How does Blockchain Technology Work?

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Cryptocurrency is a hot topic these days. Keeping up with blockchain news, Bitcoin news, and Ethereum news can seem like an arduous homework assignment. But before you buy blockchain stocks, Bitcoin stocks, Ethereum stocks, take a moment to familiarize yourself with blockchain technology.

Cryptocurrency and blockchain technology could be the future of global economics.

It’s important to understand the ways in which cryptocurrency functions. Although cryptocurrency is inherently abstract—it is comprised of code, not something physical which one can touch—its uses are firmly in the concrete realm, as cryptocurrency can be used to obtain goods and services.

A blockchain is comprised of three principal technologies: private key cryptography; a distributed network with a shared ledger; and an incentive to service the network’s transactions, record-keeping and security. None of these technologies is new, but the way in which the three technologies work together is.

Blockchain technology makes cryptocurrency transactions uniquely secure.

First, let’s examine private key cryptography. Let’s assume that two people want to have a transaction over the internet, and each of them holds a private key and a public key. Blockchain technology features this component as a way to create a secure digital identity reference. One’s identity is based on possession of a combination of both private and public cryptographic keys, and the combination of these keys can be seen as a dexterous form of consent. In turn, this creates an extremely useful digital signature, which provides strong control of ownership. This makes the transaction more secure.

However, this strong control of ownership does not necessarily result in secure digital relationships. While it solves authentication, strong control of ownership must be combined with a means of approving transactions and permissions, also known as authorization. Blockchains achieve this through a distributed network.

Why is a distributed network so important for blockchain technology?

One can conceptualize the concept of a distributed network best by using the “if a tree falls in the forest” analogy. If a tree falls in the forest and someone is around to witness it, we can say with reasonable certainty that a tree did, indeed, topple over. We have evidence to support this conclusion, even if we might not be entirely certain what caused the tree to fall.

With respect to blockchains, the distributed network functions like our observer in the forest. In a large network, validators reach a consensus that they witnessed the same thing at the same time. However, unlike our tree watcher, these validators use mathematical verification, not their sense data. In the case of our tree observer, if she is joined by others who saw the tree topple, the conclusion that a tree did indeed fall is strengthened and supported.

The more validators we have on a distributed network, the more secure the blockchain network will be.

This is one of Bitcoin’s blockchain’s better qualities. It is so large that it has amassed considerable computing power. As of early 2018, Bitcoin is secured by 3,500,000 TH/s. This is more than the 10,000 largest banks in the world combined. Ethereum, another blockchain cryptocurrency, that is younger than Bitcoin and somewhat less mature with respect to its development, is secured by about 12.5 TH/s. This is more than Google, and Ethereum is only two years old–and essentially still in test mode.

Blockchains have a system of record. When cryptographic keys are combined with a distributed network, an immensely useful form of digital interactions emerges. In this process, Individual A takes their private key, making an announcement of some sort–in the case of Bitcoin or other cryptocurrency, that the individual is transmitting a sum of the cryptocurrency–and attach it to Individual B’s public key.

How does network servicing fit into blockchain technology and secure cryptocurrency transactions?

Our analogy of the falling tree is useful to describe how distributed networks function; however it needs to be expanded to explain network servicing protocol. A distributed network is only useful if it contains a number of computers, thus increasing the aggregate computing power.

But how can one attract computing power to service a network with the intention of making it secure?

Simple: For public blockchains, mining.

This is not the sort of mining people do in coal country; the item “mined” is digital. Mining is founded on a twenty-first century approach to an ancient question of economics: The tragedy of the commons.

Blockchain technology provides incentives for network servicing of cryptocurrency transactions.

In blockchains, when one offers his or her computer processing power to service the network, there is a clear reward available for one of the computers. Thus, a single person’s self-interest is being used to help serve a larger, public need.

This is intended, in part, to eliminate the possibility that the same bitcoin would be used in separate transactions at the same time. It is in this way that bitcoin seeks to function like any other more traditional commodity, such as gold or silver. Bitcoins and their base units, satoshis, must be unique to be owned and have value. To achieve this end, the nodes serving the network must create and maintain a history of transactions for each individual bitcoin. This is done by working to solve proof-of-work mathematical problems.

These computers “vote” with their CPU power, expressing agreement about new blocks or rejecting invalid blocks, to determine the state of a particular bitcoin. When a majority of the miners arrive at the same solution, the miners add a new block to the chain. This block is timestamped, but can also contain data or messages. The People’s Republic of China has the most Bitcoin miners in the world.

Blockchain technology and the exchange of cryptocurrency is still very new and undergoing significant innovation and growth.

Some organizations, such as the People’s Bank of China, Waves, and the Korean Blockchain Association, seek to impose regulations, or compel blockchains to self-regulate, in the hopes that cryptocurrency will be less like the Wild West and more like a stable way to exchange digital coins for goods and services. As cryptocurrency options proliferate, undoubtedly so will innovations with respect to how blockchain technology develops.

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