First and foremost, some of you might think blockchain is Bitcoin, it’s not. Bitcoin or any other cryptocurrency is not blockchain. They are not the same.
Bitcoin uses the concept of the blockchain and it is the technology behind almost all cryptocurrencies. Because it is the underlying technology, it’s important the concept is understood.
Blockchain tries to remove the trusted third party that serves as an intermediary between two parties that wish to transfer money.
In order to remove this third party, blockchain uses three concepts: Open ledger, Distribution, and synchronization.
First principle: The open Ledger
An open ledger is a chain of transaction data (known as a “block“) which is available for everyone.
For example, four people (or “nodes“) wish to transact with each other: A, B, C, D.
Assume in the beginning A has 10 USD (the “genesisblock“) and A wants to move 5 USD to B.
We will add this transaction to a ledger that keeps track of all the transactions done: A moves to B, 5 USD. This transaction or block will be chained to the ledger. Next, B wants to move 3 USD to C.
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Again, this transaction will be added to the ledger. Finally, D moves 1 USD to C. Once more, this transaction will get linked to the transaction ledger.
These simple transactions and the action of adding them to a ledger is the basic idea of the open ledger. It gives that everyone can see who has money and where it was moved to.
Subsequently, if A wants to move 15 USD to C, everyone will immediately see that A cannot do this transaction.
So, it will not get added to the ledger, the block won’t be part of the chain.
Using the above example, we have one centralized ledger, but we want to move away from centralization. This next step introduces the principle of distribution or decentralization.
Second principle: Distributed
A distributed open ledger is the second principle. The chain will take the centralized ledger of the example and distribute it across the network.
Each node in the network holds an exact copy of this ledger.
This removes the centralized ledger and makes it distributed and thus decentralized. However, this introduces a problem. All the copies of the ledger need to be synchronized.
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All the nodes in the network need to have the same version to make sure that a transaction from one node to another can happen correctly.
Third principle: Synchronization
To synchronize the chain over the network the previous example can be used again. From the previously used nodes, B wants to move 5 USD to C.
Before this can happen, this intended transaction gets broadcasted across the network. All the participants will see this unvalidated transaction.
In other, for this transaction to get validated and executed miners are introduced.
These miners will compete amongst themselves who will be the first to take the unvalidated transaction and validate it and put it into the ledger.
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The first miner that does it, will get a financial reward for its effort. In case of the bitcoin implementation, it will be bitcoins.
For the miner to validate it, it needs to do two things. First, it needs to validate that the person can send the money. This is easy because the ledger is openly available.
The second part is for the node to create a key, a hash.
To find this key, the miner needs to invest computational power and time, because this search for the key is random.
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The miner is constantly searching till it finds the key. The first one that does it, gets the reward.
Assuming person D was able to validate the transaction. He will send the transaction to the network.
All the other nodes will see that the transaction has been done. It will thus add it to its ledger. Since this transaction was done, it will search for a new transaction to execute.