Blockchain technology promises to change everything from money to contracts. But how does it actually work?
There’s no shortage of information out there—but unfortunately, most explanations are confusing, incomplete, and leave you with more questions than answers.
This article explains how blockchain works in terms so simple you’ll be able to explain it to a child.
How blockchain works
Blockchain is a way of recording information where each piece of information (“block”) is connected (“chained”) to the one before it.
It’s an exciting technology because it allows information to be recorded in a way that is:
- Independently verifiable
- Subsequently unchangeable
At least in theory, information recorded in a blockchain is always true and always safe.
Here’s how—illustrated with a simple story about the first colony on the moon.
The first colony on the moon
Bob Wentz is the founder of the History Corporation, a company whose mission is to record an accurate history of the first mining colony on the moon.
Every day, Bob’s team of 100 historians observe what’s going on in the colony and then write a report. This report is added to a master document, Moon Base One: A Complete History.
But Bob has a problem—he can’t have 100 versions of each day’s report, so he needs a way for his historians to agree on one accurate version before it’s recorded.
He also needs a way to make sure that once a report is recorded, it can’t be changed.
After some thought, Bob comes up with a brilliant solution:
Instead of using Microsoft Word, Bob designs his own word processing program to store Moon Base One. He names it My Amazing Recordkeeping System (MARS), and installs it on each historian’s computer.
MARS is different than other word processors. To save each report, you have to do two things:
- Enter a code from the previous report
- Guess a random three-letter password for the current report (it sounds odd, but keep reading)
At the end of each day, historians type up their reports and then try to guess the password for that report.
When one historian guesses the password that works for his report, he shares both the report and the password with all the other historians.
If they all agree his report is accurate, they add it to their copy of Moon Base One and save it with the password.
Once the report is saved, MARS generates a random code of letters and numbers to use with the next report.
The MARS word processor solves Bob’s two problems.
- First, it makes sure that a report can’t be added to Moon Base One unless all his historians agree that it’s accurate.
- Second, it makes sure that once a report is saved, it is almost impossible to change.
If a hacker tried to change a report in Moon Base One, he would have to redo all the work of typing up each report and then guessing a password before he could recreate the next one.
This takes time, and the hacker would never catch up with Bob’s 100 historians, who have kept adding new reports in the meantime. The hacker’s altered copy of Moon Base One would never be up-to-date.
As a result, Bob can be sure that the most up-to-date version of Moon Base One is always the right one.
Pretty ingenious, right?
There are four key components to any blockchain:
- Cryptographic hash
- Immutable ledger
- Peer-to-peer network
- Consensus protocol
These four elements are what enable blockchains to record information in a way that’s independently verifiable and unchangeable.
Cryptographic hash (the MARS word processing program)
A cryptographic hash is a special type of function that converts information of any size into a small, fixed-size string of random letters and numbers—the hash code.
The conversion only works one way, and the same data always results in the same hash code. This means hash codes are nearly impossible to decipher but easy to verify.
In the story, the MARS word processing program works like a cryptographic hash. It converts each saved report into a code of random letters and numbers that is used to save the next report. This links the reports together.
Immutable ledger (Moon Base One: A Complete History)
The immutable ledger is a digital record that can be added to but not changed. It is the blockchain.
The blocks in a blockchain are linked together with hash codes. Each new block includes the hash code of the previous block, along with the new information that is being added to the blockchain.
As a result, it is impossible to change one block without changing every block that comes after it.
Peer-to-peer network (the historians)
A P2P network is a group of computers that share data—in this case, the ledger. Just like each historian has his own copy of the document Moon Base One, every computer has its own copy of the ledger.
P2P networks keep information safe by decentralizing it. If one historian lost his copy of Moon Base One, the rest of the group would still have theirs.
P2P networks also allow for fast, independent verification of data. If a new historian showed up with a different version of Moon Base One, it would be very easy to compare his copy against the 100 other copies.
Consensus protocol (guessing the password)
A consensus protocol is a method that members of the network use to reach an agreement on the validity of new blocks.
In order to add a new report (block) to Moon Base One (the blockchain), a historian has to guess the correct password for his report, then share both the report and password.
The other historians must agree that the report is accurate, or they won’t add it to their copy of Moon Base One.
What does blockchain mean for business?
Blockchain is an innovative technology with a lot of potential, and the business world is rushing to apply it to a host of new products—from Spotify alternative Choon to digital currencies with names like Dentacoin (it’s just for dentists).
But blockchain initiatives aren’t limited to startups. Many established companies—from IBM to online retailer Overstock.com—have announced new blockchain projects.
Learning how blockchain works is the first step towards understanding what this new technology means for your business.