Digital assets
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Blockchain explained in simple terms
Blockchain technology enables decentralized systems where no single entity, such as a bank or government, has control over the network. Unlike traditional systems, where data might be stored on a single entity’s server, blockchain distributes information across a network of participants.
Blockchain is a type of distributed ledger technology (DLT) that stores data in a peer-to-peer network. This data is organized into linked, sequential “blocks,” which together form a “chain” – hence the term blockchain. Blockchain technology has four key characteristics: distributed data storage, cryptographic security, immutability of records, and consensus mechanisms.
How blockchain works (simplified)
An analogy often used to explain blockchain is that of a notebook, where you record every transaction you make, similar to how a bank tracks deposits and withdrawals. But with blockchain, instead of one person or institution like a bank maintaining this record, millions of people around the world keep a copy of the same notebook. Everyone records and updates their own copy when a transaction happens, meaning that all participants have access to the same information and can verify its accuracy.
A helpful analogy is to think of it like a sports game, where everyone in the crowd can see the scoreboard. If someone tried to change the score, everyone would know it was wrong, and it would be nearly impossible to convince everyone to agree to the change.
Now, let’s break down how blockchain technology actually works:
1. Recording of transactions
Transaction creation: instead of writing in your notebook that you have transferred value to a friend, the transaction is digitally created and recorded in an electronic ledger (a register).
Verification: computers on the network (called nodes) verify that you have enough funds for the transaction. These computers follow the rules of the network, ensuring the validity of the transaction through cryptographic algorithms.
2. Shared information
Every participant in the blockchain network holds an identical copy of the digital ledger. This ensures transparency, as everyone has access to the same information at any given time and can independently verify any transaction.
3. Transaction verification
Transactions are verified by specialized nodes called miners (in Proof of Work systems like Bitcoin) or validators (in Proof of Stake systems like Ethereum). These nodes ensure that the sender has sufficient funds, validate the transaction, and ensure the integrity of the entire transaction history.
4. Consensus mechanism
In order to maintain agreement across the entire network, blockchain uses consensus mechanisms. Different blockchains use different consensus methods:
Proof of Work (PoW): used by Bitcoin, PoW requires miners to solve complex cryptographic puzzles to validate transactions. The longest chain of valid transactions is considered the correct version.
Proof of Stake (PoS): used by Ethereum, PoS relies on validators who “stake” cryptocurrency to gain the right to validate transactions. This is generally more energy-efficient than PoW.
Only when consensus is reached by the network participants (miners or validators) is a transaction considered valid and added to the blockchain.
5. The blockchain structure
Instead of using physical notebooks, blockchain technology uses an electronic ledger that organizes transactions into “blocks.” Each block contains a list of transactions and is linked to the previous block through a cryptographic hash, forming a “chain” of blocks.
Decentralization: blockchain is decentralized, meaning no single entity controls the entire network. Instead, all participants (known as “nodes”) have a copy of the digital ledger, ensuring that everyone is working from the same record.
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