Blockchain is a frequently mentioned term today. In many cases, however, the terms blockchain and bitcoin are confused, with a not entirely correct understanding of the meaning of blockchain technology and unclear interpretation of related terms. This article will focus on the basic features of blockchain and the principles behind this technology.
What Is Blockchain
From a technological point of view, the term „blockchain“ has several basic meanings.
- A set of software protocols that enable the implementation of the operation of blockchain as a technological platform.
- Blockchain database that holds transactional records; you can visualize it as a chain or records stored in the forms of blocks which are controlled by no single authority.
- Digital public ledger where all transactions are recorded immutably and kept transparently. The immutability is thanks to the fact that a specific blockchain is distributed across countless computers that are all linked together, making a specific Blockchain Network.
The blockchain is based on two fundamental concepts:
- The block with transactional information.
- The chain, which connects all the blocks in a blockchain through a cryptographic hash.
The term blockchain began to gain public awareness with the advent of today’s most famous cryptocurrency, Bitcoin, the implementation of which was launched in 2009. Bitcoin’s original idea was to enable a credible exchange of assets across the Internet, without the need for mutual or mediated trust.
Some Key Features of Blockchain
- The system works without centralized trust.
- Everyone can check the status of all the other accounts.
- Transactions are approved in a consensual manner, which is represented by the process of mining.
- Authenticity of transactions is protected by asymmetric cryptography.
- Transaction fees are paid for individual transactions.
- The database is distributed (shared) among the individual participants.
- The integrity of the database is strongly protected by the process of mining and chaining of blocks.
Basic Principles of Blockchain
Let’s describe the individual principles of the blockchain operation on the example of four people, which we will name Allan, Betty, Carl, and Daisy.
Let’s say Betty found herself in financial distress. She asks her friend Allan to send 1,000 units to her account. Allan logs into his internet banking to transfer money to Betty’s account. The bank with which Allan has an account checks the balance of his account and verifies that Allan has at least 1,000 units and makes the transfer. The next day, Betty enters the ATM with a request to withdraw $1,000. The ATM will contact the bank, verifies that at least 1,000 units is in its account, and issues the cash to Betty.
This example demonstrates the transfer of a financial amount using a banking system. A necessary factor in this process is trust in the bank. The value of a currency itself is just a metric that can measure the value of individual assets, and the currency is a representative of this metric. It is therefore quite logical that in order for a given currency to be accepted, it must be issued by someone trustworthy and its value must be properly protected. However, the question is whether this is the only possible way.
Let’s say that Allan, Betty, Carl and Daisy decided to create their own currency to send to each other. In order not to cheat each other, they need to agree on how to ensure each others’ trust. One option is to select one representative, such as Allan, who will manage the balance of everyone’s accounts and approve individual financial transactions. Allan would thus function as a central authority that would fully decide who has how much money to send to whom. But Carl and Daisy don’t trust each other, and they don’t trust the others, so they disagree with the decision. After this disagreement, the friends decide to verify each transaction together. At the same time, however, they realize that there may be situations where not everyone is available at the same time. Then there would be a delay in transactions. Therefore, they introduce the rule that after the transaction is claimed, an absolute majority, i.e. three people, are sufficient for verification.
Let’s say Daisy wants to send 1,000 units to Betty. Daisy creates an order to send 1,000 units to Betty’s account and sends a request for approval to everyone. Everyone who receives a notification checks to see if the transaction is OK; if it is OK, they send a confirmation to others to let them know that they approved the transaction. Once this transaction is confirmed by at least three participants, it is accepted, thus, Daisy has 1,000 fewer units on her account, and Betty has 1,000 more units on her account.
Questions and Answers
Blockchain has taken this very path, in which there is no centralized trust. But as the example shows, several questions arise here.
- How do we know that the transaction was really sent by Daisy and not, for example, by Allan, who would pretend to be Daisy?
- How do we know how much Daisy has in her account?
- What if Daisy has exactly 1,000 units on her account and creates two transactions at the same time, one claiming to send 1,000 units to Betty and another 1,000 units to Carl?
- What if someone decides not to confirm the correct transactions and thus restricts the execution of transactions?
- What if Betty says one day that she never received the 1,000 units from Daisy?
Q: How do the others know that the transaction was really sent by Daisy and not by Allan, for example?
A: The fact is, the others don’t know. They cannot know. The individual transactions show the account number of the sender, the recipient, and the amount transferred, but not the names of the account holders. If we looked at the transaction itself, we would not find that Daisy sent 1,000 units to Betty, but we would only see that 1,000 units went from the account XXX to the account YYY. And since there is no centralized authority in this system, no one can know who those accounts really belong to. It is this degree of anonymity that is sometimes criticized by the opponents of Bitcoin.
Q: How do the others know that the sender’s account listed in the transaction is actually the account from which the transaction was sent?
A: Blockchain uses asymmetric cryptography for this. A pair of cryptographic keys is generated for each account, one referred to as the private key and the other as the public key. The private key is known only to the account holder, the public key can be seen by everyone. If a transaction is to be sent from a given account, this transaction is first digitally signed with a private key. Others who are to review the transaction will first verify that it was actually sent from the account that is listed as the sender. And that is done by checking the digital signature with the public key.
Q: Why doesn’t blockchain use certificates?
A: In order for blockchain to work with certificates, there would have to be a central trusted authority to issue these, but such an authority does not exist, as it would be against the core principles of blockchain.
Q: How do the others know which public key to use to verify a signature on a given account?
A: The account numbers are not generated randomly, but are derived from the corresponding public key. If someone receives a transaction for which they want to verify the digital signature of the sender’s account, then based on the account number itself, they know exactly which public key to use. Thus, it is clear that once someone has a private key, they are able to create valid transactions and thus fully control the account. The entire protection of the account thus consists in securing the private key, normally stored in the so-called crypto wallets, which can take the form of software as well as hardware.
We have discussed the basic principles and key features of blockchain and dealt with some of the most common questions. In the second part, we will address some more questions related to blockchain technology.