Unless you have been living under a rock, you might probably have heard of the word “Blockchain” being spoken around recently. It seems to be one of the buzzwords of the year. But many people seem not to know what is blockchain or how does it work.
Imagine you and your friend are transacting/transferring money from one bank account to another. You would first reach the bank and ask them to transfer the money to the bank account of your friend.
Conventional process of a payment/receipt of money
On transferring the money from your bank account to your friend’s bank account, the banks keep an entry on the register of transactions (books of accounts). The entry needs to be updated on both, receiver and sender bank accounts. But there is one problem:
It is Tamper-able. Entries of transactions can be manipulated easily and changeable.
People who know how the banking system works are trying to avoid them because of this problem. This is where Blockchain comes in. Security does matter specially nowadays when hackers are getting smarter than the companies/banks.
What is Blockchain?
Let’s take an example of Google spreadsheet or MS Excel. This spreadsheet is shared among different networks of computer, where everyone has a copy of it. The spreadsheet contains information of the transactions committed by the real people.
Anyone can access that spreadsheet but no one can edit it.
This is where Blockchain distinguishes itself from the conventional system.
It works with Blocks, whereas spreadsheet works with “rows” and “columns”.
A block in a blockchain is a collection of data. The data is added to the block in blockchain, by connecting it with other blocks in chronological others creating a chain of blocks linked together. The first block in the Blockchain is called Genesis Block.
Blockchain is a distributed ledger, which simply means that a ledger is spread across the network among all peers in the network, and each peer holds a copy of the complete ledger.
Some key attributes which prove that blockchain is better than traditional system of ledger information keeping:
Peer-To-Peer: No central authority to control or manipulate it. All participants talk to each other directly. This allows for data exchange to be made directly without third-parties involvement.
Distributed: The ledger is spread across the whole network which makes tampering not so easy.
Cryptographically Secured: Cryptography is used for the security services to make the ledger tamper-proof .
Add-Only: Data can only be added in the blockchain with time-sequential order. This property implies that once data is added to the blockchain, it is almost impossible to change that data and can be considered practically immutable.
Consensus: This is the most critical attribute of all. This gives blockchain the ability to update the ledger via consensus. This is what gives it the power of decentralization. No central authority is in control of updating the ledger. Instead, any update made to the blockchain is validated against strict criteria defined by the blockchain protocol and added to the blockchain only after a consensus has been reached among all participating peers/nodes on the network.
Now the next question comes to mind, how does it really work?
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A node (computer) starts a transaction by first creating and then digitally signing it with its private key (created via cryptography) by the requester (transaction initiator). A transaction can represent various actions in a blockchain. Most commonly this is a data structure that represents transfer of value between users on the blockchain network. Transaction data structure usually consists of some logic of transfer of value, relevant rules, source and destination addresses, and other validation information.
A transaction is propagated (flooded) by using a flooding protocol, called Gossip protocol, to peers that validate the transaction based on a preset criteria. Usually, more than one node is required to verify the transaction.
Once the transaction is validated, it is included in a block, which is then propagated onto the network. At this point, the transaction is considered confirmed.
The newly-created block now becomes part of the ledger, and the next block links itself cryptographically back to this block. This link is a hash pointer. At this stage, the transaction gets its second confirmation and the block gets its first confirmation.
Transactions are then reconfirmed every time a new block is created. Usually, six confirmations in the a network are required to consider the transaction final.
ABOUT THE AUTHOR:
Imtiaz Ahmad is a young qualified Finance Professional from ICAEW & ACCA and an aspirant CEO with 14+ years of experience; worked for a diversified range of industries in Pakistan and Middle East. He is a seasoned Coach, Mentor and Teacher in Accountancy and Finance profession too. He has 500+ students who got qualified ACCA, CA and CMA to his credit in different countries around the globe.