The blockchain is the mother of cryptocurrencies; and, without it, the modern-day cryptocurrencies cannot see the daylight. In this article, we explain what blockchain is and how it works. You don’t have to be a techie to understand it. Hence the title: blockchain explained the easy way. To understand blockchain, let’s look at why blockchain is needed in the first place.
Blockchain explained in 5 points
1. Why was blockchain invented?
Satoshi Nakamoto, the unknown entity behind Bitcoin – the most popular cryptocurrency to date, was unhappy that we need to trust a third party to perform transactions online. Look at your credit card spends. You get your credit card from a bank. And the merchant has to set up a payment processing system on his online store, which is, in turn, provided from a third party.
When there is a dispute, your bank or the payment processing network will address the issue. Cash payments, however, do not need a third party. They can happen just between any two people. Satoshi Nakamoto wanted to bring the flexibility of cash transaction to the online world. And he invented Bitcoin. The underlying technology of Bitcoin is blockchain. Now, you understand how blockchain fits into the cryptocurrency picture.
2. Why the name blockchain?
The blockchain is a ledger that anyone can see. It consists of transactions. For example, Bob has 50 dollars and sends 10 dollars to Alice. And Bob says, “Hey guys, I have sent 10 dollars to Alice.” Other people in the network like Charlie, David, Ellen, and whoever listening will take a note of the transfer. And they will update the ledger with the transaction upon agreement.
So, anybody listening for the new transaction would investigate the past transactions available in the ledger to confirm and to eventually enter the transaction into the ledger. Now, Bob has 40 dollars. And he sends 50 dollars to Charlie and says, “Hey guys, I have sent 50 dollars to Charlie.” Now, people like David and Ellen will check the ledger. And they find Bob has only 40 dollars. Then, they relay the message, “Hey guys, Bob has only 40 dollars. And he says he transferred 50 dollars. This is invalid.” The transaction is rejected. And it won’t be written in the ledger.
This ledger, we are speaking of, consists of blocks that are linked to each other sequentially. Hence the name blockchain. These blocks contain valid transactions along with some useful information. Put it another way, blockchain is a series of books that contain successful transactions in an orderly manner. The newly filled book will sit on top of the previously filled book.
OK, that’s fine.
3. But, who gave the money to Bob?
There are two-ways Bob could get the money.
1. While writing the first ever book (or block), the people who initiated the process will say, “From now on whoever publishes a new book will get the fees levied for those transactions in that book plus a set amount of new money.” Apparently, the software generates the new money aka the cryptocurrency.
2. Otherwise, the initiators of the cryptocurrency will say, “Hey! We’re minting X amount of money, and it will be distributed to the following selected people for their contribution and involvement in creating this new currency. The transactional book publishers – aka miners – will get only the fees; nothing else.” Bob might be a miner or someone who involved in the creation of the cryptocurrency. Or his friend might have sent him the funds. Obviously, the ledger can show the source of Bob’s money.
4. Blockchain Mining
The word mining is drawn from gold mining. But it doesn’t completely reflect digging gold sense in the blockchain scene.
Mining is the process of verifying transactions. Typically, the miner builds a block and publishes it. Other miners in the network will check it and accept once the block is validated. That is, the block becomes a part of the blockchain.
Only the miner who publishes a valid block gets the transaction fees plus any new money minted.
So, every miner would rush to publish a block. This will cause chaos. Various mechanisms are kept in place to prevent that. These mechanisms vary from one cryptocurrency to another. One such popular mechanism is proof of work. Here, along with the block, the miner must expend a sizeable amount of computational resources.
This process discourages the miner from cheating or spamming with bad blocks. Because, if the miner found guilty of wrongdoing, his block will be rejected. And he has expended resources, for which he will not get any reward to cover the costs incurred. Also, the process of mining is leveraged to ensure the blockchain’s security, resistance to attacks, and for keeping the blockchain healthy.
5. Oh wait, isn’t it like trusting a third party?
Anyone can have a copy of the blockchain data.
Think about it. Can you have a copy of Visa payment network’s data?
And anybody can become a miner if they won’t violate rules of a blockchain.
Would you be involved in your bank’s operations unless you’re an employee?
Also, any major decision regarding a blockchain will need its community’s approval. The community consists of users, developers – the people who bring the blockchain to life, miners, and merchants who accept the cryptocurrency.
The blockchain is transparent – at least it does a better job than any central bank. And it’s more decentralized – that means no single point of failure. For example, what if there is a 24-hour blackout in the entire U.S.A? It would partly cripple many banks. For blockchain that doesn’t matter, at all. Because it would have miners from all over the world taking care; not just from the U.S.A.
The internet in 90’s was much different than now. Similarly, the blockchain revolution started in 2008 with the invention of Bitcoin. And, it is transforming day by day. Nowadays, the blockchain isn’t just a public ledger. It can do various things like smart assets – maintaining the ownership of real-world holdings on the blockchain, smart contracts – which are self-executing programs that have potential to eliminate lawyers and courtrooms, and many different things.
In the upcoming years, we would see a lot of innovation in blockchain technology.
Hope “Blockchain Explained The Easy Way” gave you a much better understanding of this unique technological approach.