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What is Blockchain Transaction? How Does it Work?

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12th Sep, 2022
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What is Blockchain Transaction? How Does it Work?

What is the first thing that comes to your mind when you encounter the term ‘blockchain’? If your answer is cryptocurrencies, you are not alone! Virtual money or cryptocurrency has been in vogue among investors globally. Recent times have seen digital currencies like Bitcoin take the crypto market by storm as investors jumped in to explore virtual money. However, cryptocurrency is not the only instance of blockchain usage. The revolutionary technology finds applications in several other areas, including money transfers, insurance, lending, voting, real estate, logistics and supply chain, and non-fungible tokens.

This article explores the concept of a blockchain transaction in detail and how it helps blockchain usage.

What is blockchain technology?

A blockchain is a distributed database that stores data electronically in a digital format. Unlike a traditional database that stores data in a tabular form, a blockchain structures data into blocks linked together into a chain. Every block has a fixed storage capacity and, when filled, is connected to the previous block in the chain. The new information that comes after the last-added block is compiled into a new block and subsequently added to the chain once it reaches its maximum storage capacity. The blockchain is shared among the computer network nodes, with each node having a copy of the blockchain or the transactions done on the network.

What is a blockchain transaction?

A transaction refers to a contract, agreement, transfer, or exchange of assets between two or more parties. The asset is typically cash or property. Likewise, a blockchain transaction is nothing but data transmission across the network of computers in a blockchain system. The network of computers in a blockchain store the transactional data as replicas with the storage typically referred to as a digital ledger. 

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Blockchain technology leverages peer-to-peer (P2P) networks to form a shared and secured ledger that records transactions as immutable time-stamped digital blocks. It is a decentralized ledger of transactions with no third-party involvement, and only participants in the blockchain network can validate transactions among them. While a blockchain can store different types of information, its most widespread use has been as a digital ledger for transactions. 

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Blockchain Transaction Example

In the context of cryptocurrency, a blockchain transaction example is an individual payment, such as Person A sending .10 BTC (bitcoin) to Person B. A  blockchain transaction would typically involve the following information getting stored in blocks:

  • Data about the transaction, such as the date, time, amount of money paid, place, etc.
  • Data about the participants of the blockchain transaction or the username.
  • Block specific data or hash, a unique code that distinguishes one block from another.

Blockchain involves three key elements: cryptographic keys, a P2P network, and a computer network to store and record transactions. A cryptographic key is a unique and secure digital identity reference used for managing and authorizing transactions. Upon merging with the P2P network, the digital signature is used by individuals on the network to reach a consensus on transactions. Once a deal is authorized, a mathematical verification certifies it, resulting in a successful transaction between the two connected parties in the network. Besides financial transactions, blockchains also hold legal contracts, product inventories, transactional details of other assets like vehicles, property, etc.

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Steps of the Blockchain Transaction Process

A blockchain transaction has to undergo several steps before it becomes a part of the blockchain, a critical aspect of the technology being the way it authorizes and confirms transactions. The pointers below highlight the steps involved in a blockchain transaction:

  1. Entry of a new transaction
  2. Transmission of the transaction to a global network of peer-to-peer computers
  3. Peer network of computers confirms the validity of the transaction 
  4. Confirmed legitimate transactions are clustered into blocks
  5. The blocks are chained together to create a long history of all transactions
  6. Completion of the transaction

Fundamentals of a Blockchain Transaction

One of the most significant attributes of blockchain transactions is security. Let’s look at the key aspects of blockchain technology that contribute to the safety of every blockchain transaction:

Hash encryptions

Blockchain employs hashing and encryption technology, mainly the SHA256 algorithm, to ensure data security. Therefore, the SHA256 algorithm transmits the transaction details as encrypted information (hash encryption), which gets added to the blockchain post verification. Thanks to the SHA256 algorithm, hash encryption becomes practically impossible to hack. 

Authentication and authorization

Blockchain transactions are authenticated using cryptographic keys that are essentially strings of data identifying a blockchain user and giving access to their account on the system. The two cryptographic keys that ensure successful and secure transactions between two parties are private and public keys. Using these keys, a blockchain user creates a secure digital identity for controlling and authorizing transactions.

Mining

In blockchain technology, mining means adding transactions to the distributed digital public ledger of existing transactions (or the blockchain). Although primarily associated with bitcoin, mining also applies to other blockchain usage scenarios. The mining process involves generating a hash of a block of transactions. Since the hash is unforgeable, it protects the integrity of the entire blockchain without requiring a central system such as a bank or regulatory body.

Proof of work

The decision to add a transaction to a public blockchain is made by consensus whereby a majority of the computers (nodes) in the network must agree to the validity of a transaction. Thus, people who own the nodes in the network need to solve a complex mathematical puzzle known as the proof of work problem to add a block to the chain. Solving the proof of work problem is mining, the people doing it are miners, and they are rewarded for verifying transactions. 

Proof of stake

Proof of stake is a validation consensus protocol in a blockchain for processing transactions and creating new blocks. It entails that blockchain participants must have a stake in the blockchain, typically by owning cryptocurrency. Hence, cryptocurrency owners get a chance to validate transactions by offering their stakes as collateral. An alternative to proof of work, the proof of stake mechanism saves significant computing power and resources.

Conclusion

Blockchain technology is making headlines with its wide-ranging practical utilities in various sectors and industries. However, the most widespread and well-known blockchain usage is in cryptocurrency. Apart from crypto, the applications of blockchain technology extend to traditional investments. Using blockchain for financial transactions is fast and cost-effective and allows investors greater control over their assets with no involvement of any third party. Besides, blockchain operations are efficient, accurate, and secure, making them ideal for sensitive operations in lending, insurance, real estate, voting, personal identity information storage, and many more.

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Pavan Vadapalli

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Director of Engineering @ upGrad. Motivated to leverage technology to solve problems. Seasoned leader for startups and fast moving orgs. Working on solving problems of scale and long term technology strategy.
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Frequently Asked Questions (FAQs)

1Where are blockchain transactions stored?

Since blockchain is decentralized, blockchain transactions have no central storage location. Instead, the transactions are stored in computers (nodes) across the blockchain network. Each computer has a copy of the blockchain or the transactions done on the network.

2What is a private blockchain?

Private blockchains work on closed networks and are typically used by private organizations and businesses to manage sensitive transaction data. A private blockchain network operates under a single authority.

3What is decentralized finance (DeFi)?

Decentralized finance (DeFi) or open finance results from decentralized technologies such as blockchain. It represents the transition from conventional centralized and closed financial systems to a universally accessible economy based on secure distributed ledgers like those used in cryptocurrencies. In other words, DeFi eliminates the control that central bodies like banks have on money, financial services, and financial products.

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