logo academy

The meaning of blockchain: what it is and how it works

May 22, 2023

11 min

The meaning of blockchain: what it is and how it works

What is blockchain, what is the meaning of the term and how does it work? These are the most frequently asked questions when talking about this now fundamental new technology. It opens the way to so many applications and solutions that stimulate technological progress, and today its fields of use are manifold. Find out in this comprehensive guide what blockchain is, the real meaning of the term and how the technology works

What is blockchain: the meaning explained

Let us try to define in simple terms what blockchain is and how it works.

Starting from the word itself, we can define it as a c’hain of blocks’ on which data and transactions are recorded in a decentralised and distributed but also secure manner. Down to the bone, in fact, it is nothing more than a decentralised data structure.

However, it may be even simpler to clarify the meaning of blockchain according to its primary purpose, i.e. as a payment system.

We can therefore define it as a type of DLT (Decentralised Ledger Technology). Simplifying further, it is like the transaction register of a shop: all exchanges of money and goods with customers and suppliers are accounted for here.

The difference between blockchain and a normal ledger is that the former is decentralised. This means that instead of there being one merchant alone keeping track of all transactions and being controlled by the owner, there are several ‘merchants’ scattered around the world recording the transactions from each shop and checking on each other to make sure they are legitimate, with no owner watching. What blockchain is and what it really means are beginning to become clearer.

How was blockchain born?

Let’s now venture into the history of this technology and go back into the past to understand why it was born, and better define what blockchain is and how it works.

It was Stuart Haber and W. Scott Stornetta who imagined in the 1990s the technology that blockchain is today. 

The two scientists at the time worked at the research and development company Bellcore Labs, Haber specialising in cryptography and computer security and Stornetta in physics. The two chose to focus their research project on the problem of the modifiability and reproducibility of digital files of all kinds: an issue that was already relevant before the popularisation of the internet. Their aim was therefore to find a way to make documents immutable and authenticable. 

The results of their studies were later cited in bitcoin’s whitepaper: 3 out of 8 sources used by Nakamoto are signed by the two scientists. 

The first solution they arrived at in 1991 was how to time-stamp a digital document using cryptography. However, the problem of preventing or resolving collusions persisted.

One day Stornetta had an epiphany: there was no need for an intermediary to resolve disputes, but a global network in which everyone witnessed the documents and in which all documents were connected together. This would create ‘distributed trust’ instead of centralisation on an intermediary. 

In 1992, they added Merkle Trees to the solution, invented by cryptographer Ralph Merkle in 1979 and still used in major blockchains today. It can be considered the first blockchain scalability solution, as these tree structures made it possible to include multiple documents in one block and cryptographically chain them together.

So in 1995 they created the first blockchain prototype: a chain of blocks connected to a small network. Every week, this network reached a consensus on incoming registration requests by publishing an alphanumeric code (fingerprint) that summarised and validated these requests. With this prototype, we can for the first time define what blockchain is and what its meaning is.

So in 2009 the Bitcoin whitepaper appeared, realising Haber and Stornetta’s idea, with some fundamental innovations. First of all, Nakamoto chose to restrict the application of the blockchain to a payment system. Secondly, he designed an incentive-fuelled consensus model: mining. In this way, he found a concrete way to realise the ‘distributed trust’ that Haber and Stornetta talked about: miners would be motivated to participate in the network and validate their timestamps through bitcoin rewards.

From the first blockchain developed and used, i.e. bitcoin, many others were born, starting a race for innovation that continues to this day. Let us start with the bitcoin model to understand once and for all what the blockchain is, what it means and how it works.

What’s the blockchain made of?

The main blockchains in use today offer very different solutions, but to know how they work and understand the differences, we can start with the main components of this technology. To delve further into what blockchain is, but more importantly how it works and what it means, we will use Bitcoin as our main reference, with its brilliant simplicity.

At the structural level, the technology consists of two elements:

  • Chain of blocks
  • Peer-to-peer networks

Let’s start with the blocks: the bricks of the blockchain.

Blocks are nothing more than packets of cryptographically synthesised and recorded transactions. Each block is linked to the previous one by a unique and irreversible hash function. You can imagine them as a jigsaw puzzle: one piece fits with the next thanks to a unique and unrepeatable shape. This makes the blocks immutable and identifiable by a simple code that never changes.

And now the network: it serves to connect all participants of the blockchain and to ensure the so-called distribution and decentralisation of the system. 

Each network consists of nodes, i.e. devices connected to the network and to each other. All nodes keep a copy of the ledger to act as ‘witnesses’. If everyone has the same copy, no one can arbitrarily modify it or manipulate it to their own advantage. If one copy is different from the others, this means there is a corrupt or inactive node and it will be therefore excluded.

The particularity of a blockchain network is that it is not based on the common client-server structure, but is peer-to-peer. This means that every participant in the network is a peer with the same power as any other: a peer is both a client – requesting data – and a server – providing data.

Blockchain: how does it work?

Having clarified again what it is and its meaning, it is worth getting to the heart of the matter and explaining how blockchain works. This technology can be programmed for specific applications, but at a fundamental level it works mainly through cryptography, which in fact allows:

  • Synthesising stored information
  • Making information readable only to specific recipients
  • Record information in an immutable and verifiable manner

For the former we have already mentioned merkle trees, while for the latter it exploits asymmetric, or public key cryptography so that only legitimate owners or recipients can use cryptocurrencies. To make information immutable, on the other hand, an irreversible hash function is sufficient.

This means that when a money transaction is transmitted from one user to another, cryptocurrencies can only be received by the indicated recipient, and the transaction that has taken place will be recorded on the distributed ledger. 

But who records this transaction and how do we make sure that a user is not trying to double spend? Here is where the consensus mechanism or algorithm comes into play. 

Let us take the bitcoin case as a concrete example of a consensus mechanism: Satoshi Nakamoto chose ‘Proof-of-Work’, powered by mining, as its consensus mechanism.

This is how the bitcoin network achieves consensus according to the PoW:

  • Bitcoin nodes examine new transactions requested on the network: they reject the illicit ones and send the lawful ones to special nodes called miners. 
  • Now it must be selected who will add the new transactions to the blockchain: Therefore, miners use powerful computing devices to solve a very complex cryptographic code. The first miner that succeeds in solving the code assumes the right to register the transactions collected from the nodes to a new block. 
  • The miner cryptographically and immutably registers the new block, broadcasting its hash to the nodes, so that the entire network re-checks the correctness of transactions and updates their copy of the register.

The hash obtained constitutes the miner’s proof of the work they have done. 

The incentive introduced by Nakamoto lies in the fact that, as a reward for this work well done, the miner receives transaction fees and new bitcoins. This is why the activity is called mining: it is as if the miners are actually mining new bitcoins.

The fact that the nodes are obliged to agree on the information recorded at each stage and that the miners have a direct interest in the proper functioning of the process, makes the network safe from malicious attackers. This, in short, is how blockchain works.

What does blockchain solve?

The technology is fascinating, and it is now clear what blockchain is, what it means and how it works. So let’s address the elephant in the room: what does it actually solve?

The main solution can be found in the very reason for its birth. The blockchain was created to create a payment or data storage system that does not need intermediaries or third parties, but can also work securely peer-to-peer: between peers.

This function is not an end in itself, but can be exploited in many different fields: a payment system independent of banks or other intermediaries can in turn be implemented in countless financial services

The ability to store encrypted information in an impartial and incorruptible manner can be useful for fields such as healthcare, the supply chain, digital identity systems, copyright (NFTs), voting systems, fact-checking and much more.

Depending on the specific solution a blockchain is intended for, it will develop according to a certain application protocol, i.e. according to certain rules of operation that are optimal for that application. 

In fact, one of the most interesting properties of the blockchain is its programmability; moreover, their codes are often open-source, allowing anyone to take a protocol and use it to develop other solutions.

What are the main blockchains?

The main blockchains today are Bitcoin and Ethereum, which represent very different protocol examples. 

Bitcoin started out primarily as a payment system, while Ethereum was born 6 years later to develop decentralised applications. Consequently, Bitcoin offers much less flexibility and programmability, although it has been making improvements lately.

These two are Layer-1 chains, i.e. they are basic infrastructures, fundamental protocols on which other blockchains can be developed more flexibly and quickly, hence called Layer-2.

Since the launch of Bitcoin and Ethereum (2009 and 2015), these and blockchain technology in general have undergone a major evolution, in terms of scalability, programmability, use cases and interoperability.

The technology is still in an experimental and intense growth phase, so we never stop learning more about the subject, but this is a great starting point to find out what blockchain is, what it means and how it really works.