This article offers a comprehensive yet easy-to-understand explanation to the commonly-asked question, “how does the blockchain actually work?”. While we touch on the subject of cryptocurrency, this article will mainly focus on the technical aspects of blockchain, with a tech-friendly approach meant for beginners. For readers wanting more of a beginner’s guide to crypto, see our “What is Cryptocurrency?” article!
Also, don’t forget to check out our Bitcoin Monetary Revolution course! This offers students valuable insights into the history of money. Plus, discover exactly how and why blockchain is transforming the financial sector. Join over 30,000 students at Moralis Academy today!
Blockchain Explained – Introduction
Blockchain is a cutting-edge and sector-wide revolutionary technology creating the foundations of the Web3 evolution. In 2009, the technology started with Bitcoin, the leading cryptocurrency. As such, people largely associate blockchain solely with crypto and decentralized finance (DeFi). However, the innovative technology holds potential use cases across a wide array of industries.
Below, we will discuss the infrastructure and technicals under the hood of blockchain. In turn, this will present a wider understanding of blockchain technology’s future. Moreover, for readers interested in the origin of cryptocurrency, see our “What is Bitcoin?” article!
What is Blockchain – Blockchain Definition
In how many different ways have you seen blockchain explained? There are various definitions available across numerous media outlets. Moreover, it can be difficult to know where to start when someone wants blockchain explained.
For example, according to Wikipedia, “a blockchain is a growing list of records, called blocks, that are linked together using cryptography”. Blockchain, explained by Google Dictionary (via Oxford languages) is, “a system in which a record of transactions made in Bitcoin or another cryptocurrency are maintained across several computers that are linked in a peer-to-peer network”. Further, IBM, a leading global IT firm, shares its blockchain definition as; “a shared, immutable ledger that facilitates the process of recording transactions and tracking assets in a business network”.
In addition to the defined elements above, we will incorporate and cover key components of the technology. In turn, this article provides a fully comprehensive breakdown and has blockchain explained in a simple and easy-to-understand approach. So, how does the blockchain actually work? Let’s explore the answer by first looking at the fundamentals.
Blockchain itself is a type of distributed ledger technology (DLT). Although the foundations of DLT had been brewing for almost 20 years before Bitcoin, the pioneering cryptocurrency was the first solution to the “double-spending” problem. In short, this means that holders of a cryptocurrency cannot spend the same digital coin more than once.
Satoshi Nakamoto, the pseudonymous developer(s), is responsible for introducing the blockchain. He/she/they incorporate several different aspects of computer scientists’ innovations surrounding transaction settlements and decentralization into the blockchain.
How Does Blockchain Work – Blockchain Technology Simplified
Blockchain technology stores transactions forever. Plus, instead of a small, centralized party governing a blockchain, it operates with an international network of users. This means that only a community majority can initiate a change to a decentralized blockchain protocol.
Herein, we will educate you on all the fundamentals of this cutting-edge technology and have blockchain explained so that you can give a confident answer to the “how does the blockchain actually work?” question. Below, we will discuss the key components in-depth of the novel technology and its development throughout the short history of the industry.
The first core concept of blockchain technology is decentralization. Various crypto projects achieve this in different ways. However, a common element in each project is a network of nodes. Nodes are computers in a blockchain network that contribute to validating transactions and the security of a network. Also, nodes form a global community of blockchain enthusiasts working towards mutual goals.
Moreover, there are different types of nodes. A few examples include mining nodes, full nodes, and master nodes. Mining nodes are responsible for completing tasks (such as validating transactions) to mine a native cryptocurrency and introduce it into circulation. Master nodes take on further responsibility for the network than mining nodes, often including operational functions and monitoring for any bad actors on the network. Plus, becoming a master node requires more upfront costs than being a mining node. This being said, it can often result in a higher passive income. A full node is any node that holds the full transaction history of a blockchain. Therefore, mining nodes and master nodes can sometimes also be referred to as full nodes.
To become a node requires upfront costs as part of one of the security aspects of the technology. Initial costs can vary with different requirements depending on the blockchain’s consensus model (explained below). Plus, becoming a node is one of the most reliable ways to earn a passive income in the crypto industry.
Every blockchain uses a consensus model that allows each node in the network to agree on a transaction’s validity before settling the transaction. The first consensus algorithm, namely, proof-of-work (PoW), was introduced through Bitcoin’s blockchain. In short, this requires nodes to use massive amounts of computational energy to compete to solve the mathematical equation that verifies a transaction. Then, the node that solves the puzzle first places the transaction into a block. Once a block is full of transactions, it becomes appended to the blockchain, with nodes receiving Bitcoin (BTC) in return.
The PoW consensus offers unprecedented settlement security, with transactions becoming immutable. Meaning that unless someone takes over 51% of the global network’s computing power, transactions cannot be altered or removed. However, the PoW energy requirement is not the most efficient or eco-friendly approach. As such, some developers have taken elements of this consensus algorithm and used it as a baseline to create a proof-of-stake (PoS) consensus mechanism. By using a similar principle, nodes must stake a minimum specified amount of a blockchain’s native asset instead of needing expensive computing gear and large amounts of energy. Then, they can partake in the chance of validating a transaction. As a result, this drastically lowers energy requirements by over 95%!
Several other consensus models are available, including proof-of-staked authority (PoSA) and delegated proof-of-stake (DPoS). Most models build on the PoS mechanism for its greener energy demands. Blockchains use consensus algorithms or mechanisms in conjunction with a chain selection rule and a “Sybil” resistance mechanism for complete security. Sybil resistance mechanisms aid in preventing Sybil attacks – where a single user or group creates many different accounts. Moreover, the chain selection rule comes into play to decide which chain is correct during the off-chance that two miners validate the same transaction simultaneously.
In addition to decentralization and security, another advantage of blockchain is transparency. By using cryptographic hashing to disguise any personal data, every transaction of all assets on each blockchain is theoretically available to view at any time. However, it depends on whether a blockchain is public or private (which we will discuss later) as to whether transactions are available to the public or only to select holders with relevant private keys. Block explorers such as Etherscan (for Ethereum) or BscScan (for Binance Smart Chain) allow anyone to search and view real-time transactions.
Additionally, the use of open-source code further increases the decentralization of the technology. All relevant code for different blockchains and applications operating on top of them is available to view. Developers can use sites such as GitHub and OpenZeppelin to use preexisting code to use and adapt within their own developments. As such, anyone has the ability to clone and expand upon existing applications.
The introduction of blockchain and decentralized technologies naturally inspired a range of Web3 development tools and applications. This includes platforms such as Moralis, Remix, and Truffle Suite that you can utilize for designing, handling backend, and deploying different smart contract applications.
The pioneering blockchain, Bitcoin, was designed to securely send transactions from wallet A to wallet B. Bitcoin fanatic and exceptionally-skilled developer, Vitalik Buterin, proposed that the largest blockchain should implement smart contracts, facilitating a decentralized development landscape. Refused by the Bitcoin development team, Buterin created his own blockchain, specifically designed to enable the development of applications using smart contracts. As such, in 2015, Ethereum was launched.
As the largest smart contract compatible blockchain, Ethereum is the inspiration for many other smart contract chains and applications. Smart contracts are pieces of code that allow funds or assets to move when specified conditions are being met. For example, if your child receives an “A” in school, you could set a transfer of $100 from your account to theirs. If they receive a “B”, you could set to transfer $75 and so on. This could apply to a range of variables, including weather and temperature conditions. For example, an “internet of things” (IoT) sensor could monitor the temperature of food or goods in transit. Businesses could create a smart contract specifying that if the goods fell below a specific temperature en route, the order could become void. Plus, this could automatically trigger another order, saving countless amounts of hours and labor capital on administration.
Smart contracts form the foundation of all decentralized applications (dApps). Further, Ethereum hosts the largest amount of decentralized finance (DeFi) applications. Moreover, smart contracts are fundamental to non-fungible tokens (NFTs). As such, developers can deploy purpose-built blockchains for dApps and NFTs, including decentralized film financing (DeFiFi), such as the Mogul Productions firm. Or, dApps can provide immutable ownership of goods using NFTs, such as Mt. Socks or Satoshi Studios trainers. Blockchain can apply to a vast range of industries, such as climate change which Klima DAO supports!
Another concept to consider when answering the question “how does blockchain work?” is scalability. A common challenge among developers is known as the “blockchain trilemma”. The combination of decentralization, security, and scalability is a delicate balance when deploying blockchains. As such, many projects focus on decentralization and security, often resulting in minimal scalability. Alternatively, some projects focus more on security and scalability. However, this compromise can sometimes result in aspects of centralization. Depending on the purpose and target market of a project, this can sometimes conflict with the technology.
However, since the initial deployment of smart contract-friendly blockchains, there have been many substantial innovative solutions. The Ethereum 2.0 update focuses on improving scalability, using sharding solutions and “zero-knowledge proofs” technologies. This includes zk-SNARKS and zk-Rollups, taking the main computational requirements off-chain. Plus, some projects use sidechain solutions that operate as a smaller chain in parallel to Ethereum, redirecting transaction settlements for faster confirmation times. Also, several layer-2 applications run on top of the Ethereum chain. Thus, many projects use scaling solutions to facilitate higher transactions per second (TPS) than applications operating on the main chain.
Developers have also addressed the issue of scalability using alternative consensus models and blockchain architecture. Many different blockchains are now available, offering sub-second transaction settlement and scalable development opportunities. Blockchains such as Solana and Velas are among the fastest in the world, processing 45,000+ TPS. However, while Bitcoin and Ethereum may lag with settlement times, the security of the chains is the leading ones in the industry with the highest number of active network nodes.
To dive deeper into the industry’s second-largest blockchain, check out our Ethereum 101 course at Moralis Academy!
Public, Private, and Permissioned Blockchains
Have you ever seen blockchain explained in a way that is seemingly contradictory or overly technical? Blockchain technology provides the most secure settlement network in the world, yet it is fully transparent and private. This concept can be confusing at first. Therefore, to give a “holistic” answer when considering “how does blockchain work?”, we’ll discuss the differences of public, private, and permissioned blockchains.
The leading blockchains, Bitcoin and Ethereum, are both public blockchains. Anyone, anywhere, can view transactions on the chain using a block explorer. Users don’t even need to own crypto or to have previously used the chain. Plus, all code is open-source and available for developers to implement or use as inspiration. The block explorer data display wallet addresses and details surrounding the transaction settlement. This being said, during the confirmation process, the data goes through a cryptographic hashing process so that it becomes unreadable. Only holders of the relevant private key (password or seed phrase) can access the personal private details (such as the first name). Therefore, if someone figures out your long-digit wallet address, they can theoretically track all transactions you make.
However, interacting with a private blockchain can change all of this. Several different private blockchains are operating with various innovative infrastructures. Overall, they all work with the same “ethos” of disguising data surrounding transactions using various mechanisms. Additionally, a permissioned blockchain also has restrictions on public users. Permissioned blockchains require users to hold relevant private keys to interact with the blockchain. This could be to view transactions, build, or interact with applications on the chain. As such, permissioned blockchains offer an ideal solution for large-scale enterprise and institutional adoption of blockchain. Plus, with complete immutability, blockchain can ameliorate accounting and stock-taking logistics for businesses.
How Does Blockchain Work – Summary
So, how does the blockchain work? We hope you discovered the answer in this “Blockchain Explained” article. In the space of 13 short years, blockchain technology has witnessed substantial advancement. Moreover, as an open-source and permissionless technology, developers around the world are continuously innovating. As a result, new chains, applications, and solutions are emerging every day to combat the “blockchain trilemma”. Blockchain encourages community innovation for the direction of growth for the technology, intricately balancing decentralization, security, and scalability.
If you would like to read more about the developments of decentralized finance (DeFi), make sure to check out our “What is DeFi?” article! Also, if you’re keen to know more about trading and learning more about crypto markets, our “Investing in Crypto” article is a fantastic resource!
Or, our Blockchain & Bitcoin 101 is the perfect blockchain course offering students industry-expert education on the deeper technicals of blockchain. Since blockchain is still a relatively new technology, gaining education in this industry will likely prove valuable in the future! Also, don’t forget to follow us on Twitter @MoralisAcademy! We would love to hear your thoughts about this “Blockchain Explained” article!