I’ve heard a lot about blockchain, but how does it work ?
Some of you who have recently started trading crypto assets (virtual currencies) or have become interested in them may have questions like these.
Blockchain is a technology for recording and managing information that is used in many cryptocurrencies, including Bitcoin (BTC) . Beyond the boundaries of cryptocurrencies, blockchain has many possibilities, such as automating and streamlining various transactions.
Here we will explain the basics of blockchain, its advantages and disadvantages, and its potential.
What is Blockchain?
Simply put, blockchain is a technology for recording and managing information . It is called blockchain because it has a structure that collects a set of information and links it one after another like a chain.
In Japanese, it is also called ” distributed ledger technology .” To explain distributed ledger technology, a “ledger” is a record of monetary transactions, and “distribution” literally means storing the data in different places.
Typically, ledgers include accounting books, payroll ledgers, basic resident registers, and real estate registries, which are managed by specific organizations such as companies, local governments, and countries. On the other hand, blockchain does not have a specific administrator, and all or part of the ledger is shared, stored, and managed by all participants who handle crypto assets . This is a distributed ledger, and blockchain is a technology that clarifies and shares who wrote what information in the ledger, when, and stores and manages it in a way that makes it impossible to forge.
Four characteristics of blockchain
Blockchain, which incorporates a variety of cutting-edge technologies, is said to be an information management technology that is highly resistant to information tampering and hacking. In fact, the blockchain used in Bitcoin (BTC) , the world’s first cryptocurrency, has never been tampered with or hacked.
Here we will introduce four representative features of blockchain that demonstrate its high level of safety and convenience.
1. P2P (peer-to-peer) networks
Blockchains such as Bitcoin are said to be highly secure because they use a P2P network to manage information.
A P2P network is a system in which multiple nodes share information by distributing data . A node is a computer terminal connected to the network of a specific cryptocurrency, such as Bitcoin, and is also called a peer.
The meaning is the same as the “distributed ledger technology” introduced earlier, so it may be easier to understand if you think of P2P as the English name for distributed ledger technology.
A problem with conventional client-server systems is that if the server breaks down or goes down, the entire system stops.
However, when using a P2P network, data is distributed and managed by multiple computers , so even if one of the servers is taken down by a hacker attack, the whole system is not affected.
Even if your data files are lost due to a hacker, they can still be restored because they are stored on other servers. By distributing and storing data on many users’ computers, risk is also distributed rather than concentrated in one place.
In this way, blockchain, which adopts a P2P network, is a decentralized system in which users monitor each other, and has characteristics that differ from previous centralized systems.
2. Cryptography
Another reason why the Bitcoin blockchain is considered secure is that it uses encryption technology .
Encryption technology refers to the technology that converts the contents of data into a format that cannot be understood by a third party and then restores the converted data . Encryption technology is characterized by the use of two keys, a public key and a private key, to exchange data. The public key and private key are paired, and encrypted data cannot be decrypted without these two keys.
The public key is made public to third parties, but the encryption cannot be decrypted without the private key. Therefore, as long as the private key is not stolen, the security of the cryptocurrency is ensured, but on the other hand, it is important to manage the private key securely.
If your private key is accidentally handed over to a third party, your data may be leaked or your crypto assets may be stolen.
3. Proof of Work (PoW)
One of the reasons why the Bitcoin blockchain is considered secure is that it uses a consensus algorithm called Proof of Work (PoW).
Simply put, Pow refers to a transaction approval system . In the case of Bitcoin, in order to add a block to the blockchain, it is necessary to solve a very difficult calculation problem.
This calculation process (the process of approving transactions) is called mining , and the first person to succeed in mining is given Bitcoin as a reward. In order to be one of the first to succeed in mining, it is necessary to introduce a high-performance computer that can perform a huge amount of calculation work at high speed.
Therefore, it is now difficult for individuals to succeed in Bitcoin mining. Also, if you try to tamper with one block, you will need to tamper with the subsequent blocks as well, which takes a lot of time and effort to commit fraud.
This makes the Bitcoin blockchain extremely difficult to tamper with.
What is PoW for crypto assets? Introducing the mechanism, types, and representative examples
4. Smart Contracts
A smart contract is a mechanism that automatically executes the contents of a contract without human intervention . Because it uses blockchain technology, it meets two conditions: “The contents of the contract cannot be tampered with” and “The contents of the contract are executed automatically without the intervention of a central administrator.”
The greatest advantage of smart contracts is that they can automate the contract process without the need for a third party, thereby shortening transaction times and reducing labor costs .
However, smart contracts are not a feature implemented by all cryptocurrencies. The most well-known one is Ethereum (ETH). Various services have already been created by people who have noticed the potential of blockchain.
What is a smart contract? Explaining how it works and its relationship with Ethereum (ETH)!
Types of Blockchain
There are three main types of blockchain:
- Public type
- Private type
- Consortium type
Let’s take a look at the characteristics of each one in order.
Public type
A public blockchain is a blockchain that does not have a central administrator and is managed by an unspecified number of users .
It is characterized by the absence of intermediaries in transactions and transparent data being made publicly available on the Internet. For this reason, public blockchains are also sometimes called open blockchains.
Public blockchains are characterized by being extremely secure compared to other types of blockchains. On the other hand, they have the disadvantage that writing new information onto the blockchain requires a lot of processing and time.
Private type
Private blockchains are managed by individuals or individual organizations, and are characterized by the ease of changing rules and the fast speed of transaction approval . While they do not have the problem of “slow processing speed” that public blockchains have, they are characterized by low transparency.
In a private blockchain, information is not disclosed to the public, ensuring privacy, and data can be stored on the blockchain within a closed system. Due to these characteristics, private blockchains are expected to be used by general companies and financial institutions, and are also called permission-based blockchains.
Consortium type
A consortium blockchain is a blockchain that is managed by multiple organizations or groups . The consortium blockchain has intermediate properties between the public and private types in terms of decentralization, security, and processing speed. More specifically, the consortium blockchain is managed by multiple organizations or groups, not a single organization, so it has higher decentralization and security than the private type. On the other hand, unlike the public type, it has a limited number of participants, so it also has the fast processing speed of the private type. Due to these characteristics, the consortium blockchain is used in blockchains created by multiple companies in the same industry in cooperation with each other.
How transaction information is recorded
In blockchain, when a transaction occurs, that information is generated, verified, and recorded. Let us briefly explain this process.
Transaction: Generate transaction information
First, the work of generating transaction information, called a ” transaction ,” is carried out.
For example, person A generates a transaction to send 1 BTC to person B. When A signs it using a pre-registered private key, other nodes connected to the network will verify the contents.
If a problem is found, the transaction is discarded and no further processing takes place.
Mining: Data verification and recording
If there are no problems with the transaction, the transaction data is verified by the participants of the cryptocurrency exchange.
If there are no problems with the content of the data or the recording procedure, it is linked and recorded on the blockchain as a single block. This is a process called “mining,” and the people who verify it are called “miners.”
Miners receive a fixed amount of Bitcoin as a reward for their work. Only when mining is completed can the transfer of 1 BTC from person A to person B take place.
What is cryptocurrency mining? An explanation of how it works and how to practice it for beginners!
Three Benefits of Blockchain for Bitcoin (BTC)
The blockchain used in Bitcoin has three main advantages:
- 1. Extremely difficult to tamper with
- 2.Low management and operation costs
- 3. High stability of the entire system
1. Extremely difficult to tamper with
The first benefit is that it is extremely difficult to tamper with . We will briefly explain how the blockchain used in Bitcoin works.
A blockchain is a chain of data blocks, and the links in the chain are made up of special strings of characters called ” hash values .”
If the information in a block is tampered with, this hash value is rewritten to something completely different, and nodes around the world can immediately detect the tampering.
More importantly, each block contains the hash value of the block immediately preceding it. If the hash value of a block changes due to tampering, the next block in the chain must also be modified to match the rewritten hash value.
This is not a simple task of simply “replacing a string of characters,” but requires repeated advanced calculations. Even if you can do that, you still have to continue the process to get to the next block, and so on.
You can understand that this is a monumental task, and it is these properties of the blockchain that keep Bitcoin secure.
However, if the miners who check and verify records and connect blocks collude and acquire sufficient computing power to account for the majority of the total, various attacks on the blockchain are theoretically possible.
This is called a “51% attack,” but it is considered extremely difficult to carry out in reality.
2.Low management and operation costs
The second advantage is that management and operation costs are low . As already explained, data is stored and managed by multiple nodes in the blockchain.
Managing all of this centrally would be extremely costly. The server alone would require a significant amount of capacity, and the costs would be enormous if subsequent maintenance and management costs were also included.
However, if nodes around the world manage it in a decentralized manner, such costs would not be incurred. Information is stored and managed by everyone involved in Bitcoin, including everyday Bitcoin users, investors looking to make profits from cryptocurrency trading, and miners who create blocks and extend the chain, who contribute their computer power little by little.
This is a major benefit of decentralized management, which allows Bitcoin to keep transaction fees low.
This is particularly advantageous when transferring money overseas, as Bitcoin allows transactions with fees that are far lower than those charged by financial institutions.