How a blockchain works

In November 2018 I visited the DOAG in Nuremberg as part of the NEXTGEN program and took part in a seminar on blockchain in addition to many interesting lectures. I didn’t know what to expect there and I didn’t have any points of contact with Blockchain. I knew that it was often mentioned in connection with Bitcoin. It quickly became clear that I was not the only one with the prejudice “Bitcoin and Blockchain belong together”. That’s why I decided to write a blog article. In order to keep the topic as simple and understandable as possible, I explain the principle of a blockchain and do without deeper algorithms for the time being.

Two systems

First of all, it is important to know that there are two systems. One is the central system and the other is the decentralized system.

In the central system there is one party that monitors all the others.

In the case of banks, for example, this is the European Central Bank (ECB). It monitors that everything is in order and that none of the banks can give itself more money than it actually owns. However, this only works if everyone trusts the central party and none of the parties are favored or neglected.

How can the problem of trusting the central party be solved?

The solution is the decentralized system. Each party not only participates in the system, but also monitors all other parties at the same time. The “power” no longer lies with one party, but is distributed among all parties.

The prerequisite for this is that everyone agrees on the state of the money.

For the banks, this means that they no longer have to trust the ECB, as they themselves monitor all other banks. The more participants the system has, the more secure it becomes, as there will be more supervisors at the same time.

However, it also follows from this that it is an unsuitable system for a small number of participants.

 

For example, if Bank A and Bank B are alone in a decentralized system, they monitor each other. Now both banks have 100,000 euros each. They agree on the state of the money and the decentralized system works.

However, if Bank A claims to have EUR 200,000 instead of EUR 100,000, Bank B would say that this is not correct and would not accept this amount. The two parties now disagree on the state of the money and the decentralized system does not work.

But if there are 10 banks in this decentralized system and Bank A would try to give itself more money, the other 9 banks would say that this is not right. Now there is a clear majority of those who say that the state of the money is different from Bank A. This is one of the most important points in the decentralized system: the majority is always right.

 

The blockchain is based on a decentralized system in which each participant has the same access rights and possibilities. This makes the blockchain a neutral system that does not belong to anyone and cannot be manipulated.

Blocks, Transactions and Hashes

In a blockchain, transactions are stored in blocks. A transaction can be any information, for example, a contract or a financial transaction. A block contains not only the transaction, but also a history. The history is the checksum of the previous block. It is created by generating a hash from the block. Thus each new block is connected to the previous block and a chain is created – the so-called blockchain. In addition to the history, the block also contains the checksum of the entire chain.

After the block has been verified and sealed, it is stored invariably and visible to all.

An example:

Three friends are in a group chat and arrange a meeting at 5 pm in the cinema.

It could look like this:

Person 2, however, is now changing his mind and would rather see a film later.  Person 2 cannot make this decision alone or change the time in the chat afterwards. According to this, person 2 must either arrange a new meeting or go to the cinema alone.

Transferred to a blockchain every message would be the transaction of a block.

Each participant can see the chat history on his smartphone or computer. The blocks are invariable because each block forms a hash that is stored in the next block.

If person 2 were to change one of the messages, the hashes would no longer match and break the entire chain. So everyone involved would notice it.

How can I participate in a blockchain?

In order to gain access to a blockchain based system, the so-called wallet is required. It consists of a private and a public key. The private key is secret and serves as a kind of PIN to gain access to your own wallet. It is also used to sign outgoing transactions. The public key, on the other hand, is visible to everyone and, simplified, the wallet address. It can be passed on without hesitation. Data can be sent to this key. Since the keys are based on asymmetric encryption, it is impossible to deduce the private key from the public key.

An example:

Person XY buys a property and is entered as the owner in the certificate. This certificate is stored in a block chain. His public key and the deed are hardwired. Every participant can see the certificate. Now person XY wants to transfer the certificate. For this he needs the private key. If he does not have this key, there is no possibility to change the certificate.

Fields of application

In addition to crypto currencies, a blockchain can be used in a variety of ways. The small town of Zug in Switzerland has been offering its inhabitants a digital identity since 2017. This identity is based on Blockchain. This enables citizens to securely manage their digital identity card themselves.

Of course, there are many other ways to use Blockchain. Some examples are:

  • Smart Contracts: Automatic contracts are enabled and can be activated or deactivated in case of certain events.
  • Music industry: Artists can manage the rights to their music themselves. Fans can support the artist directly.
  • Voting systems: The voting system would be protected from manipulation, anonymous and secure. In addition, voting could be done from home.
  • Insurance: In the case of motor vehicle insurance, for example, the driving behaviour could be analysed and the contributions automatically adjusted. Cautious drivers could be rewarded and risky drivers would pay more.

Conclusion

The blockchain offers great potential to revolutionize the future through decentralization, transparency, security and joint control. However, one should consider whether a blockchain is the right starting point for the project.

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Lisa Milde
Training as IT specialist for application development
Lisa faces every challenge in a good mood and brings momentum to our men's team in the development team.