You are reading a lot about the Blockchain and Bitcoin in the news, the incredible interest rates offered on ethereum or by platforms like BlockFi or Nexo, the waves of regulations that its facing, but fundamentally, you don’t understand what this technology is all about? I will try my best to make it easily understandable by everyone.
The record-keeping technology behind the Bitcoin is the Blockchain. It is a relatively complicated technology, if you decide to dive into all the details, However, its core concepts and applications in the real world are quite simple.
I will try my best to make it easily understandable by everyone. Briefly, the original Blockchain used as a protocol for Bitcoin transactions is a database/ledger with the following characteristics:
The ledger/database is collectively maintained and updated by the different participants of the network (these are called nodes), rather than being centralized in a fixed location (e.g. a central server). The data of the Blockchain are duplicated across the different nodes, rendering them persistent. Thus, every participant can verify the database, without the need of a central authority. This peer-to-peer network adheres to a « consensus protocol » for validating new transactions.
The Blockchain is updated through a consensus protocol, the “proof-of-work” protocol that intends to maintain a network of honest members by replacing the central authority with incentives and rules. It is a particularly power consuming protocol. Tersely, a special type of network’s participants, called miners, compete with each other. They are all using their computer power to solve a difficult cryptographic puzzle. The winners will have the possibility to add data to the Blockchain, and are recompensed for it.
The cryptographic functions used in the Bitcoin’s Blockchain ensure that the sender owns the Bitcoins he wants to send as well as decides how a transaction is added to the database. Transactions are grouped by the network into what is called “blocks”, at a certain frequency. Each block contains a defined number of transactions and a link to the previous block and contains a timestamp. Thus, all the blocks are put on the ledger, one after another in time and all blocks are linked using cryptography. The blocks are therefore arranged as a network, a time-related-chain, the Blockchain.
It is noteworthy that a decentralized database also relies on a similar principle of consensus as a Blockchain. However, this consensus will not necessarily construct the distributed database as a chain of blocks. In other terms, a distributed ledger is not necessarily a Blockchain, but a Blockchain is a distributed ledger.
Concrete Example: A Bitcoin Transaction
The full detail of all the steps for a Bitcoin transaction is beyond the scope of this blog, and relies on complex mathematical and computer science resources. However, when two people (Alice and Bob) want to conduct a Bitcoin transaction the whole process can be summarized as the following:
- Creation of Bitcoin wallets. Both Alice and Bob need to have a Bitcoin wallet, enabling asymmetric encryption. This wallet stores two keys, a private and a public key. These two keys are one of the essential cryptographic components of Bitcoin’s Blockchain. The private key is a secret number which allows the owner to connect to its Bitcoin wallet and to send Bitcoins to another user (this private key should be stored in a safe place). The public key is a number that is used to receive Bitcoins (the public key for the sake of simplicity can be seen as a Bitcoin address). The wallet in itself does not store any Bitcoin.
- Creation of a Bitcoin transaction. If Alice wants to send five Bitcoins to Bob, she will first connect herself to her Bitcoin wallet using her private key. Then she will create a transaction that will state that the amount of Bitcoin in her account should decrease by 5 and the amount at Bob’s address should increase by 5. This transaction will also contain both her and Bob’s public keys. The transaction and Alice’s private key is also used by a signing algorithm to create a Signature.
- Submission of the transaction. Alice’s Bitcoin transaction along with her public key and the signature is broadcast by her wallet to the Bitcoin’s network.
- Confirmation of the transaction and mining. Using Alice’s public key, the signature and the transaction, a miner on the Blockchain network can authenticate Alice’s transaction and confirm that she has enough Bitcoins. The miner can then create a block of transactions (which have all been authenticated) through the “proof-of-work” protocol.
- Broadcast of the Blockchain update and agreement. The miner appends the new block to the Bitcoin’s Blockchain. The miner then broadcasts the updated Blockchain to all nodes. The nodes will now try to agree on the validity of the new block
- Reward and confirmation. Once the nodes have accepted a new block, the miner at its origin will receive a reward and the wallet of Alice and Bob’s will confirm the transaction.
As we have seen, the original Blockchain used as a protocol for Bitcoin transactions can be defined as a digital, public distributed ledger of transactions. The Blockchain is updated through a consensus protocol, the proof-of-work protocol, with each block chained to the previous block using cryptography.
As described, the Bitcoin’s Blockchain is a database, maintained and updated by participants of the networks rather than by a central authority, like a bank. The transactions are entrusted to mathematical functions and codes and not to a bank. Thus, on Bitcoin’s Blockchain, everyone can actually see everyone else’s transaction providing transparency to this database, which is the opposite of banks, where you can only see your account balance and your transactions.
Bitcoin’s Blockchain is said to be transparent, while at the same time maintaining pseudonymity. Bitcoin is not an anonymous currency. Indeed, by design, the address to which you receive Bitcoin is your pseudonym. If by any means, your address is linked back to your identity, as all transactions involving your address are stored in the Blockchain, it will be easy to track everything back to you.
In conclusion, here is a very cool video by Wired, that explains the Blockchain at 5 different levels of increasing complexity. In case my article was too complex, have a look at the video’s first levels and re-read my article, everything will be clearer. On the other hand, if this article complexity was not high enough, have a look at the latest complexity levels of the video, they are very informative!
- Belin, O., 2017. The Difference Between Blockchain & Distributed Ledger Technology. Available at: https://tradeix.com/distributed-ledger-technology/.
- Moujahid, A., 2018. A Practical Introduction to Blockchain with Python. Available at: http://adilmoujahid.com/posts/2018/03/intro-blockchain-bitcoin-python/.