It’s isn’t necessary to know what the blockchain is in order to trade and benefit from cryptocurrencies, but knowing the basics of how the blockchain works is a great way to increase your comfort level with digital currencies.
Basic Concept of the Blockchain
The blockchain, in its simplest form, is merely a public ledger1 that exists in a digital format. All of the transactions that have ever been completed with a particular cryptocurrency are recorded on the blockchain and they are there for everyone to see. The only major difference between the blockchain and a traditional ledger is the way in which the blockchain is updated.
Understanding the method used to update the blockchain can be a bit complicated so please bear with us as we give you the details. The goal here is to give you a very basic definition of the blockchain, but some of the underlying concepts are incredibly technical.
Implementation: The digital ledger is made up of a series of blocks that connect to each other in a very specific chronological order. These blocks are not physical blocks, but instead, digital containers in which records of transactions exist. When you send or receive a digital currency, a record of your transaction is added to one of these blocks.
Before being added to the chain, these blocks, and the transactions within them, are tested and checked for their authenticity. The way in which this is done, however, differs greatly from what most of us are used to. Blockchain utilizes something known as ‘decentralized consensus’ in order to verify blocks and transactions. This means that no single authority is in charge of determining the legitimacy of a block or the transactions inside it. Instead, different people around the world, known as ‘miners’, test and verify the blocks and transactions before those blocks and transactions can be officially added to the blockchain ledger.
Miners don’t verify these transactions by looking at any sort of personal information, but instead do this work by solving something called a hash function. It turns out that, with a lot of math and a small amount of computing power, you can take just about any collection of data and boil it down to an arbitrary size. The short hand of this is the ‘add-to-ten example’. Lets say you add the numbers 1, 2, 3, and 4 to get the number 10. Anyone can do that math and get to the number 10, but how about if I just gave you the number 10 and asked you to tell me which numbers I added to make it? That’s quite a different story. What if it was 1, 3, and 6 or 2, 5, and 3? Solving a hash function involves doing the brute force math of figuring out what those added numbers are. Blocks in a blockchain are connected by matching data with its representative hash. All of the data in a block is reduced to a hash and that hash is stored in the next block in the chain.
If the data in a block is tampered, then there becomes a mismatch in the data and the representative hash that connects it to another block. This is exactly how the blockchain stops people from spending the same digital currency more than once. Each time someone wants to make a transaction, their entire transaction history on the blockchain is checked. If someone attempts to spend currency that they don’t have, this will be caught before the next block of transactions can be added to the chain.
So why do the miners do this work? Well, that one is quite simple. They get paid to do it. Different cryptocurrencies dole out coins in different ways, but commonly, whenever a miner is able to confirm a block of transactions, they are awarded digital currency as compensation. This is one of the reasons that the system works so well. The miners are specifically rewarded for doing the computational work necessary for ensuring the authenticity of the ledger.
Key Concepts – The blockchain is a digital ledger. It is made up of blocks of transaction data that exist in chronological order. These transactions and their order are verified by groups of individuals called ‘miners’. These miners have a vested interest in keeping the ledger accurate.
1. Personal information is not made public. Only how many coins were sent and to which accounts. Your private key is never part of this public ledger.