#Blockchain is defined as the ‘great chain of being sure about things.” by The Economist. We are moving towards a blockchain future where the marginal cost of a transaction drops to zero and peer-to-peer commerce is facilitated by ‘trustless’ transactions.
The blockchain is the subject de jour in 2017. Whether it be bitcoin or the underlying technology behind bitcoin, the ‘internet of value’ is developing quickly.
But how does it work and how does the blockchain facilitate peer-to-peer commerce, creating the backbone for a global digital currency?
The Economist has aptly described the blockchain as ‘the great chain of being sure about things.’ Many others describe blockchain as ‘a giant spreadsheet’ or ‘distributed ledger technology.’ The promise of the blockchain is to be able to efficiently verify that something – a transaction, a land sale, a legal contract – did or didn’t happen. This could happen out in the open on the public blockchain (ie. bitcoin), or behind closed doors on a private blockchain (ie. a group of banks). Fundamentally, the blockchain requires multiple parties (miners or nodes) to verify ‘blocks’ of data and create a ‘chain’ of transactions. The blockchain functions as a secure and tamperproof ledger that enables ‘trustless transactions’ where no central party is required to verify that one individual sent something to another.
The best way to understand blockchain is through the lens of a digital currency transaction on a public blockchain, such as bitcoin (see corresponding diagram):
Download a digital wallet – each digital wallet has a public key and a private key. The public is key is used to receive X digital currency from another user, while the private key is required to sign a transaction or verify that a wallet is his/hers. If a person were to lose their digital wallet, for example, they could retrieve their digital currency by entering the public key and private key. The public key is public, the private key is kept secret.
Send X currency – in the example above, the person on the left (Blue) has 10 units of currency. He wants to send 1 unit to the person on the right (Orange). Blue sends 1 unit of currency to Orange’s public key. To certify this transaction requires the signature from Blue’s private key. This is a metaphorical signature, the user does not physically sign anything, the signature is achieved by cryptography.
Publish transaction to the blockchain – once Blue has signed the transaction for 1 unit with his private key, the transaction is published on the blockchain. This one singular transaction is broadcast and validated by nodes on the network, and then grouped into ‘blocks’ with other transactions that have happened in a similar time period (average block confirmation time is 7-10 mins on bitcoin). These transactions are all ‘hashed’ together using cryptography; hashes are derived from mathematical formulas and are a ‘seemingly random sequence of letters and numbers.’ The hash acts like a wax seal on the transaction. The miners on bitcoin, for example, all compete for a reward (currently 12 BTC) to be the first to hash the block; the first miner to ‘guess’ the right hash for a given block wins the reward and the corresponding transaction fees for all transactions in that block. A node’s only job is to validate transactional data, whereby a miner is looking for new transactions and competing for block rewards. Offering these financial incentives to miners enables a public blockchain (ie. bitcoin) to become secure and reliable. Bitcoin has a ‘Proof of Work’ algorithm that makes is increasingly more difficult to hash the transactions over time; therefore specialty mining equipment is required. Blue’s signed transaction is hashed and grouped with multiple other similar transactions into a block, along with all the corresponding transactional data (block id, timestamp, etc).
Blockchain data is published – once the block is hashed, it is permanently published to the blockchain. The ‘blockchain’ is literally a chain of all the transaction blocks ever published for X digital currency. To tamper with this data would require a large-scale collusion to take over more than 50% of the network (a 51% attack). Now, all nodes on the network have an updated and accurate ledger of all transactions posted on the network. This is why blockchain is called ‘distributed ledger’ technology; the entire network of nodes all maintain the same ledger without any centralized authority to coordinate their activity. The more nodes in the network, the faster and more secure the digital currency is.
Transaction is confirmed – at this point, the transaction is confirmed and Orange receives his 1 unit from Blue. This transaction cannot be reversed or undone because there is no central party that administers the transaction. Fundamentally, the blockchain solves the ‘double spend‘ problem, which prevents Blue from sending 1 unit to Orange and then trying to send that same 1 unit to someone else. Blue’s balance is now deducted to 9 units. The entire transaction can be viewed on the blockchain by anyone using the transaction id (‘txid’). + Blockchain.info
As a whole, the blockchain is a distributed network of nodes; each node contains the updated blockchain ledger, ensuring the integrity and reliability of all transactions posted for the respective currency.
Trust and P2P Commerce
Blockchain is the major innovation behind bitcoin, it is the rails that bitcoin runs on. Many other organizations, globally, are looking for other use cases for the blockchain; however, at the most basic level, bitcoin is already being used as a digital currency to transfer value from one person to another with no centralized intermediary to manage the transaction. It’s not a perfect digital currency, and there are many arguments that it’s more of an asset, equivalent to a ‘digital gold.’ But it can be used by anyone, anywhere, anytime to transfer value to someone else in the world and is the first protocol to enable decentralized value transfer at scale.
While technologically there is a lot to improve on with the bitcoin blockchain, it has now been operational for eight years. Thus it stands as the only major public blockchain on the global market, although there are many others currently in development.