What is blockchain? Despite having been answered repeatedly, this question keeps popping up with every new crypto bull run, with every new milestone reached.
Naturally, the first person to ever give an answer to this question was Satoshi Nakamoto, the enigmatic inventor of Bitcoin who kicked off the whole blockchain revolution. Published in 2009, the influential whitepaper that proposed Bitcoin and defined the core principles upon which blockchains are built puts it this way:
“We propose a solution to the double-spending problem using a peer-to-peer network.The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work. The longest chain not only serves as proof of the sequence of events witnessed, but proof that it came from the largest pool of CPU power. As long as a majority of CPU power is controlled by nodes that are not cooperating to attack the network, they’ll generate the longest chain and outpace attackers.”
The paper goes on to elaborate on the ideas summarized in the abstract, but while the examination of those ideas is thorough, it is not exactly aimed at the general public. This approach is understandable, as the paper’s goal is to present the technical underpinnings of a novel concept and provide a reference point for future development. Nevertheless, this creates a problem – how to explain such a complex and technical concept in a way that’s accessible to non-experts?
One widely used approach is to assign colloquial terms to key blockchain terminology. That’s why terms like digital gold, miners, tokens and distributed ledger, have become so closely associated with the blockchain space. There is only one problem with this approach – without a good understanding of how blockchain works, such analogies sound vague and abstract rather than grounded. The good news is that understanding how blockchain works, at least on a high level, is not that difficult.
With this article, our goal is not only to provide an answer to the titular question, but also to lay the groundwork for that answer to make sense. We want to make sure that by the end of this piece, even non-experts will be able to decipher the excerpt from the Bitcoin paper we quoted above. And, for extra points, we’ll try to do all this by not mentioning ‘cryptographic hash function’ once!
What is blockchain?
Blockchain is a type of decentralized database that stores information in a way that makes it nearly impossible for hackers and other bad actors to penetrate a blockchain-based system. This database, which is also called a ledger, is distributed across a peer-to-peer computer network. Every blockchain protocol employs some sort of consensus mechanism that allows for network participants to agree on which version of the ledger is the correct one. A system designed according to these principles ensure a high level of transparency, security and decentralization.
This definition seems a bit more approachable than the brief explanation quoted above, but it doesn’t shed much light on how a blockchain actually works. Clearly, there’s still work to be done here, so let’s get on with it!
Blockchain technology explained
Remarkably, the word blockchain is not mentioned at all in Satoshi Nakamoto’s paper, yet it has so effortlessly become the go-to term for the new technology. This is because at its very core this new database is an ever-growing series of ‘data blocks’ chained together cryptographically. Let’s examine the core components of a typical blockchain protocol to see how this is accomplished.
The building blocks
Blockchain protocols are typically used to register and record transactions (or other messages) made on a blockchain network. Under a typical blockchain protocol, new transactions are broadcast to the network and verified against the digital signatures of the parties involved. All valid transactions are then recorded and added to the blockchain database in discrete data packets we call blocks. These packets have set size (for example, 1 MB, but it depends on the particular blockchain protocol), which determines how much data they can hold. Each new block is added at the end of an ever-growing string, or chain, of blocks.
So the question is why bother with such a complicated structure? Why not organize the records more like a traditional database? Well, to answer that question, we need to take a look at the next key element of public blockchains.
‘Mining’ is the key mechanism underpinning many of today’s most popular blockchain protocols. It’s the mechanism responsible for creating blocks in ‘proof-of-work’ (PoW) protocols. It is performed by validators, also known as miners.
The way it works is that a miner takes a bunch of transactions and organizes them into a block of data, then adds an extra record before proposing the block to be added to the blockchain. This extra record is a special number that ensures that a block’s data produces a specific output when run through a special mathematical algorithm (extra points collected!). The key here is that finding such a number is difficult and requires plenty of computational work to be done, but verifying that this work has been performed is quite easy – you just run the data through the algorithm (ka-ching!) and verify that it produces the required output. That’s why we call such a number a proof-of-work.
So if the proof-of-work checks out, the proposed block becomes the last item in the chain. Every verified block that is added to the blockchain also includes the proof-of-work of its preceding block. This system not only makes sure that only verified blocks are added to the ledger, but it essentially guarantees that already recorded data cannot be manipulated (changing a record in a block would invalidate its proof-of-work, which in turn would affect all subsequent blocks in the chain). It also creates a mechanism for the network to agree on which version of the ledger is the correct one – the longest chain is always the one to follow as it is the one with the most computational work put in.
The creation of a new block produces a set amount of native crypto tokens, which are given to the miner who created the block as a reward. This ensures that miners have an economic incentive to create valid blocks.
It is important to note that some blockchain protocols have been moving away from proof-of-work. For example, the second most popular blockchain platform, Ethereum, has kicked off its transition to a proof-of-stake algorithm, which does not rely on mining.
Now that we covered the building blocks of a blockchain ledger and the original method of creating them, let’s take a look at the elements that make up a blockchain network: the nodes.
At its core, a node is a computer that runs specialized software that allows it to be a part of a peer-to-peer blockchain network. Based on their type, nodes can have different responsibilities, the most important of which arguably being keeping a copy of the blockchain ledger. This is why people often call blockchains distributed ledgers. With numerous copies of the ledger stored across the network, the transaction data is always readily available for verification and audit. And with a functional consensus mechanism – whether it be a proof-of-work, a proof-of-stake or another alternative – at place, network members (nodes) have a way of agreeing on which version of the ledger is the correct one.
This points to another crucial function of nodes – they are responsible for validating new blocks. So if enough nodes confirm, in other words, a consensus is reached, that a block is valid, that block is then added to the chain and a mining reward is issued.
Nodes come in a variety of forms, the two main types being full nodes and lightweight nodes. The functions described above apply only to full nodes. In contrast, light nodes, also known as SPV (simple payment verification) nodes, do not store their own copies of the ledger and rely on ful nodes to receive the information they need to communicate with the network.
Depending on the particular blockchain protocol, there could also be a number of specialized nodes. For example, based on the above statement that all blockchain network members are nodes, you’ve probably concluded that miners must also be nodes. That’s exactly right – the mining nodes are, simply put, computers running specialized software that allows them to perform proof-of-work.
What can blockchain do?
Our exploration of the general principles behind blockchain already touches upon some of the advantages of the technology over existing alternatives. Let’s look at those more closely.
As we saw in the previous sections, the system of nodes, blocks and miners is designed in such a way to ensure that only valid transactions are recorded in the ledger and the data that’s been already recorded is practically immutable. In a sufficiently decentralized network, this means that potential bad actors would have to compete against the computing power of the rest of the network to keep their fraudulent version of the chain as the longest. Achieving this for a sustained period of time is unfeasible, unless there is a large-scale coordinated attack (the so called 51% attack where more than half of a network’s computing power is used to maintain the fraudulent chain). Such attacks are far less likely to occur on networks with high levels of decentralization. In other words, the higher the number of nodes, the harder it becomes to coordinate such an attack.
Create a platform
Blockchain technology is also great at supporting complex ecosystems involving multiple participants. A blockchain protocol is, after all, basically a set of rules, enforced through computer code, that govern the relations and interactions between members of a peer-to-peer network. This provides a solid foundation upon which new types of platforms and applications can be built.
The existing financial system, as well as any complex system that requires a certain level of trust between counterparties to be maintained, relies on central authorities to guarantee that the rules have been followed. In the world of finance this role is typically assumed by banks, which perform various operations to maintain trust, including validating and processing transactions. In contrast, blockchain protocols leverage decentralization, transparency and cryptography to reduce or eliminate completely the trust requirement, thus eliminating the need for such intermediaries.
How is blockchain used today?
In the years since Bitcoin’s inception, two distinct types of blockchain protocols have been established. The first type is public blockchains, which are essentially different takes on Satoshi Nakamoto’s vision for Bitcoin. The second one is the category of private protocols, which take the general idea of cryptographically linked data blocks, but place restrictions on who can have access to their networks.
Public vs private blockchain
Public blockchains are open to everyone, meaning that anyone can set up a node and become part of a particular network. This also means that anyone can audit the data recorded in a particular public ledger. This approach helps public blockchains excel in terms of decentralization, security and transparency. These protocols are primarily used for processing transactions within their respective networks, as well as a foundation for so called Layer 2 solutions and decentralized apps aimed at end users.
Public blockchains’ main drawbacks stem from their limited scalability in terms of their capacity to process transactions. Another caveat, that is especially relevant for the enterprise sector, is that they do not provide data privacy.
Private, or permissioned, protocols have emerged as a way to address those drawbacks. Such protocols usually govern closed-off networks consisting of a smaller number of participants, whose identities have been established and verified and their relations to their network peers have been well defined. This enables private protocols to ditch time-consuming and energy-intensive algorithms such as PoW and utilize lighter algorithms like proof-of-authority. Since they are closed-off systems, networks using private protocols provide better data privacy than their public counterparts. The tradeoff is that they underperform in the areas where public blockchain shine, as they cannot achieve similar levels of security and decentralization.
Private blockchain protocols are used primarily for setting up enterprise platforms for managing and documenting business processes involving multiple counterparties. A commonly discussed use case for private blockchains is tracking complex supply chains.
In just over a decade, blockchain has managed to establish itself as one of the hottest emerging technologies. It has introduced the world to a new way of making payments, new types of investment, fundraising instruments and a host of decentralized applications. And with enterprises increasingly warming up to the technology, it’s reasonable to expect that both the public and private variants of blockchain will have a bright future.
This is essentially why the question “What is blockchain?” keeps popping up all the time. The blockchain space has grown so much so quickly that the rest of the world is still trying to catch up. If the current growth trajectory persists for the foreseeable future, understanding what blockchain is will become even more important. Hopefully, this article will make for a good starting point for your journey into the blockchain world.