How Does it Work?

Blockchain technology is an advanced database mechanism that enables the open exchange of information within a business network. A blockchain database stores data in blocks linked together in a chain. The data is chronologically consistent because the chain cannot be deleted or changed without consensus from the network. As a result, you can use blockchain technology to create an immutable or indefinite registry to track orders, payments, invoices and other transactions. The system has built-in mechanisms that prevent unauthorized entry of transactions and create consistency in the overall view of those transactions.

What is the importance of blockchain technology?

Traditional database technology poses a number of challenges in accounting for financial transactions. Consider the example of a real estate sale. Once money is transferred, ownership passes to the buyer. Both the buyer and the seller can record their own money transactions, but neither party can be trusted. After receiving the money, the seller can easily claim that he did not receive it, and the buyer can claim that the money was sent, even though it was not.

To avoid potential legal problems, a trusted third party must monitor and validate transactions. The presence of this central authority not only complicates the transaction, but also creates a single point of vulnerability. Both parties will suffer from breaches in the central database.

Blockchain anticipates such problems by creating a decentralized, tamper-proof system for recording transactions. In the case of a real estate transaction, blockchain creates a single registry for the buyer and seller. All transactions must be approved by both parties and automatically updated in their registries in real time. Any discrepancy in transaction history will be reflected in the entire registry. These properties of blockchain technology have made it popular in various sectors. For example, they were used in the creation of the digital currency Bitcoin.

What are the capabilities of the blockchain technology?

Here are the main features of blockchain technology:

Decentralization

Decentralization in blockchain refers to the transfer of control and decision-making from a centralized entity (individual, organization, or group) to a distributed network. The transparency of a decentralized blockchain allows participants to level trust in each other. These networks constrain their power or control over each other, which preserves the functionality of the network.

Immutability

Immutability means that data cannot be changed. No participant can interfere with a transaction once it has been entered into the registry. If a record contains an error, a new transaction must be added to correct it. Both transactions will be displayed on the network.

Consensus

The blockchain system establishes a set of rules by which participants approve transactions. New transactions can only be recorded with the consent of a majority of network participants.

How does blockchain work?

Below is a brief overview of the complex mechanism of blockchain. Blockchain software automates most of the procedure:

Step 1: Record the transaction

A blockchain transaction reflects the movement of physical or digital assets from one party to another in a blockchain network. It is recorded as a block of data and may include the following information:

Who was involved in the transaction? What happened during the transaction? When was the transaction conducted? Where was the transaction conducted? What were the reasons for the transaction? How many assets were transferred? How many preconditions were met during the transaction?

Step 2: Reaching Consensus

Most participants in a distributed blockchain network must confirm that the recorded transaction is valid. Depending on the type of network, the rules of agreement may vary, but they are usually established at the beginning of the procedure.

Step 3: Blockchain Binding

When participants reach consensus, transactions in the blockchain are written into blocks equivalent to registry pages. Along with the transactions, a cryptographic hash is added to the new block. The hash acts as a chain linking the blocks together. If the content of a block is changed intentionally or accidentally, the value of the hash also changes, which helps detect data tampering.

In this way, blocks and chains are securely linked and cannot be edited. Each additional block strengthens the validation of the previous block and, therefore, the entire blockchain. This principle is similar to building a tower of wooden blocks. Blocks can only be stacked on top, and if you remove one block from the middle, the whole tower collapses.

Step 4: Share the Registry

The system distributes the latest copy of the central registry to all participants.

What types of blockchain networks exist?

There are four basic types of decentralized or distributed networks in blockchain:
Public blockchain.

Public blockchains do not require permissions and allow anyone to join the network. All blockchain participants have equal rights to read, edit, and verify information. Public blockchains are mostly used to exchange and mine cryptocurrencies such as Bitcoin, Ethereum and Litecoin.

Private blockchain

Private blockchains, which can also be called managed, are controlled by a single entity. An authorized body determines who can be a participant and what rights they have on the network. Private blockchains are only partially decentralized because they include access restrictions. An example of a private blockchain is Ripple, a digital currency exchange platform.

Hybrid blockchain

Hybrid blockchain combines the functions of both private and public networks. Companies can create both private and public permission systems. In this way, they control access to certain data on the blockchain, but also maintain public access to other data. They use smart contracts that allow public participants to authenticate private transactions. For example, hybrid blockchains can provide public access to digital currency while maintaining private access to bank currency.

Blockchain Consortia

Blockchain consortia are run by a group of organizations. Pre-selected organizations share responsibility for operating the blockchain and defining data access rights. Blockchain consortia are often preferred by like-minded companies that benefit from shared responsibility. For example, the Global Shipping Business Network is a nonprofit blockchain consortium focused on digitalizing the shipping industry and enhancing cooperation among shipping operators.