Blockchain is a
shared, distributed ledger that facilitates the process of recording transactions
and tracking assets in a business network. An asset can be tangible — a house,
a car, cash, land — or intangible like intellectual property, such as patents, copyrights,
or branding. Virtually anything of value can be tracked and traded on a blockchain
network, reducing risk and cutting costs
for all involved.
One solution
that has been developed to address the complexities, vulnerabilities,
inefficiencies, and costs of current transaction systems is bitcoin — a digital
currency that was launched in 2009 by a mysterious person (or persons) known
only by the pseudonym Satoshi Nakamoto. Unlike traditional currencies, which
are issued by central banks, bitcoin has no central monetary authority. No one
controls it. Bitcoins aren’t printed like dollars or euros; they’re “mined” by people
and increasingly by businesses, running computers all around the world, using
software that solves mathematical puzzles. Rather than rely on a central
monetary authority to monitor, verify, and approve transactions and manage the
money supply, bitcoin is enabled by a peer-to-peer computer network made up of
its users’ machines, akin to the networks that underpin BitTorrent and Skype.
Bitcoin is
actually built on the foundation of blockchain, which serves as bitcoin’s
shared ledger. Think of blockchain as an operating system, such as Microsoft
Windows or MacOS, and bitcoin as only one of the many applications that can be
run on that operating system. Blockchain provides the means for recording
bitcoin transactions — the shared ledger — but this shared ledger can be used
to record any transaction and track the movement of any asset whether tangible,
intangible, or digital. For example, blockchain enables securities to be
settled in minutes instead of days. It can also be used to help companies
manage the flow of goods and related payments, or enable manufacturers to share
production logs with original equipment manufacturers (OEMs) and regulators to
reduce product recalls. The takeaway lesson: Bitcoin and blockchain are not the
same.
Blockchain
provides the means to record and store bitcoin transactions, but blockchain has
many uses beyond bitcoin. Bitcoin is only the first use case for blockchain.
For example..
Imagine, Joe is
your best friend. He is traveling overseas, and on the fifth day of his
vacation, he calls you and says, “Dude, I need some money. I have run out of
it.”
You reply,
“Sending some right away,” and hung up.
You then call
your account manager at your bank and tell him, “Please transfer $1000 from my
account to Joe’s account.”
Your account
manager replies, “Yes, sir.”
He opens up the
register, checks your account balance to see if you have enough balance to
transfer $1000 to Joe. Because you’re a rich man, you have plenty; thus, he
makes an entry in the register like the following:
Note: We’re not
talking about computers only to keep things simple.
You call Joe and
tell him, “I’ve transferred the money. Next time, you’d go to your bank, you
can withdraw the $1000 that I have just transferred.”
What just
happened? You and Joe both trusted the bank to manage your money. There was no
real movement of physical bills to transfer the money. All that was needed was
an entry in the register. Or more precisely, an entry in the register that
neither you nor Joe controls or owns.
And that is the
problem of the current systems.
To establish
trust between ourselves, we depend on individual third-parties.
For years, we’ve
depended on these middlemen to trust each other. You might ask, “what is the
problem depending on them?”
The problem is
that they are singular in number. If a chaos has to be injected in the society,
all it requires is one person/organization to go corrupt, intentionally or
unintentionally.
What if that
register in which the transaction was logged gets burnt in a fire?
What if, by
mistake, your account manager had written $1500 instead of $1000?
What if he did
that on purpose?
For years, we
have been putting all our eggs in one basket and that too in someone else’s.
Could there be a
system where we can still transfer money without needing the bank?
To answer this
question, we’ll need to drill down further and ask ourselves a better question
(after all, only better questions lead to better answers).
Think about it
for a second, what does transferring money means? Just an entry in the
register. The better question would then be —
Is there a way
to maintain the register among ourselves instead of someone else doing it for
us?
Now, that is a
question worth exploring. And the answer is what you might have already
guessed. The blockchain is the answer to the profound question.
It is a method
to maintain that register among ourselves instead of depending on someone else
to do it for us.
Are you still
with me? Good. Because now, when several questions have started popping in your
mind, we will learn how this distributed register works.
Yes, but tell
me, how does it work?
The requirement
of this method is that there must be enough people who would like not to depend
on a third-party. Only then this group can maintain the register on their own.
“It might make
sense just to get some Bitcoin in case it catches on. If enough people think
the same way, that becomes a self-fulfilling prophecy.” — Satoshi Nakamoto in
2009
How many are
enough? At least three. For our example, we will assume ten individuals want to
give up on banks or any third-party. Upon mutual agreement, they have details
of each other’s accounts all the time — without knowing the other’s identity.
An Empty Folder
Everyone
contains an empty folder with themselves to start with. As we’ll progress, all
these ten individuals will keep adding pages to their currently empty folders.
And this collection of pages will form the register that tracks the
transactions.
When A
Transaction Happens
Next, everyone
in the network sits with a blank page and a pen in their hands. Everyone is
ready to write any transaction that occurs within the system.
Now, if #2 wants
to send $10 to #9.
To make the
transaction, #2 shouts and tells everyone, “I want to transfer $10 to #9. So,
everyone, please make a note of it on your pages.”
Everyone checks
whether #2 has enough balance to transfer $10 to #9. If she has enough balance,
everyone then makes a note of the transaction on their blank pages.
The transaction
is then considered to be complete.
Transactions
Continue Happening
As the time
passes, more people in the network feel the need to transfer money to others.
Whenever they want to make a transaction, they announce it to everyone else. As
soon as a person listens to the announcement, (s)he writes it on his/her page.
This exercise
continues until everyone runs out of space on the current page. Assuming a page
has space to record ten transactions, as soon as the tenth transaction is made,
everybody runs out of the space.
It’s time to put
the page away in the folder and bring out a new page and repeat the process
from the step 2 above.
Putting Away The
Page
Before we put
away the page in our folders, we need to seal it with a unique key that
everyone in the network agrees upon. By sealing it, we will make sure that no
one can make any changes to it once its copies have been put away in everyone’s
folder — not today, not tomorrow and not even after a year. Once in the folder,
it will always stay in the folder — sealed. Moreover, if everyone trusts the seal,
everyone trusts the contents of the page. And this sealing of the page is the
crux of this method.
[Jargon Box] It
is called ‘mining’ on the page to secure it, but for the simplicity of it,
we’ll keep calling it ‘sealing.’
Earlier the
third-party/middleman gave us the trust that whatever they have written in the
register will never be altered. In a distributed and decentralized system like
ours, this seal will provide the trust instead.
Interesting! How
do we seal the page then?
Before we learn
how we can seal the page, we’ll know how the seal works, in general. And as a
pre-requisite to it is learning about something that I like to call…
The Magic
Machine
Imagine a
machine surrounded by thick walls. If you send a box with something inside it
from the left, it will spit out a box containing something else.
[Jargon Box]
This machine is called ‘Hash Function,’ but we aren’t in a mood to be too
technical. So, for today, these are ‘The Magic Machines.’
Suppose, you
send the number 4 inside it from the left, we’d find that it spat out the
following word on its right: ‘dcbea.’
How did it
convert the number 4 to this word? No one knows. Moreover, it is an
irreversible process. Given the word, ‘dcbea,’ it is impossible to tell what
the machine was fed on the left. But every time you’d feed the number 4 to the
machine, it will always spit out the same word, ‘dcbea.’
What if I ask
you the following question now:
“Can you tell me
what should I send from the left side of the machine such that I get a word
that starts with three leading zeroes from the right side of it? For example,
000ab or 00098 or 000fa or anything among the others.”
Think about the
question for a moment.
I’ve told you
the machine has a property that we cannot calculate what we must send from the
left after we’re given the expected output on the right. With such a machine
given to us, how can we answer the question I asked?
I can think of
one method. Why not try every number in the universe one by one until we get a
word that starts with three leading zeroes?
Being
optimistic, after several thousand attempts, we’ll end up with a number that
will yield the required output on the right.
It was extremely
difficult to calculate the input given the output. But at the same time, it
will always be incredibly easy to verify if the predicted input yields the
required output. Remember that the machine spits out the same word for a number
every time.
How difficult do
you think the answer is if I give you a number, say 72533, and ask you the
question, “Does this number, when fed into the machine, yields a word that
starts with three leading zeroes?”
All you need to
do is, throw the number in the machine and see what did you get on the right
side of it. That’s it.
The most
important property of such machines is that — “Given an output, it is extremely
difficult to calculate the input, but given the input and the output, it is
pretty easy to verify if the input leads to the output.”
We’ll remember
this one property of the Magic Machines (or Hash Functions) through the rest of
the post:
Given an output,
it is extremely difficult to calculate the input, but given an input and
output, it is pretty easy to verify if the input leads to the output.
How to use these
machines to seal a page?
We’ll use this
magic machine to generate a seal for our page. Like always, we’ll start with an
imaginary situation.
Imagine I give
you two boxes. The first box contains the number 20893. I, then, ask you, “Can
you figure out a number that when added to the number in the first box and fed
to the machine will give us a word that starts with three leading zeroes?”
This is a
similar situation as we saw previously and we have learned that the only way to
calculate such a number is by trying every number available in the entire
universe.
After several
thousand attempts, we’ll stumble upon a number, say 21191, which when added to
20893 (i.e. 21191 + 20893 = 42084) and fed to the machine, will yield a word
that satisfies our requirements.
In such a case,
this number, 21191 becomes the seal for the number 20893. Assume there is a
page that bears the number 20893 written on it. To seal that page (i.e. no one
can change the contents of it), we will put a badge labeled ‘21191’ on top of
it. As soon as the sealing number (i.e. 21191) is stuck on the page, the page
is sealed.
[Jargon Box] The
sealing number is called ‘Proof Of Work,’ meaning that this number is the proof
that efforts had been made to calculate it. We are good with calling it
‘sealing number’ for our purposes.
If anyone wants
to verify whether the page was altered, all he would have to do is — add the
contents of the page with the sealing number and feed to the magic machine. If
the machine gives out a word with three leading zeroes, the contents were
untouched. If the word that comes out doesn’t meet our requirements, we can
throw away the page because its contents were compromised, and are of no use.
We’ll use a
similar sealing mechanism to seal all our pages and eventually arrange them in
our respective folders.
Finally, sealing
our page…
To seal our page
that contains the transactions of the network, we’ll need to figure out a
number that when appended to the list of transactions and fed to the machine,
we get a word that starts with three leading zeroes on the right.
Note: I have
been using the phrase ‘word starting with three leading zeroes’ only as an
example. It illustrates how Hashing Functions work. The real challenges are
much more complicated than this.
Once that number
is calculated after spending time and electricity on the machine, the page is
sealed with that number. If ever, someone tries to change the contents of the
page, the sealing number will allow anyone to verify the integrity of the page.
Now that we know
about sealing the page, we will go back to the time when we had finished
writing the tenth transaction on the page, and we ran out of space to write more.
As soon as
everyone runs out of the page to write further transactions, they indulge in
calculating the sealing number for the page so that it can be tucked away in
the folder. Everyone in the network does the calculation. The first one in the
network to figure out the sealing number announces it to everyone else.
Immediately on
hearing the sealing number, everyone verifies if it yields the required output
or not. If it does, everyone labels their pages with this number and put it
away in their folders.
But what if for
someone, say #7, the sealing number that was announced doesn’t yield the
required output? Such cases are not unusual. The possible reasons for this
could be:
He might have
misheard the transactions that were announced in the network
He might have
miswritten the transactions that were announced in the network
He might have
tried to cheat or be dishonest when writing transactions, either to favor
himself or someone else in the network
No matter what
the reason is, #7 has only one choice — to discard his page and copy it from
someone else so that he too can put it in the folder. Unless he doesn’t put his
page in the folder, he cannot continue writing further transactions, thus,
forbidding him to be part of the network.
Whatever sealing
number the majority agrees upon, becomes the honest sealing number.
Then why does
everyone spend resources doing the calculation when they know that someone else
will calculate and announce it to them? Why not sit idle and wait for the
announcement?
Great question.
This is where the incentives come in the picture. Everyone who is the part of
the Blockchain is eligible for rewards. The first one to calculate the sealing
number gets rewarded with free money for his efforts (i.e. expended CPU power
and electricity).
Simply imagine,
if #5 calculates the sealing number of a page, he gets rewarded with some free
money, say $1, that gets minted out of thin air. In other words, the account
balance of #5 gets incremented with $1 without decreasing anyone else’s account
balance.
That’s how
Bitcoin got into existence. It was the first currency to be transacted on a
Blockchain (i.e. distributed registers). And in return, to keep the efforts
going on in the network, people were awarded Bitcoins.
When enough
people possess Bitcoins, they grow in value, making other people wanting
Bitcoins; making Bitcoins grow in value even further; making even more people
wanting Bitcoins; making them grow in value even further; and so on.
The rewards make
everyone keep working in the network.
And once
everyone tucks away the page in their folders, they bring out a new blank page
and repeat the whole process all over again — doing it forever.
[Jargon Box]
Think of a single page as a Block of transactions and the folder as the Chain
of pages (Blocks), therefore, turning it into a Blockchain.
And that, my
friends, is how Blockchain works.
Except that
there’s one tiny thing I didn’t tell you. Yet.
Imagine there
are five pages in the folder already — all sealed with a sealing number. What
if I go back to the second page and modify a transaction to favor myself? The
sealing number will let anyone detect the inconsistency in the transactions,
right? What if I go ahead and calculate a new sealing number too for the
modified transactions and label the page with that instead?
To prevent this
problem of someone going back and modifying a page (Block) as well as the
sealing number, there’s a little twist to how a sealing number is calculated.
Protecting
modifications to the sealing numbers
Remember how I
told you that I had given you two boxes — one containing the number 20893 and
another empty for you to calculate? In reality, to calculate the sealing number
in a Blockchain, instead of two boxes, there are three — two pre-filled and one
to be calculated.
And when the
contents of all those three boxes are added and fed to the machine, the answer
that comes out from the right side must satisfy the required conditions.
We already know
that one box contains the list of transactions and one box will contain the
sealing number. The third box contains the output of the magic machine for the
previous page.
With this neat
little trick, we have made sure that every page depends on its previous page.
Therefore, if someone has to modify a historical page, he would also have to
change the contents and the sealing number of all the pages after that, to keep
the chain consistent.
If one
individual, out of the ten we imagined in the beginning, tries to cheat and
modify the contents of the Blockchain (the folder containing the pages with the
list of transactions), he would have to adjust several pages and also calculate
the new sealing numbers for all those pages. We know how difficult it is to calculate
the sealing numbers. Therefore, one dishonest guy in the network cannot beat
the nine honest guys.
What will happen
is, from the page the dishonest guy tries to cheat, he would be creating
another chain in the network, but that chain would never be able to catch up
with the honest chain — simply because one guy’s efforts and speed cannot beat
cumulative efforts and speed of nine. Hence, guaranteeing that the longest
chain in a network is the honest chain.
Longest chain is
the honest chain..
When I told you
that one dishonest guy cannot beat nine honest guys, did it ring any bell in
your head?
What if, instead
of one, six guys turn dishonest?
In that case,
the protocol will fall flat on its face. And it is known as “51% Attack”. If
the majority of the individuals in the network decides to turn dishonest and
cheat the rest of the network, the protocol will fail its purpose.
And that’s the
only vulnerable reason why Blockchains might collapse if they ever will. Know
that, it is unlikely to happen but we must all know the vulnerable points of
the system. It is built on the assumption that the majority of a crowd is
always honest.
And that, my
friends, is all there is about Blockchains. If you ever find someone feeling
left behind and wondering, “WTF is the Blockchain?” you know where you can
point them to. Bookmark the link.
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