How Does Blockchain Work?

Blockchain technology is all about trust and transparency.

In the current model of commerce, we place “assumed trust” in companies that provide a product or service — and in the intermediaries that facilitate the exchange of value.

Take the simple act of purchasing a food item. We indirectly place our trust in every single vendor, business, and intermediary that participates in the farm-to-consumer ecosystem, including our credit card processor.

Trust in “the system” is not based on transparency. Blockchain can change that.

What if you could use your smartphone to scan the QR code on a food item to learn every single step of its production, starting at the farm, how it was processed, where it was stored, and how it was transported — all in a matter of seconds?

Variations of this scenario are already in works. Projects like IBM Food Trust are already providing blockchain solutions in the ‘Farm to Table’ space.

What is Blockchain?

In the conventional record keeping system, information is stored on centralized servers. All the computers connected to the server feed the data to the central server.

While distributed ledger technology (DLT) has historically tried to address this issue, the decentralization aspect of blockchain contributes to its popularity. We will discuss the characteristics of blockchain and DLT in a future blog.

In this ledger system, the records can be changed by anyone with access and authorization. This ability to change transactions after they have been recorded is a serious flaw in terms of maintaining trust for parties outside the organization. However, that’s how business has been done since recordkeeping began thousands of years ago.

That is where blockchain technology is different.

In the blockchain ledger model, transactions are stored in multiple computers that are connected to a network. Once a transaction is recorded and accepted by all the computers, it cannot be changed.

Every time a new entry is created, it is relayed to all the computers that are connected to the network, not to a centralized server. The entry will then be verified by the network using the consensus protocol built into the program. Once consensus is reached in the network, it is updated in all the computers and is sealed with a cryptographic signature, called Hash.

For simplicity sake, let’s assume our first entry’s hash is A1. In an actual blockchain ledger, this hash would be a system generated 32-character alphanumeric code, which is very difficult to break.

Any new record will reference its immediate previous transaction. In this case, the second entry will refer to the first entry’s hash (A1), and the system assigns a unique hash to the second transaction, let’s call that B1. For the purpose of our discussion, let’s say, we created 10 records with a hash of A1, B1, C1, D1, E1, and so on until J1, respectively (see Fig 1).

Each transaction verified and accepted by the network creates a block (block of information) and the linking of subsequent blocks to the previous one, cryptographically, creates a metaphorical chain. Hence the name, blockchain.

Here is where things get interesting.

If someone tries to change the 3^rd record with hash C1, the chain linking all subsequent blocks, that is D1 thru J1 in our example, will throw an error since they no longer match with the copies of ledgers in the other computers connected to the network.

If a change is valid, instead of changing the original entry (block), a new block is created. Say, for example, someone changes the 3^rd entry with hash C1, using the consensus protocol native to the blockchain technology in use, if a majority (51%) of the computers connected to the network confirm that the changes are valid, then a new block is created.

In our example, we already had 10 blocks in place, and the last block has a hash of J1. The new block that represents the change to an existing record will be created and will then reference to J1 to continue the block sequence.

A change to record results in an additional record instead of replacing the old record, thus retaining the transparency.

This is an amazing functionality. The original entry and subsequent changes remain perpetual in it their original form. This removes the ability to commit fraud (Fig 2 above).

When a change is made in the conventional method of record keeping (such as the third entry below) what you are left with is updated entry number 3 (Fig 3). This impacts the integrity of the data and throws into question its provenance.

Translating Blockchain Jargon

Now that you’ve acquired a basic understanding of how blockchain works and how it’s different from traditional record keeping models, let’s explore the jargon associated with a blockchain ledger system.

Computers connected to the network are called nodes, and each node has a copy of the entire database or blockchain ledger. Nodes provide the computing power to keep blockchain running. Most blockchains have their own native currency, in the form of cryptocurrency that acts as fuel/reward to the nodes that contribute the computing power. A classic example would be Ethereum Blockchain and Ether, its native cryptocurrency.

Because each node has the entire copy of the database, this model is often referred to as decentralized ledger system.

Databases stored on the nodes are updated and tallied using a code within the program called consensus protocol.

Each record accepted, verified and stored in this distributed ledger forms a block.

These blocks are made permanent by a cryptographic signature called a hash, which is a long string of unique alphanumeric code assigned to the block.

Every new block references the hash of the previous block, linking them — hence the name blockchain.

The program that connects these nodes and executes the consensus protocol is the blockchain technology itself.

A Blockchain Use Case: Counterfeiting

In the current centralized record keeping system, consumers who are outside the organization do not know how many units of a particular product are produced. This leads to the opportunity for counterfeiting. Even though there are only 500 units produced for sale, one could sell counterfeit products claiming them to be part of this 500-unit production.

Consumers have no way to verify the authenticity of the product.

When such counterfeiting happens for luxury items like expensive sunglasses, it may not matter as much as counterfeiting of health-related products. It is estimated that one out of ten drugs is fake.

If these products had RFID or QR codes attached to them, and the information was traceable using blockchain technology, then counterfeit sales could potentially be eliminated.

The immutability of blockchain technology permits innovative anti-cloning and anti-reuse protection in real time. In the not so distant future, consumers could be alerted when someone tries to sell a product with cloned or fake identification.

As Mark Toohey, explained in The Australian Business Review “In the case of pharmaceuticals, consumers would be able to trace the origin of every pill.”

If and when blockchain’s potential is realized, we could see a world where trust and transparency are no longer assumed, they are verified.

Summary

Blockchain technology is all about trust and transparency.

The current model of commerce is based on “assumed trust.”

In the blockchain ledger model, transactions are stored in multiple computers that are connected to a network. Once a transaction is recorded and accepted by all the computers, it cannot be changed.

Any accepted change to record results in an additional record instead of replacing the old record, thus retaining the transparency.

Each record is a block, and when multiple records are linked together, they form a blockchain.