Blockchain Technology

Nikhil Dubey

“Commerce on the Internet has come to rely almost exclusively on financial institutions serving as
trusted third parties to process electronic payments and verify the identity of parties. While the
system works well enough for most transactions, it still suffers from the inherent weaknesses of the
trust-based model.”
- Satoshi Nakamoto (Unknown “inventor” of the Blockchain idea)

The weakness Satoshi is talking about is the need to trust banks in today’s digital transactions. We
still need the third parties to verify our identities through means like usernames and OTPs before
confirming our payment, which are actually easily copied by others and forgotten by the users
themselves. Banks, being centralized, are also vulnerable to sudden hacking which will cripple the
system in one go. Another disadvantage is that these third parties take a lot of time to process large
amounts (Eg: NEFT transactions) and even charge service fees which increases with the amount.

This is why Blockchain is creating waves. It is a trustless and decentralized system that trusts
cryptography and the codes of the computer system itself, instead of relying on others.

How does Blockchain work ?

Imagine two generals who want to attack a common enemy with their armies, and that they can
communicate only using letters. They have agreed that they want to attack, but not on the time of
attack. Now assume that a successful attack requires both squadrons to attack the city
simultaneously. The issue then, is that the two generals must agree on an attack time, and each
general must know that the other knows they have agreed.

This is difficult because acknowledgement of receipt can be lost as easily as the original message.
Thus, a potentially infinite chain of messages is required to reach consensus, which implies lots of
letters and copies. This “Double Spending Problem” or “Two Generals Problem” has riddled
programmers for decades. Blockchain solves the problem by removing the courier itself.

As blockchain is a collective ledger available to all, everyone has bank statements of everyone
else. Blockchain technology makes a collective accounting by distributing a decentralized public
ledger – a complete record of all past transactions on the network. This ledger is the blockchain. It
is on this ledger that Bitcoins are taken and given, with every transfer being broadcast and recorded
on this common ledger.

Step-by-step Example

1. Let us consider a simple example of money transfer between Person A and B. Person A begins by
broadcasting a message to the network that he is sending money to someone.

2. Simply put, he transmits the message “Send Rs.10 to Person B” using his unique “private key”,
which is like an ATM pin, along with a public key which is known to every person on the ledger
(like the address of the ATM itself, it is common knowledge). The correct combination of public
and private key (ATM pin + correct ATM) makes the Digital Signature of A.

3. Person B can now accept the transaction using his own private key, which now has to be verified.
Thus, like A, he also adds his private key and public key to let everyone know that his is, in fact,
Person B.

4. The 2 digital signatures are then combined into one “block” . A block consists of the 2 unique
signatures, a time stamp to show the time of transaction, and a hash function. The purpose of the
hash function is to hide the block as a puzzle so that only a computer find the solution.
5. For the transaction to be completed, the puzzle (which contains the instructions of money
transfer) needs to be solved by at least 51% of the computers forming part of the Blockchain
network. Once a given computer in the blockchain network solves the puzzle, it records it in the
block and passes it to the next.

6. The second computer does the same and adds a new block. Thus, a “proof-of-work” gets
recorded and a chain of blocks is formed, which increases the authenticity of the transaction. Once
51% of the computers have verified the block, Person B gets Rs.10 added to his wallet.

This chain (which are blocks verified by puzzle-solving) forms the permanent record of the
transaction. Once the block is decrypted and verified, it cannot be changed, unlike bank
account books.

Even if you replace the “Rs.10” with 10 Bitcoins, the process will remain the same. The people
providing the computers for forming the chain will be called “Bitcoin miners”, because they
earn a small commission for every transaction they process. Thus, they are rewarded with a few
Bitcoins in exchange for providing their computers, much like the service charges of a bank.