What is Blockchain and How Does it Work?
What is Blockchain and How Does it Work?

Want to know what is Blockchain in detail? What is blockchain in real life used for? And what is blockchain good for? Here is our Beginner’s Guide to get started, unless you want to join one of our blockchain education programs.

Table of Contents

What is Blockchain?

We all hear about block chain and wonder what is it all about. If you really want to understand Blockchain, understand what it does. In order for you to understand what is Blockchain, I need you to understand how the internet currently operates. For the past few decades, we have been living on the Internet of Information. Now we’re moving to the Internet of Things.

Since years we can share information over the world-wide-web. However, most users are not aware of the different technologies we use to communicate with each other. To illustrate what blockchain is and how this technology works, we have to go back in history a little.

 

the internet before 2005 closed centralized iot network

The Internet Before 2005

Before 2005 we had to operate through closed and centralized IoT networks. Do you remember the days when we had to dial up for connection? Right! We had to call a service and have been directed to a centralized IoT network. Sharing information was more likely to be done via E-Mail. Storage was very expensive.

 

centralized internet over cloud service explained

Since 2006 and Until Today we’ve Used Cloud Networks

After 2005, when data storage became affordable, Cloud services, such as Google, Amazon or Facebook let us believe that it is a good idea to send data over their centralized cloud applications. But at the latest Facebook Cambridge-Analytica scandal we all know that this was wrong. In fact, no privacy, no trust.

 

decentralized blockchain technology explained

The Internet Since we know about Blockchain

2008 Satoshi Nakamoto introduced the Bitcoin. A trading software to exchange the very first cryptocurrency. The revolution started. The possibility of distributing assets decentralized, over a peer-2-peer network, became true. Since the start of the Bitcoin Blockchain in 2009 we can share any kind of asset from one individual to another. Intermediaries are not needed anymore. No Google, no Amazon, no Bank, nor a Notary is needed.

The blockchain technology was born with the bitcoin. Since then, thousands of coders are enthusiastically searching for further applications. Vitalik Buterin for example, launched Ethereum in 2015. The worlds first open source, public and blockchain-based computing platform to share smart contracts. Furthermore, Ethereums’ own Ether became the second strongest cryptocurrency after the bitcoin. So now you know what is blockchain at a basic level. Next, we will explain what is blockchain based on a simple example. Read on!

The Blockchain explained by a simple example:

To answer the common question “what is blockchain”, we use a simple example. Imagine your name is John. Your best friend Peter calls you and says: “Hey John, I need some money. I have run out of it.”

You reply, “Ok, sure” and hung up. But you realize that there is no internet service on your phone and you can’t log in to your bank account. Hense, you cannot make the transfer. You then call your bank account manager and tell him, “Please transfer $1,000 from my account to Peter’s account.”  

Your account manager after verifying some essential security details replies, “OK, sir.”

He pulls up your bank account in front of his screen, checks your account balance to verify if you have enough balance to make the transaction. Then he makes an entry in your account like the following:

“John sending $1,000 to Peter”

You get a confirmation text message from the bank that money has been successfully transferred to Peters’ account.

Don’t forget to confirm your transaction!

Finally, you call Peter again and tell him: “I’ve transferred the money.

In this case, you and Peter both trust the bank to manage your money. All that was needed to create an entry in the online register of both bank accounts. The entry in that register that neither you nor Peter controls or owns.

This is the problem of the current centralized ledger system. The system is based on trust, however, in order to establish trust between two parties, we depend on third-parties. Intermediaries like banks to carry out transactions for us. Otherwise, we also rely entirely on these very powerful intermediaries such as for carrying out simple and complex transactions. To remember what is blockchain, simply think about intermediaries.

Intermediaries – Can we Trust them?

In todays’ world we have to ask us again and again, can we really trust someone? We can review the following intermediaries and their service gaps:

Governments
Telecommunication Providers
Social Media Companies
Banks
Insurances
Lawyers & Notaries

These intermediaries establish trust and ensure transactional value. These intermediaries perform every type of transactional logic from every kind of commerce from authentication and identification of people, clearing, settling and record keeping. They keep your personal ledger for you. But are they 100% reliable?

There is an interesting hidden fact that some of these intermediaries have limited liability when it comes to the security of your funds.

What if an entry register, like a bank account entry, in which the transaction was logged gets burnt in a fire? Or in simple words get hacked? Can we trust every bank?

What if by mistake, your bank account manager made an entry of $1,200 instead of $1,000? Can we trust every account manager?

What if your account manager did mismanagement intentionally? Can we trust any manager? By now you understand what is blockchain all about. Next, let’s talk about security.

Internet Security and Hacking

Overall, intermediaries do a pretty good job but internet hacking is about to get much worse, as the New York Times recently mentioned. Concerns are growing. Because their services are centralized, the risk of getting hacked is very high. Having a “single point of attack” is very attractive for hackers.

A recent example being “Equifax”, admitting that 143 million identities were stolen from their servers. It was the biggest heist (hack) in human history so far. In the case of “Home Depot” where a hacker managed to access over 50 million credit cards was just another example.

Some intermediaries, like Banks, exclude billions of people from the global economy, people that don’t have access or enough money to have a bank account.

Furthermore, they also slow things down, as in the above example. It might take a few hours to make the transaction based on the availability of the person carrying out the transaction on your behalf. Moreover, they take a big piece of the pie. 3 to 20% commission to send money to a different country is big business. But what is blockchain comparing to the bitcoin?

The Rise of The Blockchain Technology

As more and more people didn’t trust 3rd parties anymore, the internet needed a change. There were questions that kept new-age entrepreneurs and developers anxious. Some smart guys who know about blockchain coding went out looking for answers about the following questions:

“What if there were not just an internet of information but an internet of value. Some kind of vast, global, distributed ledger running on millions of computers and available to everybody.”

Where every kind of asset from money to music could be stored, moved, managed and exchanged all without powerful intermediaries. In other words, a native peer-peer medium, but for value. It’s called the Blockchain.

Hence, getting a much secure and reliable system, where we don’t need to pay third-parties to manage our funds.

Could there be a system where we can still transfer money without needing the bank? Satoshi Nakamoto – Creator of the Bitcoin

Is there a way to maintain the ledger among ourselves instead of someone else does it for us? Vitalik Buterin – Co-Founder of Ethereum

What if there were not just an internet of information but an internet of value. Some kind of vast, global, distributed ledger running on millions of computers and available to everybody? Richard Stallman – Founder of the GNU-Project

Open-minded people just want every kind of asset, from money to music, to be stored, moved, managed and exchanged all without powerful intermediaries in between. In other words, a native peer-2-peer medium, but for value. As we have it today and we call it the Blockchain.

Hence, getting a much secure and reliable system, where we don’t need to pay third-parties nor trust them to manage our personal data or funds.

How Does The Blockchain Work?

As mentioned before, the blockchain is the answer of profound questions on how to avoid expensive intermediaries we probably cannot even trust. Ownership instead of being depending on someone else to do it for us. The way I like to describe this awesome technology is very short:

“A Blockchain is a reliable diary where the entries are impossible to forge.” Marcel Isler – Founder of iMi Blockchain

The requirement of this method is that there must be enough people who would like not to depend on a third-party. Only a very specific group can maintain the ledger and everybody on their own.

Block Chain Basics – The Process Explained

If you want to understand in detail what is blockchain, you need to understand its process. Basically, the Blockchain works with Blocks, a block in a block-chain is a collection of data. Blockchain is a distributed ledger, which simply means that a ledger is spread across the p2p network. Among nodes in the network, and each node holds a copy of the complete ledger.

 

the Blockchain Process explained

 

Block Chain Coding – Cryptographic Hashing Explained

So as described above, John wants to create a transaction (a block) to send assets to Peter. This could be digital money, a smart contract or any other kind of information. The only thing that John needs to do is to write a Block. This block needs some simple coding to be distributed and validated across the p2p network. Blocks in a blockchain do need a Hash, a Tx_Root and each block receives a clear Timestamp. If we want to add different Blocks together (like a Chain) then each block needs to corresponding previous Hash, the Prev_Hash. This blocks then link together and communication in the Blockchain is enabled. The distribution, verification and transaction will be done by miners. Miners are nothing else than other nodes in the network. 

blockchain coding cryptographic hashing explained

Of course, there are several advantages to work with blockchain technology. First of all, John and Peter can communicate and exchange assets without a 3rd party. As each transaction automatically receives a timestamp, the traceability is guaranteed. If John would change anything on the former ledger (block), each participant in the network will be informed. Therefore, fraud can be excluded. Finally, hackers would have to attack each Node within the network separately. Hense, there is much less danger as it would be when clouds have been used.

The Bitcoin Blockchain

In 2008, shortly after the financial industry crashed, Satoshi Nakamoto created a white paper in which he developed a protocol for a digital cash. That protocol used an underlying cryptocurrency called Bitcoin.

Bitcoin is a digital asset. That can be bought, sold or exchanged between two parties over the internet with little to no transaction fees. Furthermore, we can make transactions instantaneously and anywhere in the world. Because of this, Bitcoin can be used to store value just like Fiat currencies (USD, EUR, CHF, a.o.), gold, silver and other types of investments. What makes Bitcoin so unique is unlike those other investments. Bitcoin also serves as a digital currency in which you can buy products, services, as well as make payments and exchange value directly and electronically.

However, different from other types of traditional currencies, such as the USD, Bitcoin is a cryptocurrency. In other words, it can function as an international medium of value, meaning it is not jurisdictional, or Fiat. Therefore, putting no limits onto its reach. Anyone who can access the web with the most basic of a device, can now transact and exchange value internationally.

A Bitcoin can actually be broken down into one hundred millionths of a coin. It’s called a Satoshi.

In essence, it’s a brand-new way of transmitting financial and non-financial transaction data without the need for traditional banking networks. Furthermore, this means we can store data in a transparent and unalterable way. A blockchain is an immutable time-stamped series with records of data, a ledger. All distributed decentralized and managed by cluster of computers, so called Nodes.

The technology to likely have the greatest impact on the next few decades is here. It’s not social media or even artificial intelligence, it’s the underlying technologies in all cryptocurrencies such as Bitcoin, and it’s called Blockchain.

Blockchain is the next generation of the internet as we know now. It’s a technology that has many applications and holds vast promise for every business, society and individual person.

Blockchain Technology Application Examples

If you have so far understood the technology and how it works, the application of blockchain technology isn’t limited to finance. Blockchain has a lot of potential for applications we are currently working on, like:

blockchain for cryptocurrencies

Cryptocurrencies (digital money)

Everyone can build and use his own currency. Todays’ list of existing cryptocurrencies is very long. From Bitcoin, the oldest and first cryptocurrency on the market, to Ether, Ripple, Litecoin, Dash, IOTA, Monero and many others. Each has its advantage and disadvantage. The uses are different as well.

distributed ledgers for intellectual property

Intellectual Property (creations of the mind)

If you own intellectual property you already know the copyright issue. To secure and protect your inventions, literary, music, artistic works, design, symbols, names, or images, the regular world-wide-web makes it easy to steal or copy your Trademark. Thanks to Blockchain technology this came to an end.

e-voting with blockchain

E-Voting (Applications for Governments)

Even individual identities can be created within a Blockchain. Therefore, e-Voting became the major application for government initiatives to decrease manual work and to ensure correctness of the count. Electronic voting without using the blockchain technology would be absolutely insecure.

blockchain use in supply chain and logistics

Supply Chain (Consumer Goods)

Consumers all over the world are becoming more and more attentive before buying goods. They want to know where the goods exactly come from. In addition, there is growing interest in how and with what the product has been produced. Or which ingredients have been used in detail. All these points can be easily communicated via blockchain.

blockchain use in the healthcare and pharma sector

Healthcare & Pharma (Saving for Patients)

The use of the blockchain technology could save the industry up to $150 billion every year. Mainly in saving IT costs, data breach costs, operations, support and personnel costs. Most important is the reduction in frauds and counterfeit products. Blockchain just started to revolutionize the healthcare sector. Much more is on the way to come.

distributed ledger technology for real estate

Real Estate (a global economy driver)

The blockchain technology allows the democratization of real estate properties. It will open the gates for more investors. It will solve major problems of the traditional industry such as decrease barriers, eliminate the lack transparency, decrease high transaction fees, increase liquidity, grant pricing commitments and speed up transactions massively. By using Tokenization and Smart Contract technologies, the real estate market will become even more popular and efficient.

As you now may realize, the use cases of the blockchain technology are almost limitless. The only question remaining is: “Is Blockchain just a Hype or will we see more practical applications?” Stay tuned, we will answer this question in our next blog post.

We hope this explanation was useful to understand what is blockchain. Now you should know what is blockchain. If you have any question or thoughts, then please leave a comment below.

Learn Blockchain Technology!

Blockchain Trainings in small Classes
Webinars about Bitcoin and Coding
Blockchain Courses at University Level

Get free Blockchain
Tips!

Get monthly tips on how blockchain can help your business.
On top you’ll get our free blockchain beginners course right away to learn how this technology will change our lives.

Blockchain FAQ

What is blockchain exactly?

Blockchain is a linked list of data. Each block you want to index and share in a decentralized network must contain data, a hash, the previous hash, and a timestamp.

How does a blockchain work?

Indexing a hash with a previous hash makes ledgers and its data be distributed through nodes, while miners approve and confirm the transaction.

What is blockchain used for?

A blockchain (chain of blocks) is used for distributing digital ledgers (any kind of data or information) over the internet, without the need of any third party.

What is blockchain mining?

Blockchain mining is the process to validate and confirm the transaction. Transaction records are added to each public ledger and can never be changed.

How many blockchains are there?

There are thousands of different blockchains out there. In 2020 we can say there are 6 different types of blockchain networks in place: 1. centralized blockchains, 2. decentralized blockchains, 3. public distributed ledgers, 4. private distributed ledgers, 5. consortium blockchains, and 6. hybrid blockchains.

Will blockchain fail?

Blockchain as a technology can not fail. Only humans can. There is absolutely no reason why blockchain should fail. Sure, programmers can fail or projects can fail but the technology as it is is already used for very strong applications such as the Bitcoin or other cryptocurrencies.

Can blockchain be hacked?

Yes, a blockchain can be hacked. There is never a 100% guarantee for nothing. Meanwhile, hacking a chain of blocks would mean that someone is able to control 51% of the total computing network. This is a million times less likely than to hack centralized cloud applications from Google, Amazon or Facebook. This has already succeeded more than once.

Who created blockchain?

Rumors has it that a man called Satoshi Nakamoto created the very first genesis block for the bitcoin blockchain. As Satoshi was just a nickname the real identity of this person (or group) is still unknown.

When did blockchain start?

The blockchain started in 2008. It was like a revolution when the first decentralized consensus transaction of the public ledger of the bitcoin was declared. The worlds first cryptocurrency was just a start for manyfold applications based on blockchain technology.

What blockchain does bitcoin use?

The bitcoin is using public distributed ledgers. This protocol built on blockchain technology made it possible to transfer value (bitcoin currency) from one sender to one receiver through a peer-to-peer network, without the need of a third party (such as a bank or notary).

Marcel Isler

Marcel is a Business Economist and founder of iMi Blockchain. A Consultant and international Keynote Speaker. He studied at the University of Oxford. He helps enterprises to implement Blockchain applications. On our blog, he writes about distributed ledger technology, smart contracts, cryptocurrencies, industry news, and future trends.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.