As the name suggests, the blockchain is a time-sequential ‘chain of blocks’. A block can be thought of as a parcel of transactions which have been unanimously agreed upon as being valid. Each block is cryptographically connected to the previous block, with the chain of all blocks being shared (distributed) across millions of computers across the globe. What is truly genius about the Nakamoto whitepaper, is the mechanism by which blocks are validated across this distributed network, simultaneously forming a consensus without relying on a central database.
At the heart of the blockchain, is what’s referred to as a cryptographic hash function, and in the case of Bitcoin, it is specifically the SHA-256 hash function. The SHA (Secure Hash Algorithm) is one of a many-number of cryptographic hash functions, related to, but not to be confused with ‘encryption’ algorithms. A cryptographic hash is like a signature for a text or a data file, it is a one-way function and cannot be reversed — in the same sense that your personal fingerprint is unique to your DNA, yet your DNA cannot (to my knowledge) be reconstructed from an image of your fingerprint. It is deterministic (meaning that two independent computers with the same data and same parameters will produce the same result, every time) and relatively fast to execute. making it suitable for password validation, challenge hash authentication, anti-tamper, digital signatures. Crucially, in the case of the blockchain, the hash algorithm is used, with a slight twist, to ensure that the blockchain is not, and has not, been tampered in a malicious manner.
Without getting into the fine-grained nuts and bolts, the Bitcoin Blockchain works like this:
- People are out in the world spending their digital money.
- Each potential transaction goes into a pool of unconfirmed transactions.
- Now there is basically a computerized arms race going on around the world to be the computer (or pool of computers) that builds the next block, and confirm some of the transactions.
- Each computer takes a bunch of the unconfirmed transactions and attempts to build a new block, solving a cryptographic puzzle using the SHA-256 algorithm.
- Once the puzzle is solved, the proposed solution is announced. Since hash functions are deterministic, anyone else with the announced parameters can check rapidly and easily.
- Consensus with the proposed solution is indicated when other computers check the proposed solution, accepting the block and discarding their work in progress.
- The computer that solved the puzzle is rewarded with transaction fees + Bitcoin reward, which is held within the first record of the next block.
- The whole process starts again.
Now because the cryptographic puzzle used in Bitcoin mining (referred to as proof of work) is deterministic and dependent on the state of the previous block, then this means that the solution is unique to the ledger in its present state. Malicious tampering to the ledger would mean that all the work would have to be re-done, which is computationally infeasible. The probabilistic likelihood of this occurring has been addressed towards the end of the Nakamoto paper.
The bitcoin reward is what introduces (ie mines) NEW bitcoins into the blockchain. The amount diminishes with time and is therefore anti-inflationary since it diminishes in such a way that only 21 million coins will ever be mined. 21 million is the upper-bound asymptotic amount of bitcoins that can ever exist. At the moment, 12.5 BTC is the reward per block, a couple of years ago it was 25, in about 900 days, it will reduce to 6.25 and so forth. When the full 21 million coins have been mined, the only way to reward miners will be through the transaction fees. The transaction fees and Bitcoin reward provides a mechanism to compensate the computer owner for their efforts (electricity, hardware, etc). This process is referred to as Bitcoin Mining.
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