How Blockchain Technology Works

The leading venture capitalist Marc Andreessen described blockchain as the most important invention since the internet itself. If internet changed the way we transfer information, blockchain is changing the way we transfer value. So, let’s learn about how it works.

While talking about blockchain technology, people sometimes mean different things and it can be very confusing. Sometimes they are talking about the Bitcoin's Blockchain, sometimes about crypto-currencies in general, and sometimes they are talking about distributed systems. At a very high level, blockchain is generally referred to a decentralized ledger of all transactions across a peer-to-peer network. Blockchain technology is not the same as Bitcoin. Instead blockchain is the technology underlying Bitcoin and other crypto currencies. Using this technology, participants such as buyers and sellers can interact and transfer value directly to each other over the internet without the need for a third-party intermediary. Let’s see how it works.

The blockchain technology facilitates peer-to-peer transactions without any intermediary such as a bank or a governing body. The blockchain technology makes it possible to remove all middlemen when transacting between two parties. As I mentioned earlier, Bitcoin is an application that makes use of the blockchain technology to send money around and enable transactions between two parties. In fact, it is the first application of blockchain technology applied to money.

At its core, the blockchain is essentially a database of all transactions happening in the network. The database is public and therefore not owned by any one party. It is distributed, that is, it is not stored on any one computer owned by somebody. Instead it is stored on many computers across the world. The database is constantly synchronized to keep the transactions up-to-date, and is secured by the art of cryptography making it hacker proof. These four features make this an exceptional technology.

Blockchain works as a network of computers, all of which must approve a transaction that has taken place before it is recorded, in a “chain” of computer code. In case of bitcoin, cryptography is used to keep transactions secure and costs are shared among those in the network. After the transaction is validated, the details of the transfer are recorded on a public ledger that anyone on the network can see.

In the existing financial system, a central ledger maintained by the institution acts as the custodian of the information. But on a blockchain the information is transparently held in a shared database and no one party acts as a middleman. This increases the trust among parties, as there is no possibility of abusing the system by anyone.