What is Blockchain? How does it work?

Understand Blockchain, the network underneath BitCoin, with a real-world example

Blockchain is a protocol designed to eradicate middlemen like banks while making financial transactions. Since Centralised Authorities like Banks are removed, Blockchain is considered a Decentralised Network.

Quick Side Note

Some of the terms mentioned might seem alien, but try reading through, because every aspect is explained at some point.

But why is Decentralisation needed? More importantly, what is Decentralisation?

Traditional Financial structures are rigid and have centralised authorities like Banks. Given the amount of power these Banks possess, the executives running them can essentially make risky financial plays to manipulate the market. While the banks get bailouts if things do not work out. The average customer whose money is locked up in these banks is left to lick his wounds. Decentralisation has been introduced to solve this problem. With DEC, the centralised authority would become obsolete. Transactions can go forward between people without the need for banks via P2P(or Peer to Peer). Blockchain was created as a brainchild of the decentralisation revolution. Blockchain essentially is a network that enables transactions between people. Since the coins are sent and received without a centralised authority, it would require validation or security measures to ensure the transactions are valid and securely taking place. Blockchain Consensus Mechanism takes care of this. Every Block entered into the blockchain has to be approved by miners(computers set up by people around the world). Only after the majority of miners approve, the block is entered into the ledger(a chain of blocks) and the transaction is complete, each block contains approximately 2759 transactions and one block is entered every ten minutes, so if you send cryptocurrency to someone, it would take at least 10 mins for the transaction to complete. This method also prevents double-spending(making the same transaction twice although one does not have the money), because once a transaction is entered into a block, it’s immutable so there is no way to send the same transaction again.

An example of how Blockchain works (this example considers bitcoin)

Assume A has 1 BTC(Bitcoin) which he wishes to send to B. A would log in to the crypto exchange he uses or open his crypto Wallet and choose the option send. When he clicks send, he would be asked to enter the recipients Public Address, A Public Address or Public Key is basically like a bank account number given to you after you open an account on a cryptocurrency exchange like Binance or after you create a crypto Wallet(a place to store your coins if you are a long term investor). In this example, A has to enter B’s Public Key, something B would be able to provide to A.

After A enters the key and confirms the transaction(usually through 2-factor authentication). The transaction is considered confirmed by the owner and is sent to the blockchain network, where it waits to be added to a block. After the Transactions is added to the block along with 2758 other transactions (remember A is not the only person with bitcoins), Miners/Validators will have to solve a complex cryptographic equation to validate the block. The Miner in this scenario is just a high-end computer, you and I can also become a miner but it takes around 6000 USD to buy a computer capable of mining. This equation is closely related to the block because every block contains a little number called the nonce(some random code) and the miner/computer will be tasked to take the nonce, do some computing and return a hash(a random string).

But the hash has a condition, it should begin with a bunch of zeros. The Nonce of the block is designed in a way that only the correct solution would give the hash with the right number of zeros, the resultant hash would look something like 000000000ADGWYOPG. The First Miner(Calling him Miner 1) to find the correct hash lets all the other miners know that he found the hash and after all the miners validate this hash(check if the hash is right), Miner 1 gets to add the block to the ledger and Voila!!

The 2759 transactions in the block are completed. And A had finally sent 1 Bitcoin to C, which probably took him about 30 minutes. For all the trouble the miners had to endure, spending 6000 USD on a computer and enough electricity to power a two-story building, Miner 1 would receive 6.25 Bitcoins(the current reward) plus some transaction fees. These rewards are insane as the Current Value of Bitcoin is 40000 USD. To dive deep into the workings of bitcoin, read Bitcoin’s Whitepaper.

The Miner I kept blabbering about is nothing but an expensive computer capable of handling a high hash rate. So you don’t have to be a genius to solve these equations and add blocks. All you need is 20000 USD, 10000 for the computer setup and another 10k for electricity, Give or take. Although you can mine for a lot less money as well.

The Blockchain mechanism explained above is similar for almost all coins. For instance, DogeCoin works on the same principles as Bitcoin does. The only difference is the block interval, Dogecoin create a block every minute unlike bitcoin, which creates a block every 10 mins

We’ll talk about Ethereum, a protocol/network similar to BitCoin but has some structural differences, in the next article. Stay tuned!!!

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