Foundational Knowledge
Episode 2: How Cryptocurrency Works – Understanding the Blockchain
In the previous episode, we described cryptocurrency as digital money that is decentralised. But all research is meaningless if you can’t answer how cryptocurrency actually works and what makes it secure. The answer to these two questions lies with in the structure known as blockchain.
What is blockchain ?
A blockchain is a decentralised, digital ledger that records transactions across many computers, making the data transparent, secure, and nearly impossible to alter. You can envision it like a notebook. Anytime someone sends or receives a cryptocurrency, it is logged in the notebook. But unlike a notebook that is held in an office, this notebook is not just in one place, but it’s shared and copied across thousands of computers around the world. Each time there is a new transaction, each digital notebook is updated in real time.
Now imagine that the notebook has many pages. When a page of transactions is full, it is sealed in a way that cannot be changed, almost like it is permanently laminated. It is not even possible to accidentally change it. Each sealed page is called a “block”. After sealing the current block, we begin the next block and link it to the previous one, like a “chain”. Therefore, every page represents a block. This is why the process is called “blockchain”.
Decentralisation
In traditional banking, there is always some authority to approve or authorise transactions. In other words, you were never the direct holder of the money; the bank was.
But cryptocurrency is not sanctioned or governed by a central organisation. Instead, there are thousandsof computer networks all over the world that work together to verify and properly authorise transactions. This system is decentralised and considerably more difficult to manipulate.
If someone tried to change an entry on one page, it would not match with the copies held by everybody else. The system would immediately reject it. This demonstrates the strength of blockchain, which enables cryptocurrency transactions to occur without oversight from a central authority.
When you send Bitcoin (or another cryptocurrency), your transaction is combined with others that the network verifies and adds to the chain. Once verified, transactions cannot be changed nor deleted.
Security Through Transparency
All transactions are public on the blockchain. All users are identified, not by their names, but by their long cryptographic addresses, which contain both letters and numbers.
This is where the puzzle becomes somewhat more complicated. Each party on the network knows the movement of the funds, but they do not know any of the user’s actual personal details. This is a wonderful balance of protection and transparency.
In the next episode we will discuss the different kinds of cryptocurrencies and why each one is different.
