“Blockchain”, “Bitcoin”, “cryptocurrency”

Unless you’re living under a rock, you must have been bombarded by these words every single day for the past few months. You might have wondered- what in the world is bitcoin? What is blockchain? Is it a chain of blocks? Or is it a block of chains? Where does the chain start and end?

Well, in this article, I will be giving you a short introduction to this wonderful and amazing technology which is in the cusp of revolutionizing the world. I will provide a brief explanation of terms like “Blockchain”, “Blockchain fork” and “Proof of Work (PoW)/Mining”.

After the 2008 recession and collapse of financial sector, an anonymous person (or group) with the pseudonym Satoshi Nakamoto, came up with the idea of cryptographically securing chain of blocks for the transfer of digital assets. In simple terms, blockchain is a decentralized distributed ledger. Decentralized means it is not controlled by a single authority or company (as opposed to a centralized authority- like banks or governments). It is an encrypted database secured by cryptography that acts as a public ledger to keep track of the digital assets. This technology is the core component of the cryptocurrency called bitcoin, which was the first use case of blockchain. Because of this, I will be primarily focusing on the financial/currency application of blockchain in this article.

A cryptocurrency is an “electronic money created with technology controlling its creation and protection, while hiding the identities of its users.” Cryptocurrencies are a form of digital cash designed to be quicker, cheaper and more reliable than our regular government issued money (fiat currency). Instead of trusting a government or central reserve or any other authority to create your money and the banks to store, send and receive them, users can transact directly with each other and store their money themselves without relying on middlemen like banks, Federal Reserve and even government. This results in cheaper, faster, reliable and secure transactions.

Blockchain is a ledger which records transactions between two parties in a permanent way without needing third-party authentication. Due to the underlying cryptograph and encryption, blockchain is immutable and unhackable. Each block is 256 bit hash and even with the super computers and latest technologies, it takes 9.63×10⁵² years to break it. Each block contains 3 elements- data (or transaction details), hash and hash of the previous block. Hash is like a unique id similar to fingerprint which helps to identify the block. The hash of the previous block is the feature which creates the chain and this technique is what makes the block secure

A simple blockchain illustration

So why do you need blockchain for digital money transfer?

Blockchain solves a major problem in internet asset transfer called double spending. Suppose you have a photo in your computer. If you send this photo to your mother via email, now there are two copies of the photo- one with you and one with your mother. This shouldn’t happen if you’re sending money over the internet. Once you sent it to someone, it should be deducted from your account. Centralized agencies like banks come in handy in this type of situation. They have a central ledger maintained with them with all the asset holdings recorded. Every time you want to send someone money, you notify the bank, the bank checks your balance, deducts the amount, adds it to the recipient account and updates its database.

But what if you want to do this in a decentralized way without the banks? Let’s say you distributed the ledger to a lot of people across the globe. Let’s call them peers. Every time a transaction is made, all the peers will need to update their local ledger as the transaction should not vary between the peers and there should be a consensus. Having multiple ledgers is thus a recipe for error, fraud and inefficiency.

This is where blockchain comes in handy. With no central point, the main ledger is distributed to the entire network. The ledger is publicly available to anyone and hence it eliminates the need for trust.

The distributed ledger system

So how is this ledger maintained and updated?

This is done by a process called validation by nodes. A network of computers have an identical copy of the database. When a transaction is initiated, millions of computer running the network take this transaction and store it locally in a block. Then the computer tries to solve an extremely difficult math problem associated with that transaction. Millions and billions of guesses by permutation and combination is carried out to determine the solution to the math problem. When one of the computer guesses the answer to the problem, then it wins the right, to officially add its local block to the main blockchain. All the millions of computer which did not win, throw away their copy of the local block and they update their ledgers with the block from the winning computer. Thus the ledger is kept up-to-date. This process is called mining.

Mining Process explained (Source)

Thus the computers (or nodes) are expending their resources in the form of electricity and time in order to verify and validate a transaction. This is called Proof of Work. It allows trust less and distributed consensus. Mining verifies the legitimacy of the transaction and prevents double spending. It also prevents DDoS (distributed denial-of-service) attack of the network as all invalid transactions are discarded and are not added onto the main blockchain thereby preventing fraud and manipulation.

But why would anyone want to spend their resources and cost to maintain a blockchain? No one is altruistic enough to spend thousands of dollars in equipment costs and electricity just to maintain an open ledger. That’s where bitcoin or other cryptocurrencies come into picture. Whenever a computer wins the right to add its block to the main blockchain, it is rewarded with the cryptocurrency of the block. For bitcoin blockchain, it is bitcoin, for Ethereum blockchain, it is Ether. Thus the miners are given an incentive. Thus every time a new transaction happens, miners compete among each other to solve the problem in order to get the reward. That’s why the crypto token/currency goes hand in hand with blockchain. You cannot have only blockchain and no reward.

With the insane amount of difficultly in solving the blocks, you would think that two or more computers winning at the same time would be highly improbable. But it happens quite often. This is called soft-fork. When this happens, all the nodes in the network receive both the blocks and are instructed to place their next block, if they win, on the block they received first.

When two blocks gets added to main block at the same time

Since different computers are on varying internet speed, the tie is broken when the next block is added. The winner of the next block places its block after the block which it received first. Thus the longest chain becomes the main chain and the block on the other side of the fork is discarded and the transactions will be validated again.

Longest chain

Soft fork is the reason why the system must be slowed down on purpose. Else the network would be forking everywhere frequently and there would be no consensus. Nobody would have any idea which ledger is the correct one. Thus the slowness and the immense commuting power keeps the system in consensus.

Fork fork everywhere!

As each blockchain (like bitcoin or Ethereum) is basically a protocol, each blockchain has its own features- like block size, miner rewards, transaction fees etc. All those who are participating in the network, must agree upon this rules.

For a centralized company, like Microsoft or Apple, if they want to push an update, they can just roll it out. But in the case of decentralized blockchains, if there is any push for update or change to this protocol, some developers/miners may agree and some may not agree.

I hate you because you have a different opinion than mine!

If a group of people doesn’t like the direction the protocol is heading, then they can fork the blockchain and create their own blockchain. The copy the parent protocol and make the changes they want in that. Since the protocols are open sourced, anyone can do this. After the protocols are implemented, they will announce their fork will go live after some block number. When that block is reached, some people in the community will support the original protocol whereas some will support the new protocol. New blocks are added in their own separate chains and the chains become incompatible. This is called hard fork.

Hard fork simplified

It has happened before. For instance, on August 1st when bitcoin developers couldn’t agree upon the block size, bitcoin cash was born. Some of the other hard forks of bitcoin include bitcoin unlimited, bitcoin gold and bitcoin diamond. Ethereum has also split into Ethereum and Ethereum classic.

In summary, blockchain technology is essentially just a new way of maintaining agreements. It was launched with the intention to bypass government regulations and to conduct online transactions without the need of intermediary centralized authorities. The chain is irreversible, open sourced and decentralized.

Bitcoin is the first full consensus distributed ledger mankind has ever seen. But blockchains can be used for various other purposes as well. It has applications in art, medical records, finance, identity, and even legal contracts. But if a blockchain is not distributed among many individuals and instead run by one government, organization, group or person, then I believe it is not at a blockchain at all. A centralized system like that is simply another database. Thus a distributed ledger technology represents a significant innovation and has immense potential to revolutionize the world and change the way we perceive money.

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