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What is blockchain and how does it work?
The world of cryptocurrency can be challenging to navigate. After learning about the types of cryptocurrencies and what can be done with them, there’s also the business of understanding how it all works. That’s where blockchains come in.
A blockchain is a system of recording transaction data information in a way that makes it difficult or impossible to change, hack, or cheat the system. A blockchain includes several key elements, including:
- Digital ledgers: An accurate activity log of all transactions that occur within a specific network.
- Smart contracts: These contracts act as an automated agreement between the seller and buyer which can never be edited or reversed. Because of the network’s decentralization, the automated agreement makes the transaction process more efficient with almost instant confirmation. Smart contracts are also key when it comes to accurately reporting shared transaction data in a network.
- Immutable records: A feature that makes it impossible for anyone or any entity to manipulate or edit.
How does blockchain work?
In simple terms, a blockchain is a shared ledger that records transactions or data. Instead of being maintained by a singular central authority, this “ledger” is stored and distributed across an entire network of “nodes”, each of which holds a copy of the entire blockchain.
Each block of encrypted data is permanently “chained” to one another. This data, comprised of network transaction activity, is sequentially documented to help create a record that allows visibility into past versions of the blockchain.
When peer-to-peer transactions are completed, the information related to those transactions are verified and confirmed, according to network permissions or economic incentives, before being added as another block on the chain. This verification process is defined as “consensus mechanisms”. Once added, all other blocks within the network will be updated to include this new transaction data.1
Below are specific elements of how blockchain works and the possible benefits of blockchain.
Security
New blocks are always stored chronologically and usually added to the end of a chain. That is, they are always added to the “end” of the blockchain. Once the block is added, its contents are permanent and cannot be changed unless the network majority agrees to do so. That’s because each block has an identifier, or hash, that’s essentially a random set of letters and numbers assigned to a data set. Not only do these hashes correctly identify activity within a network, they also allow users to cross-reference shared network records to avoid facilitating transactions with an untrustworthy user.
Decentralized
In the spirit of transparency, blockchain allows information in that database to be freely shared across networks in different locations. While it seems repetitive, it ensures that the shared data can be referenced and verified by users wanting to complete a peer-to-peer transaction.
Direct peer-to-peer payments
Although users can find transaction details, they can’t see any identifying information about those involved. While it’s common for people to believe this shared information is anonymous, it’s only confidential. In other words, once someone completes a transaction, their unique code (also known as a public key) is added to the blockchain, with personal information being left out.
Future potential
What makes cryptocurrency intriguing to many is its potential accessibility to people of all backgrounds. According to The World Bank, about 1.7 billion adults do not have bank accounts or any means of storing their money or wealth.2 Nearly all of these individuals live in developing countries, where the economy is in its infancy and entirely dependent on cash. Blockchains of the future are attempting to be positioned to fill this need not only as a way to store cash, but as legal contracts like medical records and property rights, too.
As cryptocurrency grows, financial providers and digital banking companies have begun entering the cryptocurrency space. Apps and services exist that allow users to hold, sell, and buy crypto, furthering the accessibility to the potential benefits of blockchain technology.
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Why is blockchain important?
On top of being accessible, peer-to-peer oriented, secure, and decentralized, other potential benefits of blockchain are its immutable records, transparency, and the freedom to store wealth and information outside of regulated industries.
Blockchain transactions
To understand the mechanics behind the blockchain transaction process, below is the process broken down into simple steps:
- A user requests a transaction.
- The transaction is shared within the network to peer-to-peer nodes.
- Miners validate and confirm the transaction.
- The recorded transactions are combined to create a data block.
- The newly created data block is added to the blockchain.
- The transaction is completed.
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