Blockchain Blog

How Does Blockchain Technology Work?


For the past few years, Bitcoin and the rest of the cryptocurrency market has grown tremendously, surpassing almost everyone’s expectations. Companies that were once skeptical of the industry are now warming up to it. Blockchain, the technology underpinning most cryptocurrencies, has also been found to be immensely useful for applications other than digital tokens.

As a result, several governments around the world, including that of India and China, have committed to building Blockchain-enabled platforms to promote transparency and efficiency. However, despite the technology’s overwhelming popularity, many still do not fully understand what it has to offer.

The history of blockchain

A theoretical concept of a blockchain was initially suggested in a research paper as early as 1991. At the time, the proposal was rather rudimentary and had only been designed to preserve timestamps of documents. It did not take long for other researchers to improve upon the original concept and publish their own findings publicly. However, it wasn’t until two decades later that the first actual application of blockchain was finally developed and released in the form of Bitcoin.

Since then, a number of other uses for the technology have been discovered. So far, companies like IBM, Samsung and even Apple have experimented with it, as is evident by the sudden onslaught of blockchain-related patents granted to them. Blockchain are most effective when used in projects that involve a lot of data collection. As a result, the logistics and finance industries were among the first to announce the development of in-house blockchain platforms and trials.

Trust: understanding what blockchain offers

Blockchain technology has often been heralded as a technological revolution similar to the internet from a few decades ago. While the internet gave the world instantaneous access to information, blockchain technology offers something known as ‘decentralized trust’ instead.

In modern day society, almost every exchange is vouched for by an institution or organization. Financial transactions, for instance, take place in the presence of a bank, while other asset-related exchanges may be done through an escrow. Needless to say, in all of these instances, the third-party is trusted to be neutral and legitimate.

Blockchain presents a radical shift in this notion of trust. Instead of relying on a centrally located third party, a blockchain transparently distributes information across multiple computers. Since users participating in the network directly benefit from its well-being, they are motivated to host these copies. Ultimately, they ensure the integrity of the network by requiring an attacker to change data across all copies simultaneously, a significantly greater challenge than hacking a single computer.

In this way, blockchain technology completely eliminates the need for an intermediary, while still offering robust protection from fraud and misdemeanour. A blockchain is most effective when it is replicated across a significant number of machines. This ensures that the network is not only decentralized, but also out of one specific individual or organization’s control.

Blockchain in cryptocurrency

In a typical digital currency like Bitcoin or Ethereum, a blockchain is used as a digital ledger to keep track of monetary transfers on the network. Since the technology inherently prevents anyone from modifying data once it has been recorded, no individual can siphon funds from another user’s account.

Blockchain’s role in cryptocurrency is not limited to preventing fraud though. Since the technology establishes decentralized trust, it also eliminates the need for typical payment processors and gateways. In contrast, accepting payments in fiat currency requires merchants to set up an account with an intermediary provider such as PayPal or Venmo.

Since third-parties are completely removed from the equation, merchants are no longer forced to pay five to ten percent of every transaction as ‘processing fees’. With Bitcoin, for instance, payments can be settled with transaction fees as low as a few cents. There are even some cryptocurrencies that promise feeless transfers altogether, even for international transfers.

Cryptocurrencies use a complex and resource-intensive algorithm to ensure that new transactions on the network are indeed legitimate. This process, called mining, is employed by most major digital currencies, including Bitcoin, Litecoin and Ethereum. Thus, for every record created on a cryptocurrency’s blockchain, a certain amount of work needs to be done on the network.

Blockchain in industry

For a few years after Bitcoin’s release in 2009, the use of blockchain technology did not evolve beyond cryptocurrency-related applications. Over time, however, as developers began working with the technology and created their own offshoots, it quickly became apparent that the scope of the technology was much larger than originally believed.

While most of the fundamental features of blockchain still exist in industry-based applications, there are a few differences between them and the ones designed for cryptocurrencies. For starters, instead of recording imaginary tokens on a ledger, industrial blockchains are used to track physical assets such as real estate, food and even automobiles.

The technology has shown most promise in the supply chain industry. With international commerce growing by the day, logistics companies have to typically keep track of millions of shipments every single day. The sheer scale of such an operation makes it difficult for them to detect corruption and other illegal practices. In the case of food items and other perishables, shipping companies are also burdened with the responsibility of delivering items before they expire.

By recording shipment data on a blockchain instead, companies can guarantee complete transparency. The buyer or recipient of a particular shipment can easily audit the blockchain and check for any discrepancies during the shipping process. Errors can also be minimized, since the need for human input is reduced dramatically. This is especially true when blockchain is used alongside other emerging technologies like Artificial Intelligence and Internet of Things (IoT). Many companies in the industry have already committed to blockchain technology, including UPS and Hyundai Merchant Marine.

Attacking a blockchain

As previously mentioned, a blockchain is most robust when protected by many computers around the world. However, in the event that a single entity gains control of most of the resources on a network, they can abuse their power to wreak all sorts of havoc. The condition, commonly referred to as a “51% attack”, allows the prevailing entity to do everything from revising past transaction data to blocking new transactions from being recorded.

On April 4, 2018, cryptocurrency Verge fell victim to a 51% attack and suffered irrevocable loss of funds. Nevertheless, such attacks are generally pretty rare and were only considered to be theoretically possible for several years. The same can be said for other vulnerabilities. While most of them have been discovered and documented, the threat posed by them is rather insignificant for larger, well-managed blockchains.

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