Frequently Asked Question

What is Blockchain and how does it work?

Last Updated 9 months ago

Confused about blockchain? If you are, you’re not the only one. Multiple surveys have shown that while the general perception of blockchain technology is largely positive, most people don’t really understand what it is or how it works.

A recent survey conducted by Vorhaus Advisors found that only 25% of US adults know what Blockchain is, while 62% believe that blockchain is the same as cryptocurrency. Relatedly, a 2019 Kaspersky survey found that only 10% of consumers surveyed understood how cryptocurrencies work.

This general lack of understanding is unsurprising. Articles about blockchain technology tend to be cloaked in technical or finance-oriented language and confusing terms that the everyday person doesn’t understand. As a result, it’s an intimidating topic. It’s no wonder that people use the terms blockchain, cryptocurrency, and even bitcoin interchangeably.

This article aims to make blockchain less intimidating, first by discussing what it is and how it works in simple terms before touching on what cryptocurrencies are and how they relate to the blockchain (particularly this bitcoin thing people keep talking about).

Read on for an easy-to-understand primer on the ins and outs of blockchain.

An all-purpose ledger for the 21st-century

Before we get into the technical nitty-gritty behind blockchain, like data blocks and peer-to-peer networks, it’s probably helpful to know what blockchain is actually used for and why it’s so significant. Maybe discussions surrounding blockchain are so confusing because the simple fact of it is that it’s kind of boring. There’s a need to jazz it up, make it a little sexier so that the everyday person thinks it’s a mysterious, mythical thing.

This is because blockchain is a digital ledger — albeit a distributed, decentralized, public ledger, but a ledger nonetheless.

If you are in any way familiar with accounting or have ever run a business, then you’ll know the importance of having a ledger that accurately records and summarizes your business transactions. Blockchain is the ultimate ledger because you don’t need to check and balance transactions and records for errors continually. The nature of blockchain means that transactions are immutable and timestamped, which means that records cannot be changed retroactively and that there is an audit trail for everything recorded. This brings a higher level of certainty and clarity regarding the ownership and history of financial assets.

So, at its heart, blockchain is an accounting technology. Perhaps this isn’t as widely known as it could be due to the ever-lingering stereotype of accountants being really boring (thanks, Monty Python), but accounting is still essential. And blockchain is a transparent and secure accounting technology that can be used for creating all manner of safe, decentralized applications. As such, it’s these days it’s actually being used for a lot more than just accounting, which we’ll touch on in a bit.

How Blockchain works?

As we’ve established, blockchain is a digital ledger of transactional records listed in chronological order. Each record is processed in a block. And each block is linked to the previous block, creating a chronological chain. AKA, a blockchain. Each block is encrypted using cryptography (the same technology behind SSL certificates) so that the data contained in the block can’t be altered retroactively nor the privacy of any user compromised.

A blockchain ledger is maintained by a decentralized, autonomous peer-to-peer network (a network of computer systems connected to each other via the Internet) rather than a centralized authority (such as a bank). Because of this, it’s considered a more democratic process as every computer on the network must work together to confirm a transaction.

Everyone on the network has access to the same ledger and collaborates in the approval of every block that is added to it, collectively verifying and authenticating it. If someone attempts to corrupt or alter a block, every participant of the network will be alerted, and it can be rectified quickly. Everyone on the network benefits from its betterment, so honesty is incentivized. This is why hacking attempts on public blockchain networks tend to be rare.

A good everyday comparison is a shared Google doc or spreadsheet. Every time someone makes a change to the doc, every person it’s shared with can access the version history to see what changes have been made. That’s as far as the comparison can go because it’s a lot more difficult to make changes to a blockchain.

Now let’s take a look at blockchain in action.

Blockchain in relation to cryptocurrency and bitcoin

We’ve discussed blockchain utilization at a macro level and how it’s a very cool kind of accounting technology. But what is it used for on a practical level? Well, it can be used for a lot of things. The media tends to focus on the digital currency side of things, but blockchain actually has myriad potential use cases, such as healthcare data management, construction workflows, and even food supply chain management.

To keep things concise, we’ll just be giving a quick rundown on what blockchain has become synonymous with over the last few years: cryptocurrency and bitcoin.

Cryptocurrency is a digital currency usually (but not always) based on blockchain technology. Much like regular currency, cryptocurrency can be exchanged for goods and services. Unlike regular currency, cryptocurrency is not issued by a centralized authority, which is why it’s considered to be immune to manipulation (at least on a government level).

Cryptocurrency based on blockchain technology appeals to people because it provides a decentralized means for people to directly and securely trade financial assets without interference or unexpected fees from an intermediary. When a transaction of cryptocurrency is made, a new, immutable block is added to the chain, as we discussed above.

Processing blocks is a complicated process known as mining that requires the use of powerful computers. Miners who add new blocks to a chain are incentivized with block rewards in the form of a certain amount of the currency they are mining. This is also how new coins are created.

Using bitcoin as an example, miners are rewarded with 6.25 bitcoins (BTC) per valid block mined. That might not sound like a lot, but the supply of bitcoins is finite, and the source code of the blockchain limits the number of bitcoins to ever exist at 21 million. Currently, there are just over 2 million bitcoins left to mine. Because of this limitation, the value of bitcoin is extremely high. Cryptocurrency, much like market stocks, attains value based on public perception, supply, and demand. Although there are upwards of 5,000 cryptocurrencies in circulation today, bitcoin is currently the largest and most valuable of all cryptocurrencies, valued at $56,494.01 per bitcoin by coindesk at the time of publication.

This has been a very simplified explanation of cryptocurrencies and bitcoin, but hopefully, it helps with understanding the utilization of blockchain.

Wrap up

While blockchain is a complicated topic, nobody should feel intimidated by it. At its core, it’s a robust and secure accounting technology with multiple potential applications, not least mining cryptocurrency.

Now that you’re better acquainted with blockchain and how it works, what it does, and why it’s so important, you’re well primed to learn about the role cryptography plays in all this.


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