When Bitcoin was launched in January 2009, it became popular shortly afterwards. A lot of people began to use Bitcoin and other cryptocurrencies for monetary transactions. Some people, who were not totally convinced about the future of cryptocurrencies, viewed them as tradable commodities.
They invested (bought) in Bitcoin and other cryptocurrencies with the hope that their value will head northward in the near future and they were duly rewarded. By the end of 2013, the value of one Bitcoin had reached the US $20,000 and investors in Bitcoin had made millions of dollars of profits.
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The reason cryptocurrencies became instantly popular is that they are: decentralized, accurate, secure, versatile, not prone to inflation, fast, and adaptable to administrative and financial changes. Cryptocurrencies work by means of blockchain technology.
So, what exactly is Blockchain technology and how does it work? Let’s have a look below.
How does Blockchain Work?
A blockchain is a series of data blocks linked together via their serial number or Hash. This concept was originally invented in 1991 to timestamp documents to prevent their fraudulent manipulation. A data block consists of the following parts:
- Serial number of the current block
- Serial number of the previous block
This part consists of information like the public key (network identity) of the money sender, the public key of the money receiver, and the amount of cryptocurrency transferred.
2) Serial number of the current block:
It is also known as the Hash of the current block. It is a unique alphanumeric code (like a fingerprint) that identifies the block in the blockchain network.
An interesting feature of the Hash is that if the data inside the block changes (which is very rare), the Hash of that block changes too. In other words, it has a totally different identity now and is no longer the same block. Hashes are useful in detecting changes (hacking) in the blockchain network.
3) Serial number of the previous block:
This is the unique Hash of the previous block. It helps to locate the current block in the blockchain network. The first block in a blockchain network has no pointers (hash) to any previous blocks and is therefore called a ‘Genesis Block’.
If the hash of a block changes (as a result of data change), it will make all of its following blocks invalid. To make them valid again, the previous hashes inside the following blocks have to be changed accordingly.
Previously, we had discussed that if the data in a data block is changed, its hash also gets changed automatically and a change in a data block’s hash will make the subsequent data blocks invalid.
We also saw that to make the subsequent data blocks valid again, we have to change their previous hashes accordingly. Assuming this change happens in a blockchain network, how do we know if it’s a legal change (authorized change) or not (hacked manipulation)?
1) Digital sign as a proof of change
Any changes to the data in a data block will be approved only if the money sender signs it digitally. If it’s not signed digitally, then the changes to the data will not be affected.
The digital signature for the data changes is given when the money sender logs into the blockchain network via his ‘Private Key’ and manipulates the transaction data himself.
The digital signature for the data changes is generated by a very complex computer algorithm known as ‘Cryptographic Hash Function’. It takes the data changes made as to its input line and converts it into a 64-bit output line (digital sign).
This technique helps in determining whether the changes made in a blockchain network are genuine or not.
2) Creation of a new Data Block
Creating a new data block (registering a new user) or manipulating an existing data block in a blockchain network is not easy. The verification/authentication of a new data block (new user) takes about ten minutes! This is a fool-proof way to ensure that only genuine users (and not hackers) are added to a blockchain network.
The verification of a new data block in a blockchain network is also called ‘Proof of Work’. Every user (computer/node) in a blockchain network is given a copy of the users and transactions happening in that blockchain network.
This helps a node in a blockchain network keep track of the changes happening in that blockchain network. It also helps in authenticating the changes happening in a blockchain network.
When a new data block is added to a blockchain network, the hashes and the data of the new data block are sent to all the nodes in that network.
Only if all the nodes in that blockchain network receive the same hashes and data of the new data block, it is officially added to the blockchain network. This process is called ‘Group Authentication’.
Blockchain and cryptocurrencies are constantly evolving technologies. The most recent development in the cryptocurrency domain is a new facility called ‘Smart Contract’. It enables the buying and selling and exchange of cryptocurrencies via a cryptocurrency exchange website.
The major drawback with cryptocurrencies is that one needs an internet connection to use them, one needs to be literate in order to register oneself on a cryptocurrency exchange website and transact in cryptocurrencies, and one needs to understand the value of all the sub-denominations (usually around 10) in a cryptocurrency to use the cryptocurrency well.
Cryptocurrencies may replace traditional currencies and banking systems in the future or they may be abolished altogether. So one needs to be careful before investing in cryptocurrencies.
The value of one Bitcoin declined by over 50% during June 2014. That incident demonstrated the volatility and uncertain future of cryptocurrencies. So, please be careful before investing in cryptocurrencies.
What is a blockchain system?
A blockchain system includes all the details of a blockchain network like its algorithms, its cryptographic functions, its network details, etcetera.
What are the blockchain applications?
A blockchain application is a cryptocurrency that employs a feasible blockchain technique.
What is the main advantage of cryptocurrencies?
Users do transactions on cryptocurrencies anonymously. This feature provides users with a great deal of security and privacy. But it also enables terrorist organizations and terrorists to send and receive cryptocurrencies for criminal activities. This security chink must be addressed soon.
What is Decentralized Finance?
No person or committee or organization is in charge of generating and distributing (mining) cryptocurrencies. It is done by complicated computer algorithms. Since cryptocurrencies are not controlled by a central agency or a person. They are also known as Decentralized Finance (Defi).