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Overview

A blockchain groups transactions into blocks that reference earlier blocks. Computers called nodes check updates against the network’s rules and use a consensus mechanism to agree on the chain. This guide explains how accounts, transactions, blocks, and cryptography fit together. See Ethereum’s block documentation for a concrete example.

If you're new to blockchain and want to understand more about blockchain as a technology and would someone need it, check this guide on the basics of blockchain.

How does Blockchains Work?

Think of a blockchain as a shared journal that a group of friends (the participants) decide to keep together. Each friend has their own copy of this journal. Whenever something important happens, like a friend lending money to another, they write it down as a new entry in their journal.

Before accepting an entry, the friends check it against their shared rules. For example, they can check that the person authorizing a transfer has enough balance. Their agreement establishes a common record; it cannot independently prove an outside event, such as whether a physical item was delivered.

The analogy illustrates a shared history, but real blockchains do not require every participant to approve every entry individually. Each protocol defines its own agreement and finality rules, and recent blocks may be reorganized before they reach the required confirmation or finality threshold.

Looking at it literally, a blockchain is a network of distributed computers. These computers all store a local copy of the blockchain, which can be thought of as a distributed database or ledger.

Adding data to the blockchain is very similar to our shared journal analogy. When data is added, the change is propagated throughout the network and every computer updates its copy. Every addition or modification is a transaction. All of the transactions that happen within a given timeframe get bundled into a block. Different blockchains have their own mechanisms for determining how long that timeframe is.

This block is then added to the pre-existing chain of blocks, and once this is done, every computer, just like the journal-keeping friends, updates its own copy of the blockchain; that's where the name comes from. It's literally a chain of blocks.

But that's just the beginning of the story. Behind the scenes, a whole array of components and mechanisms are working to keep blockchains secure and operating in a trustless environment. Now, let's dive into some fundamental concepts to get a clearer picture.

Accounts, Transactions, Blocks

In this section, let's understand accounts, transactions, and blocks.

Accounts

An account represents an address and associated state on a blockchain. Account models differ between networks. On Ethereum, the two account types are externally owned accounts (EOAs) and contract accounts:

• Externally owned accounts (EOAs): A private key authorizes transactions from an EOA. The account has an address and can hold ETH or interact with contracts. The public key and address are related, but they are not the same value.
• Contract accounts: These accounts contain smart contract code and have no private key. Their code executes in response to calls during transaction execution. A contract can call another contract as part of that execution.

The Ethereum account documentation explains the distinction. These categories describe Ethereum and should not be assumed to apply unchanged to Bitcoin, Solana, or every other blockchain.

Transactions

Transactions are the actions initiated by accounts to transfer assets from one account to another, interact with smart contracts, or deploy a smart contract. Every data addition/modification on the blockchain by an account is in the form of a transaction. A transaction in a blockchain typically includes the following information:

• Nonce: A counter representing the number of transactions sent from an account. Learn about Nonce in this in-depth guide.

• To: The recipient account address (can be an EOA or contract address).

• From: The sender's account address. For an Ethereum transaction, the sender is an EOA; a contract-to-contract call happens within transaction execution.

• Amount: The transaction's native-currency value, if any. On Ethereum, token transfers typically encode an action in the transaction data rather than in the native-currency value field.

• Signature: This is the cryptographic signature generated with the sender's private key. This proves that the transaction was not tampered with and was indeed initiated by the sender's account address.

• Transaction Hash: This is a unique identifier for the transaction, created by hashing the transaction's details. It's like a fingerprint for the transaction, ensuring its integrity and uniqueness.

Blocks

A block groups transactions with metadata that connects it to the chain. Nodes validate it against the network's rules. Inclusion records a transaction in the current chain; an application may need additional confirmations or finality before treating it as settled. Typical block information includes:

• Block header: Contains metadata such as a reference to the parent block, a timestamp, and cryptographic commitments to the block's contents or state. Fields vary by network. Difficulty targets and mining nonces belong to proof-of-work designs and are not universal consensus fields.

• Transaction List: A list of all transactions included in the block.

• Block Hash: An identifier calculated from block data according to the network's hashing rules. Proof-of-work chains impose an additional difficulty requirement on valid block hashes.

Now, let's dive a little bit deeper into nodes and consensus mechanisms.

Nodes & Consensus Mechanism

Nodes are the computers of the blockchain on which the blockchain network runs, and consensus mechanisms are the rules that govern these nodes' operations.

Consensus Mechanism

A consensus mechanism is like a set of rules or a protocol that allows all the nodes in the blockchain to agree on the validity of transactions and the current state of the blockchain. This ensures that all the copies of the distributed ledger are synchronized and valid. This mechanism is vital for maintaining the decentralized, trustless nature of the blockchain, where all the nodes can agree upon a specific thing without trusting each other. There are several types of consensus mechanisms which has been developed to suit different use cases, but the most common ones are:

• Proof of Work (PoW): Proof of Work is a consensus mechanism that powers the Bitcoin network. It ensures network security and integrity by requiring miners to solve complex cryptographic puzzles. This process, known as mining, demands significant computational resources, making it difficult for malicious actors to alter the blockchain. The first miner to solve the puzzle validates the transactions and adds a new block, receiving tokens as a reward. PoW's strength lies in its simplicity and proven track record in securing blockchain networks.

• Proof of Stake (PoS): Validators commit stake and perform duties defined by the protocol. The selection, voting, reward, and penalty rules vary between networks. Ethereum uses validators to propose blocks and attest to the chain, with penalties for missed duties and slashing for specific conflicting behavior. See Ethereum's proof-of-stake documentation.

• Delegated Proof of Stake (DPoS): Token holders elect participants who produce or validate blocks. Details vary by network. Restricting the active validator set can simplify coordination, but it also introduces trade-offs around voting power and validator concentration.

• Alpenglow (Solana): Solana runs Proof of Stake. Its original consensus, TowerBFT, used Proof of History as a clock. Its current consensus, Alpenglow, finalizes blocks in about 150ms using signed votes that validators aggregate into certificates.

Checkout this comprehensive guide on blockchain consensus mechanisms.

Nodes

If we relate to our example from the earlier sections of this guide, nodes are like the journel-keepers who keep track of transactions in their journel. In the context of blockchain, a node is an individual computer participating and connected to the blockchain network. The data a node stores depends on its role and configuration; not every node retains the entire transaction history. There are different types of nodes, each serving a specific purpose:

• Full Nodes: These nodes independently validate transactions and blocks against the network's rules. Some configurations prune old data, so full validation does not necessarily mean retaining every historical state or block.

• Miner Nodes: In blockchain networks that use a Proof of Work (PoW) consensus mechanism, miner nodes compete to solve complex mathematical problems and add new blockchain blocks. The first miner to solve the problem gets to add the new block and is rewarded with tokens.

• Validator Nodes: In networks utilizing a Proof of Stake (PoS) consensus mechanism, validator nodes validate transactions and create new blocks. Validators are chosen based on the number of coins they hold and are willing to "stake" or lock up as collateral.

• Lightweight or Light Nodes: These nodes don't hold a complete copy of the blockchain. Instead, they only download the block headers to validate the authenticity of transactions. They rely on full nodes for more detailed transaction data.

Learn more about Ethereum nodes. Now let's go a little bit more technically deep and understand cryptography and hashing.

Cryptography and hashing

Cryptography in blockchain serves as the bedrock for ensuring the security and integrity of data within the network. At its core, blockchain technology leverages cryptographic algorithms to achieve various objectives, including secure transactions, identity verification, and data immutability.

Hashing

A cryptographic hash function converts input data into a fixed-size digest. Blocks can include a hash reference to their parent, linking the chain. Changing the input changes the digest, making hashes useful for detecting changes and checking data commitments.

Hashing is not encryption. A hash is not designed to be decrypted to recover the original input. Blockchain addresses, transaction identifiers, and state commitments use network-specific cryptographic rules.

Key-pair (public-key) cryptography

Blockchains use asymmetric cryptography to facilitate peer-to-peer transactions. Each participant has a pair of cryptographic keys: a public key, which can be shared with others, and a private key, which is kept secret. For a key-controlled account, the private key authorizes signatures and must remain secret. The relationship between a public key and an address depends on the network. Contract accounts and program-derived addresses do not necessarily have a corresponding private key.

Digital Signatures

A digital signature allows a verifier to check that data was signed with the private key corresponding to a public key and has not been altered. It does not encrypt the signed data. NIST describes these properties in its digital signature definition.

Replay protection requires additional protocol rules. For example, Ethereum transactions include a nonce, and replay-protected signing includes the chain ID. A valid signature alone does not prevent reuse of a message. Applications that verify signed messages must define their own replay protection where needed. See the Ethereum transaction documentation and the guide on verifying Ethereum signatures.

Encryption

Encryption protects confidentiality by transforming data so that it can be recovered only with the appropriate key. Hashing and digital signatures serve different purposes: checking data and authorizing or authenticating actions.

Public blockchain data is generally visible to anyone who can access the ledger. Applications may use encryption to protect a payload, but should not assume that publishing data on a blockchain makes it private. The image below illustrates hashing, not encryption.

Further Reading

If you made it to this section, you now know a lot about blockchain's inner workings and fundamentals. If you want to learn more about different types of blockchain, then Ethereum and Solana can be a good start.