How does Blockchain actually work ? - A Beginner’s Guide to Blockchain
To understand how a blockchain works we must first understand that a blockchain is a digital ledger that can be used to store information. In this capacity blockchain has similarities to a database which readers may be more familiar with, the similarities are outlined in the image below. However blockchain differs in a number of key areas which is why it was seen as being disruptive.
The purpose of this article is to take a complex subject such as the protocols and encryptions of blockchain and explain in a simple manner how the blockchain actually works and how people use it day to day. For the ease of explanation, I will be using Bitcoin as the cryptocurrency example in a blockchain environment.
The article will go through the following topics in an attempt to explain how a blockchain works:
- How do I get started on the blockchain?
- How do I send bitcoin on the blockchain?
- How is my transaction validated on the blockchain?
How do I get started on the blockchain?
The first thing to note about blockchain is that is not stored in one location or on one server, it is stored in each computer that downloads the blockchain, each computer is then known as a "node" on the network.
To transact bitcoin or any cryptocurrency you do not need to download the blockchain
The only reason to download the blockchain is if you want to validate transactions and contribute to the network infrastructure itself. This is not something that is required in order to complete transactions or trade bitcoin, however if becoming a node on the blockchain is something that interests you, the costs, benefits, technical aspects and guide can be found on the bitcoin website here.
All you need to get started on the blockchain really is a cryptocurrency wallet.
A wallet is the equivalent of a bank account it is used to store, send and receive bitcoin or other cryptocurrencies.
There are numerous wallets available and a wide choice based on the level of control and management that you want to undertake. You can download a wallet and get started trading bitcoin in a matter of minutes. The only recommendation that I would make would be to:
- Find a wallet with 2 Factor Authentication – An extra level of security adds to the safety
- Back-up your wallet – Same as any digital file, keeping a back-up is best practice
- Encrypt your back-ups – The more secure your wallet the better
- Make regular back-ups – Your wallet will differ in amounts at different times
How do I send bitcoin on the blockchain?
Now that you have your wallet set up and ready you can start trading in bitcoin or the equivalent cryptocurrency.
If you do not already have bitcoin, you can buy bitcoin by purchasing it on an exchange. There are a number of different exchanges that offer different levels of privacy and security so choose one that fits your needs.
A cryptocurrency exchange works exactly like a Bureau De Change in your local bank or post office. You exchange on currency (euro dollar etc.) for another (bitcoin, ether, etc.)
The prices will vary based on the currency value and exchange you go to and you will be charged a small commission fee to exchange currencies. At the time of writing the top 5 cryptocurrencies and their prices are below:
Now that you have your bitcoin you may want to send some to a friend or use it to pay for good or services. On the surface, this is very similar to the normal bank transaction process:
- Log into your wallet
- Select the "send cryptocurrency" option or equivalent
- Add in the address of the person you want to send to (Email / Unique ID / Username/Bitcoin Address depending on wallet)
- Select the cryptocurrency and the amount to send
- Add in a note/reference if option is available
- Hit send
It’s as simple as that to send bitcoin from one person to another.
How is my transaction validated on the blockchain?
Now that you’ve sent your bitcoin across the blockchain network you want to know that they've arrived safely. We have seen from our previous articles that blockchain uses complex mathematical codes/formulas to protect its information and allow people to use it safely. We will know delve a little more into this and provide in order to provide a better understanding.
On the bitcoin blockchain there a number of transactions taking place at any one time. These are than validated by nodes on the network and grouped together. On average on the bitcoin network takes 10 minutes for each block to be formed.
When a number of validated transactions are grouped together they are called a block. Each block is linked to the block previous to it, in order to make it more secure. The block forms one long chain, hence where we get the name Blockchain.
In order to add a new block to the blockchain it has to go through a Cryptographic Hash Function which is one of blockchains security measures. This uses information from the previous block and the block that wants to be added to generate a unique string of 256 character called a hash number. This hash is than the main component that is used in the mathematical formula that nodes on the network tries to solve. For a more in depth overview this article helps to define the security measures.
Nodes on the network are incentivized to solve the mathematical formula as the first one to do so will receive bitcoins as a reward, thus a payment is received for the work that is done to validate the transactions and add them to the blockchain. The more blocks on the blockchain the more solid the record will become. Remember a once a block is added to the blockchain it cannot be edited or changed.
In summary, the blockchain bares resemblance to a database but differs in how it works when it comes to cryptocurrency. You don’t need to download the blockchain to trade bitcoin or another cryptocurrency, all you need is a cryptocurrency wallet to store, send and receive it. Your transactions on the blockchain are validated and put into blocks. Each block is than put added to the blockchain by nodes on the network using cryptography.
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The next article will be called "What is a smart contract"
