What is blockchain and how does it work?

Blockchain is a shared distributed ledger technology in which each transaction is digitally signed to ensure its authenticity and integrity — and it's poised to make big waves in a wide range of business use cases.

What is blockchain and how does it work?
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Blockchain technology backs up Bitcoin and other cryptocurrencies to this day, but there’s been a recent groundswell of interest from a variety of industries in making distributed ledger technology work, especially in business. Here's a primer on what blockchain technology is, how it works, and where it is showing the most promise in business.

What is a blockchain?

A blockchain is the structure of data that represents a financial ledger entry, or a record of a transaction. Each transaction is digitally signed to ensure its authenticity and that no one tampers with it, so the ledger itself and the existing transactions within it are assumed to be of high integrity.

The real magic comes, however, from these digital ledger entries being distributed among a deployment or infrastructure. These additional nodes and layers in the infrastructure serve the purpose of providing a consensus about the state of a transaction at any given second; they all have copies of the existing authenticated ledger distributed amongst them.

How do blockchains work?

When a new transaction or an edit to an existing transaction comes in to a blockchain, generally a majority of the nodes within a blockchain implementation must execute algorithms to evaluate and verify the history of the individual blockchain block that is proposed. If a majority of the nodes come to a consensus that the history and signature is valid, the new block of transactions is accepted into the ledger and a new block is added to the chain of transactions. If a majority does not concede to the addition or modification of the ledger entry, it is denied and not added to the chain. This distributed consensus model is what allows blockchain to run as a distributed ledger without the need for some central, unifying authority saying what transactions are valid and (perhaps more importantly) which ones are not.

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How can blockchains be structured?

Blockchains can be configured to work in a number of ways that use different mechanisms to achieve consensus on transactions and, in particular, to define known participants in the chain and exclude everyone else. The largest example of blockchain in use, Bitcoin, employs an anonymous public ledger in which anyone can participate. For more private uses of blockchain among a smaller number of known actors, many organizations are deploying permissioned blockchains to control who participates in transaction activity.

What are the benefits of blockchains?

Blockchain is attractive to a number of different constituencies for a variety of reasons, including the following:

  • The lack of a requirement for a central authority makes it an ideal ledger and settlement solution for joint ventures and affiliate relationships that are generally made on an equal or 50/50 footing without a provision for an arbitrator or manager. Indeed, having the computers verify transactions and settle them eliminates the need for clearinghouses and other settlement agents, providing disintermediation in a business arrangement and generally reducing costs while improving the speed at which transactions can be made, verified, settled, and recorded.
  • The digital signatures and verifications make it difficult to envision a scenario wherein a bad actor could cause fraud and introduce problems that are costly to remove and resolve. The cryptographic integrity of the whole pending transaction, as well as examination by multiple nodes of the blockchain architecture, protect against threats and malevolent use of the technology. (It is important to note that this security protection has largely been untested in the marketplace and, while strong on a theoretical basis, questions remain about how well the protections will hold up in the reality of the digital economy we live in today.)
  • The concept of blockchain works really well at tracking how assets move through a supply chain, through certain vendors and factories to transmission and transportation lines and into their final locations.

Related video: The building blocks of blockchain — what it is, what it does, and how companies are already using it.

What are the downsides of blockchain technology?

The biggest problem with blockchain technology now is that it is hard to apply, mainly because, as is typical with open source projects, there are numerous projects each with their own teams and ideals. Marrying all of the functionality into a practical application is difficult. “The only thing that gives me pause about Blockchain is the community that builds the code,” says Matt Reynolds, blockchain application development expert. “Bitcoin is open source, but the team that manages it do not behave in the way you’d ideally like FOSS maintainers to maintain. They behave more like an ‘answerable to no one’ proprietary software team, and that’s not good for anyone using Bitcoin’s blockchain implementation in their own projects.”

What is Hyperledger?

Hyperledger is a project that tries to unify all of the different open source blockchain approaches that exist currently. The goal? According to the official Hyperledger website, it is to “create enterprise grade, open source, distributed ledger frameworks and code bases to support business transactions.”

What is significant about this project compared to the various and sundry other open source projects that litter the Internet is the industry participation and big names behind this: according to the project, founding members of the initiative include ABN AMRO, Accenture, ANZ Bank, Blockchain, BNY Mellon, Calastone, Cisco, CLS, CME Group, ConsenSys, Credits, The Depository Trust & Clearing Corporation (DTCC), Deutsche Börse Group, Digital Asset Holdings, Fujitsu Limited, Guardtime, Hitachi, IBM, Intel, IntellectEU, J.P. Morgan, NEC, NTT DATA, R3, Red Hat, State Street, SWIFT, Symbiont, VMware and Wells Fargo.

Hyperledger’s current goals are to combine three projects into practical blockchain applications:

  • Rippled, a public distributed ledger written in C++ that handles cross-currency payments using order books
  • IBM’s Open Blockchain, a low level fabric that implements smart contracts, digital assets, record repositories, consensus oriented networks, and cryptographic security
  • Digital Asset’s Hyperledger, which is a ready to deploy blockchain server with a client API currently intended for use by financial services enterprises. It works by using an addition-only log of transactions that are designed to be replicated across multiple separate organizations all without a nexus of control. (The parent company, Digital Asset Holdings, lent the Hyperledger trademark name to the open source project as part of its contribution.)

Technology industry giant IBM agrees: it is contributing tens of thousands of lines of code to the Hyperledger project while also being clear that it believes that open technology is the best way to create a truly applicable implementation of blockchain to today’s business and enterprise market. In fact, IBM sees blockchain and ledger technology as making the Internet more aware of commerce.

“As a broad, open initiative inclusive of many different blockchain experts, the Hyperledger Project will advance the open blockchain standard for uses across many industries,” says Jerry Cuomo, vice president blockchain, IBM. “By focusing on an open platform, there’s no limit to the types of applications and frameworks that will one day be built on top of it.”

Of course there are practical limits to this. “The problem with practical applications to Blockchain is that it’s quite hard to find projects that are genuinely good fits,” says Reynolds. “There’s a lot of ‘I have a hammer, so this must be a nail’ thinking around Blockchain. It’s best suited for scenarios where the data itself is public, but that you don’t want to have to explicit give trust to entities to update the data. Regulatory or public applications tend to fit well into this.”

With that said, there is clearly a place for building a foundation for distributed ledger-based ecommerce in the Internet landscape today. In a keynote at The Block Chain Conference in San Francisco in February, IBM’s Global Blockchain Offering Director John Wolpert says, “You need a fabric that allows for lots of competition on platforms and huge competition on solutions. We need to evolve the Internet to become economically aware and this Internet is not going to be an application, it will be a fabric.” And he sees Hyperledger as the project that’s putting the best of breed technologies together to build this fabric. 

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