What Is the Blockchain?
Some say that the Blockchain is a chain of blocks. It sounds funny in the beginning, but after the first impression, this sentence brings many questions: "What is a chain?", "What is a block?", "What kind of information does the block contain?", etc
Imagine this is 1998, and you have just read a paper published by an engineer called Wei Dai, which describes a new electronic cash system that is based on a protocol which does not require any real money or checks to transfer funds from one account to another. This was an era before the credit cards became so popular and before PayPal (PayPal was established in December 1998 as Confinity).
Wei Dai claims that a community should own the money, not one centralized organization, company, or individual, and the owners should be anonymous. All parties are identified only by a number or a public key. The system described by Wei Dai and inspired by Tim May's crypto-anarchy should cover a couple of aspects in his opinion: No one owns the system (neither the government nor a single institution) In a traditional banking system, one organization — the bank — manages the funds that others put into their account. At this point, the Bank as the owner permits to transfer money from one account to another and confirms this transfer. The bank calculates the current money balance available on the account. In the result, the Bank can manage the funds in whichever way they choose to — it is possible to reverse or cancel the transfer, block your account, or add some limitations. The question is, if the Bank can do all of this stuff with your account, does it mean that you still own the money? A decentralized financial system may be a solution for this problem. If nobody owns the system itself, nobody can change the rules or agreements alone. It should provide an efficient medium of exchange the money The main purpose of having money is to exchange it for some goods. Transferring funds from one account into another is one of the fundamental features of any financial system. Moreover, making a transfer should be as easy and secure as possible. Nobody likes to write a check with all the mandatory information and then confirm in the Bank that this specific check is valid, and the owner has enough funds on his account. In the best case scenario, the transfer should be a short message that says: "The Xnumber of B-money, should be transferred from Account A to Account B. Transfer signed by A-Account Owner." It should provide a way to enforce contracts In the real world, all rules or laws from a specific country apply between the transaction parties. In the Blockchain there is no room for interpretation or misinterpretation, it should provide a mechanism based on conditions and numbers. If two or more sides agree to the agreement conditions and all requirements are qualified then the payment or the transfer should be done automatically. The system exists because of cooperation of all participants. This rule is an implication from the first one — no one owns the system. That also means that anybody who wants to participate in the system needs to cooperate to keep this system running. All transfers, contracts, and actions should be computed and confirmed by the participants. It should be fully anonymous Because the system is distributed and every participant has a copy of all information, that makes the system quite transparent. However, nobody wants to share all the information about their financial transactions with the world. That means the system should also be anonymous. The proposed solution is to change the names into numbers and do not add any additional fields to transfers. As a result, the accounts or the transfers cannot be identified, because they are just numbers, i.e., some amount of B-money are transfers from account 1111 to account 2222 signed by 3333. The protocol did not describe how it should be done, but the general idea, which is to create a decentralized system where all nodes have their own copy of the same database keeping information about all users, transactions and the current state of this system. The question is how to keep those nodes or servers continually working, how to encourage their owners to participate in the system and how to secure the information from all vulnerabilities. And the answer is always the same — money.
Where the Money Comes From
Usually, in a traditional financial system, the government is responsible for printing and distributing money. In the system where everything should stay decentralized and none should be able to make or generate the money without a clear agreement with other participants, the question where the money comes from becomes pretty solid. The system cannot be opened with one address that owns and distributes all funds. Wei Dai proposed to reward the users for solving specific, complex calculations with some amount of virtual units — B-money. The computations should be quite complicated to perform, but easy to confirm by others. Moreover, all the work done by the servers should be useless and worthless, so there may be only one reward for doing them — the B-money or any other virtual currency. I.e., let us imagine a problem to compute that takes 100 hours to solve on a typical machine. Those 100 hours may be rewarded with 1 B-money coin, the same amount of funds that were required to perform the computations.
Bitcoin — The First Blockchain Implementation
In 2008, an individual or an organization called Satoshi Nakamoto published a manifesto that described a possible implementation of a new virtual currency. In January 2009, this cryptocurrency was presented to the world — the Bitcoin. The idea behind Bitcoin was to create a system that meets Dai Wei’s B-money description and provides a solution for all the problems pointed out 10 years prior. Because Bitcoin was the very first fully-functional and widely accepted blockchain implementation, and because most of the new systems and applications that are working with the blockchain are based on the Bitcoin mechanism, all further information about the blockchain will apply to Bitcoin.
Bitcoin was mentioned for the very first time in October 2008, by an individual or organization called Satoshi Nakamoto. He or she published a paper on a Cryptography Mailing list explaining a new idea of a cryptocurrency called Bitcoin that was decentralized, transparent, anonymous, and cryptographically secured. On the 3rd January 2009, they published the Bitcoin software and mined block 0. Until mid-January, all mined funds remained untouched. Satoshi mentioned that Bitcoin's purpose is to handle micro-transactions without any broker between the sender and the receiver, i.e., without a bank or a government that could block your assets, cancel the transfer, or freeze the account. With Bitcoin, you are the money owner with all the rights and obligations. It is a huge responsibility. If you transfer funds to a wrong account or even to the wrong network (that happens surprisingly often), it will be gone.
Bitcoin can be described as a ledger of transactions. Every transaction can be explained by a simple sentence. Some amount of funds is transferred from address A to address B and signed by A's owner with their private key. This sentence introduces a couple of terms that are fundamental for Bitcoin — the address, the transfer, and the private key. There are a couple more that I will explain — a block, a confirmation, etc.
Imagine that you write this sentence on a piece of paper and give it to your friend. He also wants to make a transfer, so he writes his own sentence below yours in the same format — word for word — and changes only the A, B, and private key variables. The paper goes to the next person until there will be no more place to write or until the time frame will end. After 10 minutes, the paper is put on the stack, on the top of other similar papers. This stack is the blockchain, a single piece of paper is a block, and the sentence you wrote is a transaction. Bitcoin is a digital currency, and the general perception of the money transferring mechanism seems to be pretty similar to Internet Banks. I bet you have one or two open accounts in some Internet Bank. Those accounts are just numbers. To get access to those accounts and manage your money, you need to enter your username and password. When you log in to the bank’s website, it is possible to make a transfer by filling the amount, a title and a receiver’s address. In most banks, it is not mandatory to put all information about the receiver, like the name or address. Bitcoin generally works in the same way and may be compared to the Internet Banks, but with few differences.
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