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What is blockchain and how does it work?
Blockchain is the technology behind Bitcoin, Ethereum and thousands of cryptocurrencies. Understand how this distributed ledger system works, why it matters for crypto investing and where blockchain technology is heading.
What is a blockchain?
Blockchain technology was invented in 2009 by Satoshi Nakamoto – the pseudonym used by the mysterious person (or group) who created Bitcoin. Since its inception, blockchain has become the foundational technology underpinning cryptocurrencies including Bitcoin, Ether, Litecoin and thousands of others.
A blockchain is a data record that is distributed across a network of computers, meaning there is no single point of failure.
What makes it unique is that there is no central authority in charge of the blockchain file or the data it contains. Instead, each computer keeps its own copy of the file, and any update requires the approval of a majority of machines in the network.
The blockchain is made up of 'blocks', which each contain a section of data. The most recent data is always added at the top of the chain, while the oldest sits at the bottom in what is known as the 'genesis block'.
The blocks are linked together by cryptography (complex mathematics), which is how the chain is formed. The mathematics involved means that any change to existing data breaks the chain, so any attempted changes can be detected and rejected by the network.
How does blockchain technology work?
The key to understanding blockchain technology is understanding the structure of the blockchain, how new blocks are added and how conflicts are resolved.
The structure of blockchain
Each block in the chain contains some data and a 'hash' – a digital fingerprint that is generated from the data contained within the block using cryptography.
Every block also includes the hash from the previous block. This becomes part of the data set used to create the newer block's hash, which is how the chain is linked together.
Even the smallest of changes to a block's data will invalidate its hash and the hashes of any blocks that follow, which alerts the network to any attempted changes. This helps to keep the blockchain secure.
How new blocks are added
Because blockchain files are distributed across a network of computers (nodes), updating the file is not simple – new blocks must be approved by a majority of machines in the network.
Computers compete with each other to create new blocks in a process known as 'mining'. This involves collating new data into a block, along with the hash of the previous block and attempting to generate a new hash.
This competition can be run in two ways:
Proof of work
Under this system, all the computers in the network compete to create the hash. The difficulty of generating hashes is adjusted as the network expands, so that new blocks are created and approved at a constant rate as the computing power in the network changes. The difficulty of generating Bitcoin hashes, for example, is adjusted by changing the number of zeroes they must start with, ensuring that a new hash is found only once every ten minutes or so by the entire network.
Proof of stake
Under this system, nodes are selected via a lottery that takes their 'stake' in the system into account. This is usually how much of a cryptocurrency they own, with this stake held in the system to demonstrate that the node has a vested interest in the reliability of the blockchain. This system was created to deal with some inherent problems with the proof of work method, particularly high energy usage. Ethereum transitioned from proof of work to proof of stake in 2022.
Once a computer has generated a hash, it adds the block to its version of the blockchain file and broadcasts the update across the network. The maths involved means that hashes are difficult to generate, but easy for other computers to verify. Consensus is achieved when a majority of computers have verified the new block and updated their copy of the blockchain file.
The computer that mined the block is then rewarded, for example with some freshly mined cryptocurrency tokens (such as bitcoins) or transaction fees.
What are bitcoin forks and how do they work?
Very occasionally, two correct hashes are generated by different computers at the same time, creating two blocks. When this happens, competing versions of the blockchain can exist temporarily. This is called a 'fork' because there are two potential paths the blockchain could take.
Forks are generally resolved quickly, because one chain will become longer as additional blocks are added. The blockchain then continues along the longest fork. Any data contained within the 'orphaned block' (on the rejected fork) will be added back to the pending queue to be reprocessed.
For this reason, a block should not usually be considered to be a definitive part of the blockchain until several blocks have been mined on top of it. Bitcoin transactions, for example, are not usually considered final until at least six blocks have been confirmed.
Updating the blockchain: hard forks vs soft forks
Just as updating the blockchain file is not simple, any proposed update to the underlying protocol (the software's code) must be carefully managed. There are two ways to update the software:
Soft fork
This is a backwards compatible software update, meaning that users are not required to run the update to maintain access to the network. A soft fork is considered complete once a majority of users have updated their software.
Hard fork
This is a more radical change, where users are required to update their software to maintain access to the network. It can happen when a network cannot reach consensus on an update, causing a minority group to break away to implement it on a separate blockchain. Both blockchain files will be identical until the point of the split, but be completely separate thereafter.
What can blockchain technology be used for?
For cryptocurrencies like Bitcoin, the blockchain is used to store transaction data. But a blockchain can be used to store any type of digital data (for example, documents, photos or computer code) or to manage permissions. This makes the technology very versatile and means the potential applications are practically limitless.
1. Cryptocurrency and digital payments
Blockchain enables peer-to-peer value transfer without intermediaries. Bitcoin, Ethereum and thousands of other cryptocurrencies use blockchain to record ownership and facilitate transactions globally, 24/7, often with lower fees than traditional financial systems.
2. Smart contracts and decentralised applications
Blockchain technology could be used to create new secure systems. For example, the Ethereum network allows users to build decentralised software applications on the blockchain and add 'smart contracts'. These contracts are written as lines of code and automatically enforce their clauses when predetermined conditions are met. This technology enables decentralised applications (dApps) that operate without central control, covering everything from decentralised finance (DeFi) to gaming.
3. Supply chain management
Blockchain technology could be used to track products from manufacture to delivery, creating transparent or verifiable supply chains. This application helps verify product authenticity, ensure ethical sourcing and quickly identify contamination sources in food safety incidents.
4. Digital identity and voting systems
Blockchain technology could be used to create new secure systems to record votes in an election, act as an unalterable archive or keep track of intellectual property rights. Some networks are exploring blockchain-based voting to increase election security and transparency while reducing fraud.
5. Healthcare and document management
Blockchain could be used to ensure citizens pay their taxes, manage healthcare records securely or store any form of official documents. Medical records on blockchain could give patients control over their health data while ensuring information remains accurate and accessible to authorised providers.
Advantages and disadvantages of blockchain
| Advantages | Disadvantages |
| Enhanced security through distributed networks and cryptographic protection | Scalability issues, with many blockchains struggling to process transactions as quickly as traditional systems |
| Reduced costs by removing intermediaries from transactions | High energy consumption, particularly with proof of work blockchains |
| Faster transactions that operate 24/7 without geographic limitations | Regulatory uncertainty as governments determine how to regulate blockchain applications |
| Increased transparency with complete transaction visibility | Irreversibility of transactions, meaning mistakes cannot be easily undone |
| Improved traceability through permanent, chronological records | Technical complexity that requires specialized knowledge |
The future of blockchain technology in crypto
Blockchain technology continues evolving to address cryptocurrency's most pressing challenges. Developers are implementing scaling solutions like layer-2 networks to process crypto transactions more efficiently, transitioning to energy-efficient consensus mechanisms that reduce environmental impact, and building bridges that enable seamless movement of digital assets between different blockchain networks.
The cryptocurrency landscape is maturing as traditional financial institutions integrate blockchain-based digital assets into their offerings. From crypto custody services at major banks to central bank digital currencies (CBDCs) in development worldwide, the infrastructure supporting cryptocurrency is becoming more robust and regulated. These developments could make crypto trading and investment more accessible to mainstream users.
For crypto traders and investors, understanding blockchain's evolution is essential to evaluating new cryptocurrencies, assessing network upgrades and identifying emerging opportunities in the digital asset space. As the technology advances and regulatory frameworks develop, blockchain's role in reshaping how we store value and conduct transactions continues to expand.
FAQs about blockchain technology
Is blockchain the same as Bitcoin?
No, blockchain and Bitcoin are not the same thing. Blockchain is the underlying technology – a distributed digital ledger system. Bitcoin is a cryptocurrency that uses blockchain technology to record transactions. Think of blockchain as the engine and Bitcoin as one type of vehicle that uses that engine. Many other cryptocurrencies and applications also use blockchain technology.
Can blockchain be hacked?
While blockchain technology is highly secure due to its distributed nature and cryptographic protection, no system is completely immune to attacks. The decentralised structure makes it extremely difficult to hack because an attacker would need to control the majority of computers in the network simultaneously. However, individual users' wallets or cryptocurrency exchanges can be vulnerable to hacking if proper security measures aren't followed.
Who controls the blockchain?
No single person, company or government controls public blockchains like Bitcoin or Ethereum. Instead, control is distributed across all participants in the network. Decisions about updates and changes are typically made through consensus mechanisms where the majority of network participants must agree. Private blockchains, however, can be controlled by specific organisations.
What's the difference between public and private blockchains?
Public blockchains are open to anyone – anyone can join the network, validate transactions and view the blockchain's history. Bitcoin and Ethereum are examples of public blockchains. Private blockchains restrict access to approved participants only and are typically used by businesses for internal processes. Private blockchains offer more control and privacy but sacrifice some of the decentralisation benefits that make public blockchains unique.
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