A blockchain serves as a distributed database or ledger shared among nodes in a computer network. Although most known for its vital role in maintaining secure and decentralised transaction records, the blockchain extends beyond crypto applications. They can make data immutable in any industry, preventing alterations.
The inherent inability to modify a block eliminates the need for extensive trust, primarily required at the point of data entry by a user or program. This reduces reliance on trusted third parties, such as auditors or humans, often introducing costs and human errors.
The usage of blockchains is increasing with the creation of various cryptocurrencies, decentralised finance (DeFi) apps, non-fungible tokens (NFTs), and smart contracts. These have harnessed the power of blockchain to revolutionise several industries and offer innovative solutions in digital finance.
Though the underlying mechanisms of blockchain are complex, below is a concise overview of how the blockchain works:
A blockchain transaction tracks the transfer of physical or digital assets from one party to another within the network. This information is recorded as a data block. It may include details such as the involved parties, the transaction's details, the time and location of occurrence, and the amount of assets exchanged.
For a recorded transaction to be considered valid, most participants in the distributed blockchain network must reach a consensus. The agreement rules can vary depending on the type of network and are typically established at the network's outset.
The transactions are written into blocks, and each block is also appended with a cryptographic hash, creating a chain linking the blocks. This hash is a security measure to detect any intentional or unintentional modification of block contents, ensuring data integrity.
The blocks and their interlinked chains are securely structured, making them immutable. Each new block strengthens the verification of the preceding block and the entire blockchain.
The latest version of the central ledger is distributed to all participants, ensuring everybody can access the latest information. This transparency and synchronisation among participants enhance the overall security and reliability of the blockchain.
Transactions on different blockchains follow different processes. For instance, in the case of Bitcoin's blockchain, initiating a transaction using your crypto wallet—the interface for the blockchain—sets off a series of events.
When you trade in Bitcoin, it is temporarily stored and queued in a pool until a miner or validator picks it up. Once included in a block, the block gets filled with other transactions and is then closed and encrypted using an encryption algorithm. The mining process then begins.
The network attempts to "solve" the hash in this process. Each miner generates a random hash and a "nonce", starting with a nonce of zero and appending it to their hash. If the resulting hash is not equal to or less than the target hash, the miner increments the nonce by one and generates a new block hash. This continues until a miner finds a valid hash, becoming the winner and receiving the reward.
Once a block is closed, the transaction is considered complete. However, the block is not confirmed until five other blocks have been validated to ensure security. This confirmation process typically takes about an hour; the network averages just under 10 minutes per block.
Note that not all blockchains follow this precise process. For example, the Ethereum network randomly selects one validator from all users with ether staked to validate blocks, then confirmed by the network. This is generally faster and consumes less energy than Bitcoin's process.
A blockchain must be cryptographically secure, requiring two cryptographic keys for database access or data addition: a public key, serving as the address in the database, and a private key, acting as a personal key authenticated by the network.
A blockchain also serves as a digital log or database of transactions, entirely operating online.
Lastly, a blockchain is a shared public or private network database. For example, the Bitcoin blockchain is a public network where anybody can open a Bitcoin wallet or become a node. Some blockchains are private networks commonly used in banking and fintech, where participants' identities, data access, and private keys are crucial.
A blockchain facilitates data distribution in a database across multiple network nodes—computers or devices running blockchain software—at various locations. This distributed setup not only ensures redundancy but also preserves the integrity of the data.
For instance, if someone attempts to modify a record in one database instance, the other nodes would prevent unauthorised changes. This decentralised approach ensures that no single node can tamper with the information stored within the network.
Due to this distribution and the encrypted proof of work, the information and history recorded on the blockchain, such as transactions in a cryptocurrency, become immutable and irreversible. Beyond transactional data, a blockchain can also hold diverse information, including legal contracts, state identifications, or a company's inventory. The inherent security and permanence of the blockchain make it a reliable and trusted platform for a wide range of applications and use cases.
The decentralised nature of the Bitcoin blockchain ensures that all transactions are transparently visible to anyone with access to a personal node or through blockchain explorers that display real-time transaction data. Each node maintains its copy of the blockchain, updated as new blocks are confirmed and added. This transparency enables the ability to track Bitcoin movement throughout the network.
For instance, in exchange hacks that resulted in significant cryptocurrency losses, the stolen crypto can be easily traced because the wallet addresses of the hackers are recorded on the blockchain, even if their identities remain anonymous.
Despite this transparency, the records stored on the Bitcoin blockchain are encrypted, ensuring that only the individuals assigned to specific addresses can reveal their identities. This cryptographic layer allows blockchain users to remain anonymous while benefiting from the network's transparency and traceability.
The blockchain is robust and difficult to breach. There are two main methods by which a blockchain system can be hacked.
The first is a 51% attack, wherein control over more than half of the verification nodes allows for inserting fake data and double-spending cryptocurrency coins. However, executing this attack on networks the size of Bitcoin or Ethereum is nearly impossible due to their vast size and security measures.
Another risk comes from bugs in the blockchain management system's code, leading to the insertion of incorrect data blocks. Well-established networks with a long track record in the public domain can effectively deal with and block several bug-exploiting attacks. However, new blockchains may face more difficulties, although they can benefit from the lessons learned from attacks on more extensive networks.
While crypto trading exchanges and digital wallets have been breached in the past, these incidents are separate from the inherent security of blockchain technology. Poor security practices and human errors can risk crypto accounts being hacked.