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What is Blockchain?

When most people think of blockchains, they are referring to the decentralized or public blockchains like Bitcoin. But is worth mentioning this technology can also be used to build centralized blockchains, which have some advantages for corporations over the public ones.

But what exactly is a blockchain?

A blockchain is a distributed ledger, similar to a database, but rather than being controlled by a central authority (i.e., a firm like Google, small company, or individual) the ledger is dispersed across multiple computers, which can be located all over the world and run by anyone with an Internet connection. At its core, a blockchain is a ledger through which data is added and updated in real-time via consensus of the different nodes running the software in the network.

However, once the data is added to the ledger, it cannot be removed or edited like with a database. This is a product of the overall design of blockchains. 

Why a chain?

At a high level, a block is composed of  a list of data, and the “chain” is a stack of the blocks of data continually that grows over a specific period of time. If a transaction is embedded deep in a blockchain (i.e., earlier in the chain’s history), it becomes exceptionally challenging to alter that data — making blockchains a unique medium for storing valuable data.. 

Imagine a digital tower of blocks, where a new block of data is added to the top every 10 minutes from the original “genesis” block at the base of the tower. This is what occurs in Bitcoin, and the data in each block is comprised of financial transactions broadcast by users of the network along with the cryptographic proofs that those transactions are valid.

Why blockchain was created?

One of the core components of blockchains that enabled them to materialize is their use of consensus. But to understand consensus, we need a brief history of why Satoshi Nakamoto, the anonymous creator of Bitcoin, created a blockchain in the first place. And incidentally, it gives an excellent overview of a significant problem that blockchains solve. 

In the conventional financial world, banks and clearinghouses serve as the ultimate arbiters of the account-based financial hegemony. If Alice send $100 to Bob, then $100 is deducted from Alice’s bank account and credited to Bob’s account. However, the actual settlement of the transaction (when the bank clears the transaction as valid) can take several days on the back-end. 

The clearing is performed by clearinghouses and a series of other financial institutions that verify the authenticity of the transaction and that Alice has the requisite funds to send to Bob. Clearinghouses, however, are centralized entities that are subject to external influence from governments or other organizations. 

In the budding world of cypherpunks and digital currencies in the 2000s, a primary problem was how to circumvent a central clearinghouse with a purely digital currency. Known as the “Double Spend Problem,” there was no way to validate that, had Alice sent Bob $100, that she couldn’t just turn around and spend that same $100 again. If Alice handed Bob $100 in cash, she cannot spend that same $100, but the process is more complicated in the digital world without using a central clearinghouse. Enter blockchains. 

A peer-to-peer network

Bitcoin Blockchain is a peer-to-peer (P2P) network, meaning that there is no central entity. Instead, all “peers” in the network are equal and serve as validators of the state of the ledger. However, whereas central clearinghouses determine the state of ledgers in conventional finance, Satoshi Nakamoto realized that converging on the accurate state of a blockchain ledger in a P2P network required an innovative method that did not sacrifice the decentralized nature of the network — known as consensus.

Peer to Peer network

In Bitcoin, remember that a new block is created and added to the chain every 10 minutes. Those blocks are determined to be valid and appended to the blockchain by the distributed nodes in the network — no clearinghouse. They perform this function via Nakamoto Consensus, which is a version of a concept known as “Proof of Work” or Byzantine Fault Tolerance in distributed computing.

Through a series of clever game theory incentives, cryptography, and distributed consensus, a blockchain can achieve secure and accurate consensus on the state of the ledger, just like a central clearinghouse, but over a decentralized network where no single entity is in control.   

Cryptography in blockchains makes the verification of data (i.e., transactions) trivial, and nearly impossible to forge. This task is performed by network operators that run nodes and automatically validate the blocks and transactions in the network through a set of consensus rules, which can be run by anyone with a computer on a public, permissionless blockchain like Bitcoin.

Blockchain consensus protocol

Blockchain applications

Since Bitcoin, the concept of blockchains has extended even further. Rather than using a blockchain strictly for financial data, projects seek to leverage the blockchain as a medium for storing and validating arbitrary data, including anything from social media applications to game data. This is the concept underscoring platforms like Ethereum, which uses a “Virtual Machine” layered over the blockchain as its core settlement layer.

Overall, blockchains are a new protocol architecture that removes the need to trust individuals in a permissionless network, fostering social scalability, and a medium of value transfer free from the control or corruption of malicious parties.

In a blockchain network, storage and data are redundant, meaning that as long as people run nodes (i.e., the software client), there is no central point of failure. As a result, they have achieved significant attention and hype for a variety of uses, some of which are promising and many that are spurious at best. 

how blockchain works

Beyond the hype, blockchains have, if anything, already accomplished a significant goal in technological and monetary history — the creation of Bitcoin.

January 29, 2024

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