What is blockchain and how does it work? A complete visual guide for beginners

04/20/2022, 04:32 PM

What is blockchain and how does it work? A complete visual guide for beginners
What is blockchain and how does it work? A complete visual guide for beginners

You can think of blockchain technology as digital accounting. Therefore, blockchain is a “digital ledger” that contains important information on every transaction (for example, transaction participants, transactions status, etc.)

Blockchain technology has been around for 14 years. However, many people are still trying to understand how blockchain technology works and what it is supposed to change in the future.

What is the reason?

The first reason lies in the fact that blockchain is still a “new” technology. Although it was first mentioned in 1991 in a research made by Stuart Haber and Scott Stornett, the technology came to life in 2009, when Satoshi Nakamoto made the first Bitcoin transaction. Basically, the technology has not reached its “adulthood” yet.

The second reason is terminology filled with professional jargon. Since the technology is in its early days, many explanations of how it works and what problems should it solve are filled with jargon known only to experts in cryptography, mathematics, and programming.

That is why the general public struggles with understanding the matter. As a consequence majority of people who watch video explainers, read blogs or research papers about blockchain technologies end up saying: “I still don’t quite understand what is it all about”.

To get around this problem, we decided to simplify the blockchain explanation and describe how it works with visuals. Let’s move on to the first issue - the blockchain definition.

What is blockchain?

Four fast facts about the blockchain:

  • Blockchain is a database that can be easily shared among all blockchain network users.
  • Currently, the most stored data on the blockchain are cryptocurrency transactions.
  • Unlike regular databases, that store data in folders, blockchain stores data in blocks in chronological order.
  • Once stored on the blockchain, data can never be reversed or changed.

You can think of blockchain technology as digital accounting. Therefore, blockchain is a “digital ledger” that contains important information on every transaction (for example, transaction participants, transactions status, etc.)

All information is in chronological order and protected by cryptography.

The illustration shows a woman leaning on a large orange book with the title "blockchain".
Blockchain can be described as a ledger that contains important information on every transaction.

Blockchain can be duplicated and shared among other computers (nodes) in the network. That is why blockchain is often described as a “distributed ledger”.

The illustration shows how blockchain data is distributed to other users within the network.
Every computer (node) that runs the blockchain network has a direct insight into the history of all transactions.

Since everybody has the access to information in blockchain it is considered very transparent.

Many people are still confused about several things like: “Is there only one blockchain” or “Are blockchain and Bitcoin the same thing”?

In short, blockchain is the technology, while Bitcoin is the cryptocurrency that is powered by blockchain technology.

There are many blockchain networks. Each blockchain network has a wide range of possibilities. What is more important, blockchain networks have more uses cases besides keeping track of transactions.

When it comes to Bitcoin, its blockchain is keeping records of transactions. If we are dealing with Ethereum, it’s usually keeping transaction records, but it can be a few other things, like for example smart contracts.

For other altcoins, they could be the usage of your Wifi or files or documents.

Basically, blockchain networks can record and store data about any form of asset that could have value. Blockchain is a general-purpose technology, which means it can be applied in every sector. Some of the most common commercial applications of blockchain are in areas like:

  • finance
  • real estate
  • medical research
  • election votes

How does blockchain work?

Many databases use folders to store all information. Blockchain uses blocks instead of folders.

How is information stored in each block?

Take a simple transaction as an example. Person B buys a certain number of Bitcoins from Person A. (*it could be any type of asset besides Bitcoin. Since blockchain is most commonly used to keep records on buying and selling cryptocurrencies, we took Bitcoin as an example).

The illustration shows buying Bitcoin for fiat currency.

Once the transaction is completed and confirmed, all transaction details are recorded.

The illustration shows how a single transaction is recorded before being added to the blockchain.
A simple example of how a transaction is recorded.

Imagine that every transaction is recorded in a list like this (image below).

Illustration showing a simplified version of cryptocurrency transaction history list.

Once the lists of transactions is collected they are stored in a single block (image below). It’s important to know that each block has a limit, in other words, it can’t receive an infinite number of transaction lists.

The illustration shows how transactions are stored in a new block.
A simplified example of how transaction data is stored in blocks.

Once a single block reaches its maximum, it connects to the previous block. After it gets verified it becomes part of the chronologically organized chain.

A new set of transaction lists moves to a new “empty” block and the action is repeated. The blocks are connected together to make up a chain of records, and this is why the technology is called the blockchain.

An illustration explains how new blocks are added to the blockchain network.

Blockchain saves these blocks in a format that allows us to view a perfectly recorded history of Bitcoin transactions.

Who confirms and verifies the transaction in the blockchain?

You’ve probably thought by now: “Okay, transactions are stored in the blockchain, but who decides whether the transactions are valid?

The transaction verification process is very simple actually. Blockchain is powered by a computer network. Every computer that uses a blockchain also acts as a "node” (* in order to participate in the blockchain network all you need, is a computer and an internet connection).

This is how you can picture a network full of nodes that run a blockchain network.

The visual representation of how nodes run the blockchain network.
Visual representation of a single node that runs the blockchain network.

How are transactions confirmed and added to the blockchain?

When two parties make a transaction, the transaction must go through the network. All computers (nodes) check the details of the transaction to verify that it is valid.

Since every computer (node) has direct access to every transaction in the network (from the previous blocks), it is easy to determine if the same person who made a transaction tried to make the same transaction twice, or tried to change something in the meantime.

If nodes approve the transaction it will be stored on the blockchain. From that point it can’t be changed again. If the nodes discover that the person who made a transaction tried to change something or made the same transaction twice at the same moment it will automatically decline the transaction which means it won’t be stored on the blockchain.

An infographic showing the process of verifying the transaction before adding it to the blockchain.

5 key features of blockchain

1. Blockchain is a decentralized network

Decentralized means that cryptocurrency operates without a third party such as a government, bank, company, etc.

Blockchain is not stored in one place. Blockchain is scattered among many computers and places. Therefore, if one computer stops working, many other computers within the network are still sufficient to record and store transactions and ultimately for the network to function normally.

2. Blockchain is a transparent network

By now we established the fact that blockchain is a distributed ledger. This means that transactions and data are stored in an identical way in multiple locations simultaneously.

In other words, all computers (nodes) have an identical copy of the history of all transactions. Every action is immediately visible to every computer (node).

As each computer has access to the history of all transactions, the entire network automatically eliminates any possibility of fraud.

3. Blockchain provides security for all users

Security is one of the greatest features of blockchain technology. How is blockchain secured? As we mentioned in the example above, each transaction must be approved by a computer network (node). All transactions are approved by consensus between all computers on the network.

Additionally, each transaction is encrypted. So if a certain malicious actor suddenly tries to change the data in his favor, it will not be possible.

First, all computers have access to a history of transactions that have occurred. Because they have all insights, every computer on the network will determine that the malicious actor has changed the data. When computers (nodes) detect malicious activity, the transaction will be rejected.

4. Blockchain technology enables instant transactions

With the help of blockchain, you can make a transaction in just a few minutes, anywhere in the world. Imagine how much would it cost you to send money across the world with traditional banking, not to mention the sending time.

A person who makes cryptocurrency transaction transactions can execute a series of transactions in a few moments. All "documentation" on transactions made with cryptocurrencies is stored on the blockchain, thus eliminating the need for paper exchange and additional time.

In addition, fees for sending cryptocurrencies are very low (compared to traditional banking services).

5. Blockchain provides instant insight into all data

As a consumer, would you like to have an access to all the information about the origin of a product (from the beginning of production to the moment of placing on the market).

This is what blockchain technology will enable us in the near future.

Blockchain technology creates a “trace” that documents each step of the entire journey (whether we talk about production, shipment, transaction, etc.).

This can be crucial in building trust between different industries and consumers, especially in times when consumers are more concerned about environmental and similar issues.

For example, clothing manufacturers who claim to use natural materials can share all the information with consumers about the origin of the ingredients used in the products.

In the blockchain world, there are already projects that seek to solve problems in supply and production chains. The most popular is VeChain.

When it comes to blockchain technology, many automatically identify it with cryptocurrencies. Blockchain technology is currently most widely used in the financial sector. However, the technology has other uses as well.

Health care

There are currently several projects that apply blockchain technology in the medical industry. Blockchain technology is used as a means of recording medical research, medical records of patients in a transparent way.

Real estate

Whether it is from property rights, or the size of the property, blockchain technology can secure transparency in the real estate industry and transactions between contractors.

Voting

The idea of using blockchain technology to improve the voting process has been circulating in the public for a long time. The most common arguments for using blockchain in voting systems are the prevention of potential voter fraud and offering an easy way to count the votes.

Conclusion

Blockchain technology is an innovation that offers a solution to challenges such as secure storage and data protection. The technology also seeks to provide a useful way to authenticate information, identities, transactions, and other elements, while creating a secure “book” of information that can be updated in real-time.

As the boundaries of the physical and digital worlds shrink rapidly, the application of blockchain technology will continue to grow.

If blockchain technology keeps growing exponentially, we could soon witness the creation of an ecosystem in which individuals, companies, and organizations can collaborate in a secure, confidential, and virtual way.

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