What is the Blockchain?

We can’t understand the underpinnings of Bitcoin without referring to the backbone technology that facilitates bitcoin transactions: the blockchain.

The blockchain is a decentralized database that is immutable, meaning its contents are impossible or very resistant to change, and that can hold various types of information for a long time — a perfect tool for financial systems, tracking and maintaining ownership, managing identities, and enabling students to safeguard their achievements.

There are thousands of possible applications for blockchain technology, and every day it seems new use cases are being created for it.

How the Blockchain Works

‘Blockchain’ and ‘distributed ledger’ are synonyms, and can be understood to represent a single concept.

Imagine the ‘ledger’ as a sheet of paper with many transactions written on it, i.e. ‘Stephen paid Josh $10; Josh paid $5 to Sarah, etc…’ and this sheet of paper is the only account of the transfer of value.

In a traditional financial system, there’s only one copy of this sheet of paper, and it’s being monitored and managed by a financial institution such as a bank. In Bitcoin, everyone has a copy of this sheet of paper, and nobody, in particular, is a trusted authority that everyone comes to when there’s a dispute about the state of affairs.

Instead, there are special nodes (people running specialized computers) called ‘miners’ who compete with each other to check and validate the transactions by solving complex mathematical problems on their computers. As soon as a mining node validates a transaction, it broadcasts it to everyone in the network so they can edit their sheet of paper with the latest information.

Since multiple people are validating a transaction it’s that decentralization that provides the real benefit of the blockchain. It provides a record of transactions that are transparent and cannot be changed unlike a centralized system that can be tampered with.

As a reward for the work that the miners have invested into the maintenance of the network, or using our analogy, for the ‘editing of the sheet of paper’, they’re rewarded with newly created bitcoins in what is called a ‘generation transaction’. This is essentially how new bitcoins are created ‘out of thin air’.

The Double Spending Problem

From the get go, Satoshi Nakamoto faced the demon widely known as the ‘double spending problem’. Solving this problem through a trusted third party (such as a bank or a clearinghouse) is more than possible, however, it does not allow for other important principles to be followed.

Third parties would significantly compromise anonymity, present a centralized point of failure, and would not completely prevent censorship.

Having a peer-to-peer network managed to solve this double spending problem, by asking each and every one of the participants on the network to help with confirming, collecting, and tracking all of the information related to transactions.

Miners have the job of calculating the proof-of-work algorithm that is necessary to create new blocks on the blockchain, while nodes are responsible for collecting new transaction information and packing it into blocks.

Nodes are also responsible for communicating with the rest of the network and achieving consensus, based on the longest blockchain available.

Thus, the very design and underlying operating mechanism of the blockchain inherently takes care of the double spending problem.

Page 7 – Trading and Investing Bitcoin

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