Understanding Blockchain Technology

What is Blockchain Technology?

At its core, blockchain is a revolutionary way of storing, sharing and using information in a secure decentralized manner. Blockchain is a type of distributed ledger technology (DLT). It allows data to be stored across a network of computers (or nodes) rather than in a single, centralized computer.  

Bitcoin was the first successful implementation of digital currency using blockchain technology, which played a significant role in popularizing the concept of blockchain. 

By introducing a decentralized digital currency that operates on a blockchain, Bitcoin demonstrated the practical applications of this technology, making blockchain widely recognized and paving the way for its use in various other fields.

Key Features of Blockchain Through a Simple Analogy

The Key features of blockchain includes Decentralization, Transparency, Immutability and Security. Let me give you a simple analogy here to understand all the above-mentioned features of blockchain.

Imagine a group of friends playing a card game, but instead of keeping the score on one person's piece of paper (Centralization), everyone writes down the score on their own pieces of paper (Decentralization).

Every time someone scores points, everyone in the group writes it down and displays the records to the audience. (Transparency). If someone tries to change their own score later to win the game, the other players can easily see that it doesn't match with what they have written down.

In this way, no single person can cheat or alter the results without everyone else noticing. (Immutability and Security). Decentralization in blockchain works similarly: everyone keeps a record, and any attempt to change the information without agreement from the group gets rejected. This ensures that the information stays accurate and trustworthy.

Now that you have a good understanding of the key concepts behind blockchain technology, let’s dive deeper into how a blockchain works. Don’t worry -I’ll try my best to keep it simple!

How Blockchain Works: Step-by-Step Process

1. Transaction Initiation: A transaction is initiated by a user, who uses their private key to sign and send the transaction to the network. (Private key is a special cryptographic key known only to the owner, it is the only key which is used to sign, authorize and initiate a transaction in the context of blockchain technology).

The transaction includes information such as the sender, receiver, and other details relating to the nature of the transaction – for example in the context of digital currency like bitcoin the transaction includes transaction ID, Output index, digital signature, amount being sent etc., in the context of supply chain management, transaction details can include Product information, logistics information, regulatory information etc.

2. Transaction Propagation: The transaction is then broadcast to all nodes in the network. Each node receives and verifies the transaction to ensure it is valid and complies with the rules of the blockchain. The transaction is verified using Digital signature.

A Digital signature is created when someone sign a transaction using the private key, and a digital signature ensures that the recipient (or anyone verifying the transaction) can confirm that the transaction or document was indeed signed by the legitimate sender and that it hasn't been altered since it was signed. Transactions are the lifeblood of a blockchain network.

They carry information and value across the network, ensuring that all nodes (participants) are updated with the latest data. Just as blood flow is essential for the body's health, transaction flow is essential for the blockchain's operation and integrity.

3. Block Creation: Valid transactions are grouped together into a block (a digital container) by a node operator (miners or validators). Before this, transactions are kept in a temporary holding area called the memory pool. The is where transactions wait until they are included in a block.  

Each block has two parts: a header and a body. The block's header contains important details, including a link to the previous block’s unique code, called a hash. All this information including the detailed transactions in the body of the block is processed to create a new hash for the block.

For example, if Block 3 is created, it includes the hash from Block 2. If someone tries to change the information in Block 2, it will alter Block 2’s hash, making Block 3’s hash no longer match. This connection between blocks helps keep the entire chain secure and ensures that the information remains accurate.

4. Consensus & Validation: The new block is added to the blockchain only after reaching consensus. There are different types of consensus mechanisms. 

The main purpose of a consensus mechanism is to ensure that all nodes in the network agree on the validity and accuracy of the transactions. 

Don’t worry we will be discussing this in this blog as this is a crucial factor for the proper functioning of the blockchain network.

5. Blockchain update and Transaction Confirmation: Once a block is added to the blockchain, it is updated across all nodes in the network, ensuring that every node has the same, up-to-date version of the blockchain.

At this point, the transaction is considered confirmed, and the recipient can see the updated transaction details in their blockchain record. The transaction becomes immutable, meaning it cannot be altered. Only after a transaction is confirmed will the recipient’s wallet reflect the updated crypto balance.

What is consensus mechanism in a Blockchain?

A consensus mechanism in blockchain ensures the integrity and accuracy of transactions and blocks by requiring approval from the majority of network participants. This process prevents any single party from manipulating or cheating the system.

By involving multiple participants in the validation process, the consensus mechanism upholds the trustworthiness and reliability of the entire blockchain network. 

The consensus mechanism is the "brain" of the blockchain. It makes decisions on what data is valid and what can be added to the blockchain, just as the brain coordinates various processes to make decisions and maintain its function, a blockchain's consensus mechanism coordinates multiple nodes to agree on the state of the blockchain. Both systems are designed to ensure accurate, reliable outcomes and prevent errors or fraud.

Crucial Roles of a Consensus Mechanism

Maintaining Integrity: It ensures that all transactions are valid and accurately recorded on the blockchain.

Preventing Fraud: It prevents any single party from manipulating or tampering with the data.

Enabling Decentralization: It allows a decentralized network of nodes to agree on the state of the blockchain without relying on a central authority.

Securing the Network: It helps protect the network against attacks and ensures that only legitimate transactions and blocks are added to the blockchain.

 

Consensus mechanism is like a game, where everybody has to agree on the rules of the game before starting to play the game, But the question is what makes everybody to agree on the rules?

The answer for this question is very simple. It is the Cost associated with cheating that makes participants to agree on the rules.

Similarly, this concept is mirrored in law and order within a country. For instance, breaking traffic rules results in fines, and engaging in illegal activities can lead to imprisonment, depending on the severity of the offense.

Now, let’s examine how this concept of "cost of cheating" applies to two well-known consensus mechanisms: Proof of Work (PoW) and Proof of Stake (POS).

 

Proof of Work (PoW)

Proof of Work (PoW) is a consensus mechanism used by blockchain networks, most notably Bitcoin. In PoW, participants, known as miners, compete to solve complex mathematical puzzles in order to validate and add new blocks of transactions to the blockchain. 

This process requires substantial computational power and consumes a lot of electricity, making it costly. Because of this high cost, it's far more practical for miners to follow the network's rules and earn cryptocurrency rather than attempting to cheat, which is likely to fail and be a waste of resources.

The term "Proof of Work" comes from the fact that miners must demonstrate they have invested significant effort and resources into solving these puzzles. Additionally, the Bitcoin blockchain is designed to adjust the difficulty of these puzzles based on the total number of miners in the network. 

As more miners join, the difficulty increases to ensure that a block is mined approximately every 10 minutes. Conversely, if miners leave the network, the difficulty decreases, maintaining the 10-minute block time. This adjustment mechanism helps regulate the supply of Bitcoin and ensures the network remains stable and secure.

Proof of Stake (PoS)

Proof of Stake (PoS) is a consensus mechanism where validators are selected to validate and add blocks to the blockchain. Unlike Proof of Work (PoW), which relies on miners competing to solve complex mathematical puzzles using computational power, PoS uses validators who must "stake" a certain amount of cryptocurrency to participate.

Staking involves locking up a specific amount of cryptocurrency in a special wallet, which allows participants to take part in the network's operations, such as validating transactions and adding new blocks to the blockchain.

In PoS, validators are selected in a semi-random manner. The selection isn't purely random but considers factors like the amount of cryptocurrency a participant has staked, how long they've held their stake, and sometimes other criteria like the age of the stake or the validator's reputation. 

This combination of randomness and deterministic factors ensures fairness while also incentivizing participants to hold and stake more cryptocurrency, increasing their chances of being chosen as validators.

If a validator in a PoS system attempts to cheat, they risk losing some or all of their staked assets. The system is designed to ensure that the potential loss from cheating is always greater than any financial gain they might achieve by trying to manipulate the network. This discourages dishonest behavior and helps maintain the integrity of the blockchain.

Nice! now you have a basic understanding of how blockchain works. It's important to note that there are many other consensus mechanisms like Delegated Proof of Stake (DPoS), Proof of Authority (PoA), and Proof of Burn (PoB), each with its own rules designed to prevent fraudulent behavior. However, to keep things simple, we won't dive into all of these mechanisms in this blog.

Summary

In a blockchain, a transaction is initiated using a private key and digitally signed to create a unique signature. This transaction is broadcast to thousands of nodes across the network. Each node verifies the transaction's digital signature for validity. Once validated, transactions are stored in a memory pool, known as the memory pool, where they await inclusion in a block.

A miner or validator selects transactions from the memory pool and adds them to a block. The block is then processed using a consensus mechanism, such as Proof of Work (PoW) or Proof of Stake (PoS), specific to the blockchain network. After mining or validation, the block is broadcast to the network, where other nodes verify its validity. If confirmed, the block is added to the blockchain, and the miner or validator receives a cryptocurrency reward.

The continuity and integrity of a blockchain depend on its consensus mechanism, which ensures that all participants act truthfully and maintain the network's proper functioning. Just as different games have distinct rules that all players must follow, blockchains rely on various consensus mechanisms to ensure that miners or validators behave honestly and uphold the network's integrity.

Disclaimer: The contents of this article are for informational purposes only and are not financial advice. The views here are just the author’s opinions. The crypto market is volatile, so be sure to do your own research before investing.