Blockchain for Dummies: How Does it Work?

In this beginner’s guide to blockchain, you’ll learn everything you need to know about blockchain technology to start investing in cryptocurrencies.

Before you invest hundreds, or even thousands, of dollars into intangible assets such as cryptocurrencies, it’s vital to understand the technology behind them. Fortunately, while blockchain technology is complex, the concept is pretty straightforward.

What is Blockchain?

Blockchain technology is essentially a way of recording information in a decentralized way, for example a shared list of transactions, without any centralised authority in control. Blockchains consist of many blocks of data that are systemised in chronological order, with the blocks linked together through the power of cryptography. 

Blockchain in cryptocurrency

So what does it have to do with cryptocurrencies? Basically, a blockchain is a digital ledger, which can be thought of as just a very long logbook. In the case of cryptocurrencies, the ledger records transactions. 

These crypto transactions are distributed and duplicated across the entire network of computer systems on the blockchain, recording new transactions as they happen on each block in the chain.

How does Blockchain work?

When you buy bitcoin — let’s call your bitcoin, “bitcoin ABC” — an entry is made on the Bitcoin blockchain to reflect the fact that you now own this specific bitcoin. That’s ultimately all bitcoin is. Simply a digital entry in a distributed ledger.  

Every time the bitcoin changes hands, the transaction is recorded in this massive shared logbook. Every ten minutes a set of these recorded transactions is grouped into what’s known as a “block” and these blocks are linked in a chain through the power of encryption. Together they create a record going back to when the coin was first created.

So if a bitcoin is an entry in a logbook, the blockchain is the digital equivalent of a physical logbook, recording every transaction electronically.

Disadvantages of blockchain

Most people when learning how blockchain works might start doubting its security and reliability. Let’s talk about the blockchain’s drawbacks first.

Can Blockchain be hacked?

Could a hacker change the blockchain? Let’s say a hacker named John hacks into Bitcoin and seizes control of Bitcoin ABC which was sold by Liz to Peter. John changes the sale entry in the Bitcoin ledger to read “Liz owned this and sold it to John,”  instead of “Liz sold this to Peter.” This is called the “double spender problem”. This was a longstanding problem that prevented digital currency from existing without a centralized authority prior to the invention of Bitcoin. 

An attack of this kind is unfeasible for Bitcoin because of the amount of computing power that would be needed to fool the network. However, this has happened to smaller blockchains that are more vulnerable to attack. 

For example, an unofficial “fork” of Bitcoin known as “Bitcoin Gold” was hacked this way in 2018. But fear not, Bitcoin itself has never been hacked, and here at Xcoins, we only list cryptocurrencies that are respected worldwide, to ensure our customers are protected from this type of risk.

The double-spender problem is an issue because any currency —cryptocurrency included—only has value when it is scarce. Nothing has financial value if it exists in infinite amounts. 

This is why governments fight so hard against counterfeiters. As long as only the Treasury controls the printing press, they can keep the dollar scarce and therefore spendable.

Duplication problems

It is true that entire blockchains can be duplicated indefinitely. 

There’s nothing to stop our hacker John from copying the entire database over and over again and calling each new copy of the blockchain “Bitcoin Gold,” “Bitcoin Silver,” and so on.

This does indeed happen, that’s why there are tens of thousands of clones of Bitcoin and other cryptocurrencies. But unless our John can convince masses of people to start using their cloned blockchain their tokens remain worthless and Liz and Peter’s tokens remain just as valuable.

In fact, if someone were to clone the blockchain, or “fork” the chain, as it’s known, Liz and Peter could even stand to gain. On August 1st 2017, Bitcoin was “forked” into two chains, with a competing chain that had lower fees and faster transactions called Bitcoin Cash. All Bitcoin users who held Bitcoin before the fork got to keep their original bitcoin, and they also got free Bitcoin Cash! 

Advantages of Blockchain

There are many reasons why blockchain and all the activities that take place on it have been a success story. Let’s take a look at the key reasons behind this.

Blockchain nodes & public access

Each blockchain is monitored by a network of computers called “nodes.” Whenever you buy a bitcoin, that transaction is broadcast to the entire system for verification. 

The person selling the bitcoin provides a private key proving ownership and as long as that key matches the one on the blockchain, the network approves the transaction and records a new owner.

The important thing is all of this happens in public.

Every node on the network has a copy of the entire blockchain, which means that Liz’s ownership is recorded on hundreds, or even thousands, of individual hard drives. All of those nodes check and confirm each other’s work. If something goes wrong on one node, the rest of the network rejects the false information.

So hack away. You might succeed in hacking one computer, but there are copies of the entire blockchain on thousands of other computers that must all be in agreement all of the time. The corrupted ledger will simply be corrected.

Once again, think of the blockchain as a physical book. The blockchain works like a circle of accountants all sitting in one room watching each other. When one of them updates his ledger, every other accountant checks his work. If someone falsifies a record, every other accountant will catch the problem and correct it. It’s not enough to distract the accountant and falsify one book — you somehow have to divert every single accountant and falsify every book at the same time.

The blockchain is a public record of history. It tracks an asset back to the beginning and does so in full view. That’s what makes it work.

So, you can’t just copy a bitcoin over and over again because the database tracks every bitcoin back to when it was first created. You could copy that database all you want, but it’s still just a record of who currently owns Bitcoin at any given time.

Nor can you just create a new Bitcoin “DEF”, because each blockchain tracks every token’s existence back to when it was first created. So if a token appears to have sprung out of nowhere, the database will reflect that and you won’t be able to spend it.

Summary

For the first time in history, Bitcoin has made it possible that a currency can exist with no central authority in control. No one can ever alter the database and change it to say that you no longer own your Bitcoin. 

This is because a decentralised global network comprising of thousands of computers has a copy of this database. If you hack one computer to change the database, every other node will compare that ledger against its copy and reject the change.

That’s what blockchain is. The system is an encrypted, digital database edited and updated in public view. That’s what makes it work, and that’s what you’re buying into.

The blockchain revolution is only just beginning

Bitcoin was the first technology to harness the power of blockchain, but it will certainly not be the last. Bitcoin revolutionised how the world thinks about currency but the potential of blockchain goes far beyond currency. For example, Ethereum is using the power of blockchain to allow people to write decentralized software and even run entire decentralized organizations on the blockchain!

While blockchain and cryptocurrency are still technologies in their youth, blockchain has proven itself over recent years to be a truly revolutionary technology that is changing how the world is doing business. So go ahead and sign up for free to start buying bitcoins in a convenient and hassle-free way today! 

Frequently Asked Questions (FAQs)

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