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Blockchain part Two: How it actually works

Saša Ivičević, Director of Software Engineering

In first part of this blog series, I outlined some fundamental concepts pertaining to blockchain technology. Now I would like to dive deeper into how Blockchain actually works and see the inner workings of the technology itself.

Let’s start with trust: all interactions on a blockchain consists of some element of trust. If one is to interact on the blockchain, all parties will have to agree. If the parties cannot trust one another, then there needs to be a neutral authority that oversees the transaction and if necessary, will mediate between the parties to achieve a mutual agreement.  Just think of Lawyers, Banks, Government officials and how they should represent the interests of their clients and citizens when thinking about the role of a mediator. All these institutions have a fiduciary duty to keep some sort of records concerning any sort of agreement or transaction that will happen or has occurred. These records in the blockchain world are called ledgers.

Ledgers are a form of storing information and thus have a variety of applications. For example, ledgers are used for property records, such as when alterations were made, or the house was sold or inherited. With ledgers, we keep historical records for a certain property and organize information in the land registry. Even money that is circulated is identified in a ledger system. Every bill has a serial number that is recorded by the bank. Other applications of ledger systems include social security numbers or TIN, our cars have VIN numbers and license plates. All that data is stored in a central database. This is what makes information verifiable and accurate so that trust can be maintained between two or more parties. The current structure has data centralized under a single authority while blockchain makes ledgers public to make it verifiable.

When we talk about validity a great example is bookkeeping. Accountants use ledgers in bookkeeping to record and keep track of assets, liabilities, and equity during a certain period (usually a per quarter, per month or per annum period). The most reliable method in Bookkeeping is double-entry accounting. This is because single-entry accounting lacks transparency and accountability. Despite double-entry accounting being stronger than single-entry accounting, it still has its issues namely entries are accounted for separately, making it difficult for one party to verify the other party’s records. An even greater issue is, records using traditional ledgers are also easy to tamper with, meaning you can easily edit, remove, or add a record. As a result, unless you know the people handling the books, regardless of human error, it is not guaranteed that the information in any ledger is 100% accurate.

As trust is hard to guarantee in these transactions, Blockchain technology can guarantee trust and solve the above forementioned issues. Blockchain is a technology that can augment the traditional bookkeeping model by decentralizing bookkeeping meaning that accountability is given to multiple parties, not just one person. Blockchain allows all parties to keeps records of transactions. We mentioned peer-to-peer or P2P network in first part of this blog series . Blockchain relies on a P2P network so that everybody can hold ledger records.

An additional benefit of blockchain is that all transaction is encrypted meaning all transactions are secure transactions. Everybody can hold information or ledger records, even those with malicious intentions. By securing transactions, we protect not only data that is transferred but also the reliability of records, or as we call records in the blockchain world- blocks on the blockchain.

By placing transactions on a blockchain, parties are ensuring through a distributed consensus mechanism that their transactions are safe meaning trust is ensured between the two transacting parties. The consensus mechanism also ensures that new blocks get added to any blockchain is verified by all parties. This is known as Proof of Work (PoW) or often referred to as mining.

This is a very simple example of how blockchain works but I hope this gives you an overview and lays the foundation to understand how blockchain works. In the next part of this series, we will discuss the different types of blockchain.

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