How Blockchain Technology Works

We’ve established that blockchain is a game-changing technology already transforming how the business world does accounting, auditing, and banking.

As discussed in our article, Blockchain Technology Simplified , a blockchain is a single ledger that records transactions between organisations. Everybody with permission to join can see the same information in real time. Three main components work together to create a blockchain — private key cryptography, a distributed network with a shared ledger, and a reward for servicing the network’s transactions, record-keeping and security.

Here is how it happens.

Cryptographic Keys

Security being paramount when two parties transact online, this component of blockchain technology creates a secure digital identity in the form of cryptographic keys. Each party is therefore assigned a private key as well as a public one. This results in the identity of each party being based on having a combination of private and public cryptographic keys, or in other words, a tamper-proof digital signature. This digital signature is ultimately a useful tool for certifying and controlling ownership. It works much the same way as an email password or a credit card PIN, except it is much more secure.

The issue of security and authentication solved, it must then be coupled with a method of authorisation to approve transactions.

For blockchains, this starts with a distributed network.

A Distributed Network

A clear way of understanding the benefit and need of a distributed network is seeing it as visual evidence. For example, if a video camera records you walking into a hotel, it is very clear evidence of that action, and would be hard to refute. Likewise, with blockchain, the distributed network act as validators, and together, they are witness to the same transactions at the same time. Instead of camera, the method of verification is mathematical. Consequently, the larger the network, the more secure. Hence one of the attractive features of bitcoin blockchain is its incredibly large distributed network and computing power.

System of Record

Now the big question: how do you attract computing power to service the network and keep it secure?

This is where mining cryptocurrencies comes in. Put simply, it lets users’ computers do all the work. With blockchains, by offering your computer processing power to service the network, there is a reward available for one of the computers. The user’s self-interest is therefore being employed to help the public, in exchange for an incentive. This is the way in which blockchains work.

With bitcoin, the goal of the protocol is to eliminate the possibility for a bitcoin to be used more than once in a transaction at the same time. This way, we can assure that there is no fraud of users spending more than they truly have. In other words, each bitcoin is unique and can be treated as gold. To make sure this happens, all of the nodes in the network track all the transactions and keeps them, creating a history of each bitcoin by working to solve a mathematical problem.

The CPUs express their agreement of new blocks if they are ‘safe or correct’ or reject other blocks if they do not meet the protocol. By adding blocks, it creates the blockchain, and the process continues, with more blocks being added.

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