If you are interested in getting into Bitcoin or other cryptocurrencies, it is very important that you understand the underlying mechanism which makes the smooth functioning of these currencies possible – blockchain technology. This term is often thrown around, but it seems as though not everyone knows what it is. The goal of this text is to briefly explain how it works, why it was implemented, and how it impacts the overall functioning of Bitcoin as a payment method.
What exactly is a Blockchain?
Briefly put, a Blockchain is a digital, decentralised public list of all transactions made on the network. The most recent transactions get added to the list periodically as a new ‘block’ in the blockchain. These blocks are constructed and added to the chain in chronological order, allowing every user to have insight into all the transactions that are made on the network, without relying on a central authority to determine the veracity of individual transactions. Every user, or ‘node’ as they are called in technical terms, gets a copy of the entire blockchain. This is downloaded to their computer automatically.
Though blockchain technology was developed to keep track of transactions for Bitcoin specifically, the same sort of Distributed Ledger Technology can be used to record any sort of document. That means that the record cannot be changed once it is made. It also implies that the entire community can verify all the contents of the chain, and that any major decision must be taken through consensus.
What is a block, then?
The term ‘block’ refers to the current part of the Blockchain, one that is being recorded at the moment. Most or all of the transactions taking place at present are being recorded in the current blockchain. Once it is up to capacity, it is considered ‘completed’ and gets permanently added into the Blockchain. Once it is in the Blockchain, there is no way to alter the record, or delete the transactions within, which is precisely the point of the entire DL technology.
There is an almost limitless number of these blocks in the chain, which are all connected to each other in a strictly linear, chronological order, with each block containing a hash of the previous block. Inside the Blockchain, records of all the addresses and balances of all the users that have made any transaction on the network are kept, from the very first block, to the most recent one. These blocks are added to the chain using cryptography, which means they cannot be tampered with. This information can thus be distributed, but not copied. Still, the fact that every transaction is recorded along with all the information pertaining to all the parties which made the transactions, the ever increasing size of the chain can cause synchronization problems, as well as problems with storage.
Why is the Blockchain important to Bitcoin?
The blockchain is arguably the chief technological innovation introduced by Bitcoin, and it is one of the main reasons for its success. Seeing as though Bitcoin is a decentralised currency, its users constitute its sole authority. That means it falls to the users to validate transactions whenever someone makes a payment, which eliminates the need for a third party service to process and catalogue payments.
Once completed, the transaction is recorded into the current block, and eventually makes its way into the blockchain, where it is subject to verification by every user of the network, and is distributed on a peer-to-peer basis. It is estimated that a new block is added to the Blockchain every 10 minutes due to Bitcoin mining.
Each node on the network has a copy of the full database, as previously discussed. When a new user joins the network, they receive a copy of the Blockchain, and thus have access to the public records of all transactions which took place on the network form the very beginning.
How does Blockchain Technology work?
What are the advantages of Blockchain technology?
When compared to the services provided by traditional financial institutions, the cost savings facilitated by the use of Blockchains are very significant indeed. These DLT systems allow businesses and financial institutions to significantly speed up their internal operations, drastically reducing the number of mistakes, the expense, and delays caused by simple human error during the process of reconciliation of records.
There are several areas where the Blockchain technology can bring vast savings. Firstly, electronic accounts or ledgers are much lest costly to maintain than traditional methods of accounting. That means the number of employees in this field of work can be drastically reduced, resulting in big savings for the company.
Another advantage of the Blockchain when cost savings are concerned is the fact that with Blockchains there is no need to re-do any result, as there can’t be any mistakes made through human error. This elimination of repetitive checks can help businesses retain quite a bit of money in the long run.
Since the processing delay is reduced to a minimum with the Blockchain technology, there will be less need for capital to be held against the risks of pending transactions. That gives businesses a lot more leeway to conduct business exactly the way they see fit.
The removal of any human involvement in transactions is especially beneficial in the case of cross-border trading, which usually take much longer to be completed. That is because there are always time-zone issues, and because all parties have to confirm that the payment has been processed. The Blockchain eliminates all of this.
The decentralization that is ‘central’ to the way the Blockchain works offers lots of opportunities for the creation of previously impossible businesses and business models, in a secure and flexible way. The demand for middleman services relating to Blockchains is on the rise, and the technology is getting ever more serious and ever more accepted.
It remains to be seen, however, whether this technology will percolate into the mainstream any time soon. This shouldn’t come as much of a surprise if it does happen, since the Blockchain technology can have an almost limitless number of different uses.