You probably know bitcoins – and if you want to know how the blockchain technology behind it works, read on.
Blockchains are perhaps the most significant tech trend at the moment. And you are probably familiar with at least one application: the cryptocurrency Bitcoin. But what else can blockchains do? And above all: how do they even work? Here you will find a clear overview:
Blockchains are distributed databases
Blockchains are nothing more than databases – storage for vast amounts of data. The main difference to a Microsoft Access database, for example, The Access database is available locally as a single file, the blockchain database is distributed over a network. This is an entirely normal peer-to-peer network, as we know from the previously popular file-sharing via eMule & Co.
However, with the difference that, as a rule all data is with all users. As soon as you install the Bitcoin client, the Bitcoin blockchain is synchronized with over 70 gigabytes on your computer. And so the first advantage is clear: the database cannot simply be deleted!
And another difference: Databases like Access store any data. Blockchains can do that, too but are primarily designed for transactions. Blockchains are often referred to as a ledger. The term comes from accounting and describes the central register with all cash flows of a company. And so, the blockchain also primarily manages transactions.
In cryptocurrencies, a data record usually consists of the sender, recipient, and amount; there is also metadata such as the time. It could just as well be saved where, for example, fishery products are currently located: the sender is the sea, the receiver is the cutter, and the amount of the catch.
In the next step, the cutter would be the sender, and, for example, the factory in the port would be the recipient of the catch. It could go further with the factory as the sender, a truck as the recipient, and filleted fish as the amount. So you could always see where a catch is or was. All these fish transactions can now be combined in a so-called block and attached to the existing chain of blocks – nothing else is a blockchain.
In practice, in the supermarket, for example, you could see precisely where a canned fish comes from – and with a look at the blockchain, you could prove that this is true because blockchains are not that easy to manipulate.
Also Read: What Is Phishing?
Secure through cryptography
The great thing about blockchains is this security against manipulation. And this happens in two ways: On the one hand, the participants in the network have to agree that every newly added block is a correctly structured data record – they have to establish consensus. So it is not possible to attach a manipulated block with fabricated transactions. On the other hand, the blocks, the name already suggests, are linked together so that the blocks cannot be changed later.
Let’s start with the simpler concatenation. A block consists of the actual user data and cryptographic data that are supposed to ensure integrity. To put it simply, you can think of it this way: A new block contains a value that was derived from the data of the previous one. This value, also called hash, is calculated using cryptographic means and is therefore practically unique. And this hash is also used when calculating the next hash for the next block. If you were to change a block somewhere in the chain, its hash would also have to change in the following block – and it’s in its successor and so on.
Establish consensus in the network
The question of how a new block is appended to the chain is more complicated. This is about the so-called consensus algorithm. The keyword you may know from the Bitcoin world is mining. When working with blockchain data such as Bitcoins, as already mentioned, transactions occur that are summarized in blocks and attached to the chain. And if you attach the block, you will be rewarded with Bitcoins in this case. Who that is cannot be predicted – and thus manipulated blocks cannot easily be added to the end of the chain.
This mining takes place in a very simplified way in two steps. On the one hand, it is checked, but the block compiled by a miner is formally correct. On the other hand, there is competition among the miners to determine who can contribute to the block.
In this case, the one who is the first to solve a cryptographic puzzle is allowed to do so: If you use any cryptographic method such as SHA256, a specific hash is created for the block. The task can now calculate a hash for the smaller block than a specific value, i.e., starts with four zeros.
To get a different hash, something has to be changed in the block data. The transaction data and the previous block hash are taboo, so you add a short string of characters to the block.
This consensus algorithm is called Proof of Work because the solved puzzle proves that effort/work has been done. Solving the riddle requires computing power, which in turn consumes electricity – a lot! Entire countries could be supplied with the annual consumption of the Bitcoin blockchain.
In the early days of Bitcoin, this mining was also worthwhile for private users on regular hardware; today, there is special hardware and associations of miners (mining pools) – so it has been professionalized. This goes hand in hand with the fact that the big miners naturally influence: instead of hundreds of thousands of private miners, a handful of professionals now determine the Bitcoin universe.
Proof of Work will not survive much longer in this form. The power consumption is not acceptable. In the long term, it is better if private users can also participate meaningfully and equally. There are all possible alternatives to Proof of Work.
Still, the only important thing is a basic understanding of consensus algorithms: Blockchain participants use a (practically) non-manipulable process to produce new blocks and participate in a kind of lottery that allows the winner to win his Add a block a new component of the blockchain. He is rewarded for his effort.
Also Read: What Is Virtual Reality?
More than just money: intelligent contracts
However, cryptocurrencies are not the only ones used for blockchains. For example, the fishing example above is an actual application. Banks and international consulting firms are planning to use the technology for the internal transfer of digital goods. Toyota is using tamper-proof data in the context of autonomous driving. There is a lot of discussion about its benefits in the medical field.
The next stage is then intelligent contracts, such as those running on the Ethereum blockchain. In very abstract terms, these clever contracts can automate transactions according to certain conditions. A simple example: You bet a friend for five euros, that’s hot on December 24th, 2017, the word “X-Mas” will be published on its homepage.
This simple contract could be implemented as a smart contract so that an app automatically checks on the 24th whether the word can be found on Heise and, depending on the outcome, transfers five euros (in bitcoins) from you to your friend or vice versa. By the way: Instead of an app, it should be called Dapp. The D for distributed means that the app does not run on a single server but in the P2P network. So you don’t need a trustee to manage the money (and charge fees for it). And once set up, no one could unilaterally withdraw from the contract.
It’s not interesting with such a simple bet, but insurance and stock market transactions are ultimately nothing more than bets. And since blockchains cannot be manipulated (well, should be), such larger bets and other transactions can also be automated and thus made cheaper and, in certain respects, safer. Of course, such blockchains do not necessarily have to be public; they can also be set up in-house.