Blockchain: How It Works (Part 1)

There has been lots of talk about blockchain recently. But I have a feeling only a few people fully understand what it is.

Blockchain’s founding principles are simple enough to comprehend, yet the trouble that many financial bodies have – it seems – is the terminology. Buzzwords are thrown about, sometimes in the definitive form, to describe an entity that is still developing. In part one of this blog I will breakdown some key points to the blockchain and provide an overview of its history.

Blockchain has many applications. It is a peer-to-peer system of running a currency and can be used to cut the cost of international money transfers or service high value and low value transactions.

It is a diverse tool and has the potential to change the financial industry in the same way mobile phones and email continues to reshape communication.

In 2008 Satoshi Nakamoto, a pseudonym for a mystery person or indeed group of people, introduced the world to bitcoin and its decentralised infrastructure system.  It has gained widespread attention due to its affiliation with the Dark Web’s go-to black market, Silk Road. Even though this network has since closed down, its existence meant that people were in need of payment system that allowed some form of currency to be transferred across vast geographic distances and between strangers.

Research by Innovalue and Lorde Locke, a strategic management and financial technology advisory firm, describe the reliance of “trusted third parties such as a card schemes” as instrumental to the payment infrastructure. Yet blockchain, the report states, replaces traditional middle figures by “providing a distributed ledger of verified transactions of a particular unit.”

The ledger essentially takes note of every transaction made on the blockchain. Within this context, information regarding the transaction is transferred in ‘blocks’ to the ‘chain’ and between members of the community. Entries in the ledger can be seen by all participants and are added in chronological order.

There are two more constructs that underpin the blockchain: cryptography and open source software.

Cryptography safeguard’s and organises the blockchain. It is the use of code to send messages to a specific person. Similarly, open software instils the public and shareable element of the technology.

Since blockchain’s inception and its subsequent mainstream popularity, the basic premise – a decentralised network – has been manipulated by fin-tech developers with radically different purpose in comparison to the bitcoin world. This has resulted in blockchain amalgamation, whereby centralised networks can exist within a decentralised blockchain (which is the distributed ledger).

In my next blockchain blog post, I will write about the distributive ledger, centralised and decentralised networks.