For those who still have these questions in mind ‘What is blockchain?’ ‘How does cryptocurrency work?’ and ‘How does this emerging technology work?’ Take a few minutes and read this brilliant article by Mr Ritesh that provides an easy explanation along with some technical details of the Blockchain concept.
For those that cannot access the article for any reason, we have replicated the article in full below:
Bitcoin, Cryptocurrency, Ethereum — you must have heard about these buzzwords. And maybe the stories of people making a quick fortune out of it, and why not — look at the market capitalization of so-called ‘Cryptocurrencies’ and how it has grown in the last year. Blockchain is the idea which drives them all.
Looking at the chart, you might think that you are late in the game, but a Blockchain-101 now could be like figuring out the internet in 2000 — not too late.
This article is an attempt to provide an easy yet technical details of the Blockchain concept. Hopefully, it will help you understand the core fundamentals of this-new-thing-in-town!
A bit of history never hurts 😉
“What is money?”
Money is an entity which can be used in exchange for goods and services. Then there is another system to keep track of its ownership and transactions — who owns what, who has what, and who owes how much to whom. That is all that money is.
We need a third-party trusted entity to keep track of money, to keep those transactions and deal with the conflicts, if applicable. But that trusted party i.e. the Government, comes with a cost in terms of efficiencies, potential for corruption, extra fees and so forth.
In simple terms, let’s follow these steps and see the money flow in a specific scenario in the USA during 2008 where trust model did not work that well:
- People started earning more money and store them with a central authority (i.e. banks).
- The central authorities/banks started to give-out risky loans to attract new customers and faced significant defaults on such loans.
- Due to the inability of the people to pay back the money, many banks collapsed and filed for bankruptcy.
- Banks were also using people’s money to invest and lost all the money that the customers had trusted them with. In a nutshell, the banks lost the money that the customers deposited with them, leaving the customers no way of recovering them back.
- Noticing the widespread issue, the Government tried to save some institutions by offering people’s money (i.e. tax money).
- As that offering is an extra expense and whenever the expenditure of the Government exceeds its income, Government asks the central bank to print more money and theoretically, there is no fixed limit to the amount of money that a Government can print. In the past days (in USA and many other countries), Gold used to be the standard where you cannot print more money than your gold reserves and arguably, that is a good way to ensure that we use our economy like debit cards. But hey, credit cards are there for a reason and that’s why Roosevelt and Nixon cut ties with Gold. Effectively, the Government can print as much money as they want which brings a bunch of issues.
- Primarily, with more money printing, the value of money gets reduced and the economy gets impacted. As an example, if you have $100 and the country has a total of $ 1000, you own 10% of the money (you must be pretty rich :)). If Government prints additional $1000, you only own 5% of the money and that decreases the value of your money.
This is what happened in the crisis of 2008. Banks giving bad loans was the cause. Printing the money was a mitigation which helped in this specific case.
Six weeks after the crisis, on Nov 01, 2008, something happened that is actually going to reshape the financial world much more than the crisis itself — this guy (or these guys?) named Satoshi Nakamoto invented a decentralized (crypto)currency known as Bitcoin based off a novel concept known as blockchain. The idea was to create a world where any central authority doesn’t control all the money.
“I’ve been working on a new electronic cash system that’s fully
peer-to-peer, with no trusted third party.” — Satoshi Nakamoto
Bitcoin has its problems and it still needs to be tested with a crisis like 2008 but that is just one use-case (blockchain-as-a-payment) and it doesn’t defeat the purpose of blockchain and how it can cut middle-men in different aspects of our lives. With the historical aspects covered, let’s get into the technology behind the blockchain.
So, what is the blockchain?
A blockchain is a decentralized, distributed and incorruptible digital ledger that is used to record transactions across many computers.
A bit complicated? Ok, Blockchain in simple terms is a:
- A distributed network of computers (nodes)
- where each node contains a chain-of-blocks
- where each block contains a ledger with a list of transactions
- where each transaction is incorruptible (i.e. cryptographically secure)
- & is linked to the previous transactions for the resource it is representing.
And what is a crypto-currency? Is it same as blockchain?
Blockchain and Cryptocurrency are not the same but used interchangeably because of the invention which relates them i.e. Bitcoin.
Blockchain is a concept and cryptocurrencies are the applications using that concept to solve real problems. The complete list of cryptocurrencies by market cap can be found here.
I read it somewhere which correctly summarizes the relationship
“Cryptocurrency is to blockchain, what email is to internet”.
We will discuss about generic concepts but once in a while we will take examples from the Bitcoin to understand the blockchain better.
So, let’s break the aspects of blockchain and understand them one by one:
Incorruptible (“crypto” of cryptocurrency)
Everything stored on the blockchain is encrypted. BUT encryption alone is not a complete security and doesn’t make it incorruptible by any means.
So, what does blockchain do to make itself secure? There are three concepts we need to understand :
- Hash Function (H(x)): A function which is used to convert a random set of input to an output of a fixed size. For any input x, H(x) is the value of the hash function.
Hash function needs to have some properties:
- It should be one-way i.e. given H(x), you shouldn’t be able to figure out x.
- Collision free i.e. for no two different x and y, H(x) should be equal to H(y).
Well, looking at the image above, there is no way that a hash function can be collision free, right? Yes, that’s true. But the only motive is to ensure that it is practically impossible for available machines to find the collision.
This property is used in blockchain at the core level and we will discuss about them in a while.
2. Digital Signatures: Digital signatures are like our normal signatures in digital form. They need to have this basic property:
- Only you can sign BUT anyone can verify.
So, given a message encrypted with your secret key (aka password or private key, technically), there is a publicly available key (i.e. public key) which anyone can use and confirm that you wrote this message. No attacker can fake your signature unless your password is compromised.
This property is used in the blockchain to ensure that only the rightful owner can transfer the assets from his account and anybody on the network can validate the transaction. Bitcoin uses ECDSA for digital signatures.
3. Hash Pointers:
Hash pointer is another good data structure that is leveraged in the blockchain technologies.
A standard pointer is an address for the data stored, whereas, a hash-pointer also validates if data has been corrupted by keeping a cryptographic hash (hash function that we discussed earlier) of the data itself.