A blockchain is a new form of database, predicted by many to revolutionise finance and online business. As a concept, it’s closely associated with the Bitcoin payment system, but its possible applications go way beyond digital currency.

What is blockchain?

So what is a blockchain exactly? The basic idea is to record data in the form of a continually growing list, but crucially, once new data is added (as a ‘block’ in the ‘chain’), it can’t be changed. At least, it can’t be changed without the tampering being painfully obvious. In theory, this makes a blockchain an incredibly secure, trustworthy and transparent method of recording data.

Why use blockchain technology?

We generate a massive volume of data on a daily basis, some of it very important to us. Financial transactions are high on the list since they control the flow of money, goods and services, who owes what to whom, and so on. Blockchains offer a way for transactions to be recorded with total accuracy in an open, independently verifiable format that’s almost impossible to fake. This is why blockchains are often referred to as ‘digital ledgers’.

How does blockchain work?

Blockchains are distributed databases based on peer-to-peer networks of machines or ‘nodes’ that can run into the hundreds or thousands. Data is never stored solely in one place and is always updated across the whole network, maintaining the blockchain in a consistent state on a huge scale and ensuring no single point of failure.

This means that if you wanted to hack or modify existing blockchain records, you’d need to control the whole network, or at least the majority of it. In practice this would require massive amounts of time and effort, making blockchains highly resilient to attack. When new records need to be created, several transactions are bundled together in a block and added to the chain in strict chronological order. Each transaction is verified with a unique signature that proves its identity, using a method known as hashing.

Hashing out the details

‘Hashing’ data essentially means crushing it down into a string of characters that defines its content. Hashing is a one-way process, so there’s no way to convert the hashed output back into the original data. But because the hash will be totally unique for any given file, even tiny changes to the content would result in a completely different hash code.

For the purposes of a blockchain, hashing is ideal because it makes records essentially irreversible. Any changes to previously added blocks would result in a different, invalid signature for the data in question, making it obvious that existing records had been compromised.

Blockchain and Bitcoin

Bitcoin is a cryptocurrency that uses the technology of blockchain to create a decentralised payment system that allows transactions between individual parties without relying on institutions like banks – effectively a distributed ledger. Since Bitcoin came on the scene, many other alternate digital currencies such as Ethereum and Litecoin have been developed, alongside a whole industry dedicated to cryptocurrency speculation. But with no third party in the middle, how can transactions be independently verified?

The first blockchain was implemented in 2009 to track and verify Bitcoin transactions. The objective was to create a public ledger and eliminate the problem of ‘double spending’ where digital tokens are spent more than once. With a blockchain, every transaction is publicly recorded to prevent fraud and disputes.

In the Bitcoin blockchain, the actual verification is performed by special nodes called miners. The miners verify transactions and create new blocks in the chain by solving complex mathematical problems that are intentionally demanding in terms of computing power. But miners are rewarded with a fee of newly created bitcoins – fulfilling the dual purpose of verifying existing transactions and introducing new bitcoins into the system.

Blockchain banking

Blockchain technology offers more than just a ledger for digital currency systems. It has potential applications across a variety of business sectors – most obviously in the financial industry. While traditional banking systems rely on extensive back-office processes to verify transactions before money can be transferred, blockchains could offer a much faster alternative.

There are many advantages that blockchain can offer the banking industry such as faster payments, faster accounting and auditing, and the lowering of asset exchange fees by removing the middleman. Blockchain can also help banks verify the identity of customers and counterparties, and generally save them money by cutting out paperwork and bureaucracy.

Tech giants like Microsoft and IBM are developing their own blockchain systems, while the Big Four accounting firms are all testing blockchain networks. In an ideal world, more efficient transactions would result in cheaper financial services. The added transparency of blockchains could also be advantageous in terms of regulation and fraud prevention.

With so much important data floating around, the ability to create an accurate and unchangeable record of events has obvious benefits. Blockchain technology has huge potential advantages for the globalised supply chains that crisscross the world. By offering more transparency and accurate end-to-end tracking, companies can digitise physical assets and make a decentralised record of every transaction so that it's possible to track every link in the chain. This helps companies make better business decisions and prevent fraud. It also promotes ethical decisions by consumers and companies, such as being able to track individual diamonds from mine to jeweller to end-consumer, to verify their origin and ensure they aren’t funding militias in warzones.

Ultimately though, Blockchain development is still at a relatively early stage, so it’s not yet clear how much of a disruptive effect it will have. What is certain is that distributed, decentralised systems like blockchain will continue to have a major impact for years to come.