcoming bugs and maintaining data consistency (for example, see the CAP theorem ). Any time data is sent or retrieved (be it a message about your lunch or your bank account balance) they are subject to these dangers.

In the case of something important, like your bank account, the traditional way to make the data secure and accurate is through a trusted agent, for example, the bank. The distributed version of banking has so far been a graft of traditional practices on the Internet. The bank is trusted to persist and retrieve our financial information.
The limitations of this deal are explained in the Bitcoin white paper that triggered the cryptocurrency tidal wave.

Cryptographic signature

The central mechanism of such a network are the cryptographic pairs used to sign transactions. The owners of the electronic currency (or more generally, of a digital state) sign on the currency (or the state) to the buyers with their public key and verify themselves with their private key. Each transaction also carries a hash of the previous transaction and the owner’s public key.

Double spending and blockchain

If all network participants acted in good faith, the transaction chains would already be secure (that is, the system would be safe from direct external tampering thanks to the cryptographic signature). The weak point is that the owners of the coin could cheat the system by spending the coin more than once. A buyer has no way of knowing if the currency he buys has already been spent .

Solving this problem without recourse to a central authority is not trivial. It requires that all participants in the network know all transactions and their order of occurrence. If we could pull it off, nodes could accept only the first instance of a transaction and discard the others as fraudulent. The mechanism to achieve this is the chain of blocks ( blockchain ).

51% attack

All the work on the chain would need to be redone, which is less and less likely as the chain grows. The name for trying to beat the legitimate blockchain is a 51% attack. The idea is that an attacker gets more than half of the computational power involved in the system and uses it to validate fake transactions. As the blockchain grows, this becomes more difficult, and even if it is achieved, it offers limited capabilities.

Optimized storage

An amazing fact about this tree of nodes is that the entire chain (representing a market capitalization close to a trillion dollars) is stored on each participating computer system . This is possible thanks to intelligent design. A central mechanism for this is the use of a Merkel tree, which allows the system to store only the relevant root and leaves of the chain.

As each node works to validate its block of transactions, the other nodes do the same. If a given node receives a competing block from the network, it stores that block in a competing chain and continues to work on its own chain. If the node receives enough new blocks on the competing chain, it discards its work and accepts the competing chain as the real one. If the current node finishes its work before the competing chain is confirmed, the current node broadcasts its effort to the network. The other nodes behave in the same way with respect to validating that assertion.

Mining and coinage

Mining activity is highly publicized as it has taken on geopolitical importance . But what is it? With our understanding of the blockchain so far, we can clearly describe it.

When a node succeeds in validating its block (getting a good hash and proving to the network that it is the first valid new block in the chain), it receives a new coin of its own. This is mining. The coin serves as an incentive for the system to participate in the mining process.

Blockchain: The New Technology of Trust

The main achievement of the blockchain is the security of a network that works with nodes that are owned by everyone. It seems counterintuitive, but the system works by making assumptions not just about cryptography, but about human behavior. That a system widely distributed and controlled by (let’s be frank) dodgy humans works safely is impressive .

Once the functionality of this system has been demonstrated by Bitcoin, the explosion of new digital currencies has been remarkable. One noteworthy currency is Ether , created by Ethereum , a company that proposes to put a Turing complete computer on top of a Bitcoin-like blockchain. And there are many others.

In the specific case of currencies, traditional banking will undoubtedly continue largely as it is, and entrenched interests in the financial system will work to gain advantage within the cryptocurrency system. They have already moved to introduce their own currencies.