As the foundation of Bitcoin, the blockchain has made headlines, it is praised as a technological marvel. What is behind it, how does the blockchain work?
How the blockchain came about
It is no exaggeration to say that Blockchain, along with the Internet, is one of the greatest inventions of humanity. Does it solve a fundamental problem: How can anonymous users on the Internet send each other money without having to trust a central server?
Trust is necessary when money is transferred electronically. This is unaware of most of us because we have become so used to our banking system. For example, we trust our bank that it does not suddenly reverse a transfer that has been made, so we lack money.
For years, the cryptographic community worked on peer-to-peer (peer-to-peer) currencies, which, like BitTorrent, should work without central servers, ie without banks.
The problem was the lack of trust among anonymous users: If the payment history is not on a server, but distributed over many nodes (called “node” in the peer-to-peer world a single computer), how can you node prevent it from circulating a fake payment history?
Nobody had a solution to this dilemma. The dream of a decentralized, community-based currency seemed unattainable.
A mysterious hacker who calls himself Satoshi Nakamoto and whose identity is still unclear solved the problem of lack of confidence in 2008. He combined existing technologies such as encryption and hashing in a new and innovative way into a total work of art: the blockchain. Due to its special structure, the Blockchain is forgery-proof, payments cannot be reversed.
The first blockchain application, Nakamoto launched a free peer-to-peer currency: Bitcoin. Many other applications followed, including Ethereum, Ripple, Litecoin, Dash and Monero.
That’s in the blockchain
The blockchain is a way to store data. In Bitcoin, this is transaction data, that is, information about payments: who paid whom, when, how much Bitcoin, etc. From this, the “account balance” of each Bitcoin user can be calculated.
A block contains a certain number of transactions, for example, “A paid 0.1 bitcoin to B”. In other words, multiple transactions are grouped together. When a block is “full”, the following transactions come in the next block. Each block refers to the previous one. So the blockchain is a chain of blocks. Hashing plays an important role here. A hash is a kind of digital fingerprint of data. Every record, every transaction, has its own fingerprint, which distinguishes it from other records.
The transactions from each block are combined into a hash tree. In addition, each block is described by a header. Each header contains the hash of the previous block header, pointing to the corresponding block. In this way, the blocks form a chain.
Each node (computer) in the Bitcoin network has a copy of the blockchain, so it knows the “balance” of each Bitcoin user and the entire transaction history. In addition, each node may add a new block to the blockchain by bundling current transactions.
But what’s stopping a knot from orbiting a fake block or even a fake blockchain that enriches itself?
Satoshi Nakamoto had a simple but ingenious idea: the hash of each block header must be smaller than a certain value. As a result, a node can not simply calculate the first hash. He has to find a suitable hash with brute force. This process is called mining. It’s similar to digging gold: you have to dig something until you find a suitable hash.
Why the blockchain is safe
The process of nodes having to solve a search problem in order to add a new block to the blockchain is called Proof of Work. With the solution of the search problem, a node proved that it had to invest a lot of computing power in the search. This makes the blockchain tamper-proof, Each node simply assumes that the longest blockchain in circulation is the real one, all others are counterfeits. Because in the longest Blockchain logically most of the computing power has flowed, that is, most nodes must have worked on it. This innovative way of consensus building is the outstanding feature of Blockchain.
In the Bitcoin software, the difficulty level of the search problem is set to take about 10 minutes to “find” a new block. All nodes are feverishly searching for a matching hash for the next block. Why? Because the one node that solves the search problem gets a reward. This is currently at 12.5 Bitcoin – that’s over 7,96,076.24 Indian Rupee at the current exchange rate.
Who now thinks, here is fast money to get, is wrong. The computing power in the Bitcoin network is so absurdly high that one wins the lottery rather than finding a new block on the home laptop. Without specialized hardware, you have no chance to survive in the technological arms race of Bitcoin miners. The computing power of the Bitcoin network is 2.81 trillion hashes per second – and rising.
As long as most nodes are honest, the blockchain is safe. If a node wants to bring a fake Blockchain into circulation, it must muster at least 51 per cent of the computing power of the Bitcoin network. Then he can convince the other knots that his fake blockchain is the real one – he can override it, so to speak. Such a 51 per cent attack is virtually impossible. Even if you recruited the 500 most powerful supercomputers in the world for such an attack, you would have less than 0.01 per cent of the computing power of the Bitcoin network together.
Bitcoin is just the beginning
The blockchain is nothing more than a distributed database. In 2008, Bitcoin was the first and only application of this technology. Since then, many more cryptocurrencies have been developed based on blockchains, such as Litecoin, Dash and Monero. The principle is the same everywhere: Thanks to a blockchain, all nodes agree on who paid how much money to whom.
Some cryptocurrencies have features that go beyond Bitcoin. For example, Dash and Monero use techniques that make it difficult to trace cash flows. This allows users to protect their privacy.
Blockchains can do much more. A network called Ethereum uses a blockchain, which allows the execution of small computer programs (scripts). Each user can load their own scripts into the network running on the node. The user pays with the integrated currency Ether. This is how smart contracts can be realized – intelligent contracts. For example, a user can put his own shares in circulation. Scripts guarantee that stockholders have certain rights, such as voting.
However, it is unclear how safe Ethereum is. Due to the high complexity of the software caution is required, there have already been incidents. Nonetheless, some experts are convinced that “smart” blockchains such as Ethereum’s will change the financial system in a sustainable way.