Blockchain basic applications I: crypto currency

If we look at how a normal bank normally handles this, we see the principle of the general ledger. Transactions - deposits, payments, withdrawals and receipts - are all recorded centrally in a ledger and kept there. The bank thus has an overview of all money flows and guarantees that your balance based on the ledger really belongs to you. This is a safe and orderly thought for yourself and for others.

Trust

But how can you rely on that to happen without such a bank? After all, if no one centrally holds your property (or debt), can you trust that someone else (a peer) will have real money to pay you right away or that someone else will actually deliver something after you pay them?

The answer to this consists of several steps :

1. The creation of a blockchain in which all transactions are recorded in blocks, digitally signed, so that they cannot be changed just like that afterwards .
   So, a hash-based ledger that contains the complete history of all transactions, which we know to be correct and with which we can verify whether someone who wants to make a subsequent transaction (still) has the means to do so.
   
2. The creation of a large number of copies (nodes in a peer-to-peer network) of such a blockchain (ledger) for an unlimited number of anonymous users (the peers). In it, all the nodes know the same, complete transaction history (size, time, nodes).
   So a distributed ledger.
   
3. The creation of digital encryption keys (private keys and public keys), used for decentralized approval and handling of transactions (i.e., payments and receipts) between nodes.
   Elimination of the need for controlling intermediaries, who centrally manage or control the transaction records: banks, governments, accountants, notaries.

If the signature is approved, it can be placed in the latest/last block to become part of the transaction history in this blockchain and will also show whether - based on that history - the transaction can proceed as such.

Miners

And with that, the next urgent challenge starts: how do we create a new block in a chain that satisfies all nodes? After all, the power of a distributed ledger is that all participants know the same transaction history and approve new blocks together.

For this purpose, we introduce the concept of miners. These are nodes that can add new blocks to the chain (mining). Two aspects are important for this:

Aspect 1: The mathematical algorithm underlying the specific blockchain.

Aspect 2: The requirement for hashes in that particular blockchain.

The first aspect is related to the type of digital currency (also called crypto currency) used in a blockchain. The oldest and best known type is bitcoin. In fact, this currency is nothing more than a complete economic transaction history, recorded in a blockchain that uses the unit of account bitcoin in transactions and where blocks are created with an algorithm that belongs to the creation of the currency bitcoin.

Note: anyone who has devised a new algorithm to create blocks in a certain, new way (mining) and defines a fixed, new unit of account for all transactions in these blocks, is thereby creating a new crypto currency themselves. Just like bitcoin is.

The second aspect is also related to the coin type, but concerns a specific requirement placed on the hashes in the chain. For example, in the simplified table from the previous introduction, we saw that each new block hash started with four zeros.

Now what a miner in this example is doing (with a small amount of currency as a reward) is checking how the algorithm of the specific crypto currency and the exact content of a block produces an outcome that starts with the required four zeros.

Nonce

Mining is like laying out a trial-and-error puzzle. That is, very often placing another number in the algorithm, until the concrete contents of the records and the hash of the previous block produce an acceptable new hash (four zeros) from that algorithm. This one number is called a nonce and thus belongs both to the content of the block and to (the algorithm of) the specific crypto currency. Only in that algorithm and with that content does the nonce in question produce a hash with four zeros

In a large blockchain, new blocks are thus offered by miners, who earn their money with them. The miner who first finds the next nonce and whose proof of work (or proof of stake) is accepted by the other nodes, may add the new hash and with it the new block to the chain, after which it can be copied by all other nodes and added to their copy of the chain. Then the transactions in that block can be checked and executed (credible) or skipped (overspent).

Crypto currency is therefore a particularly clever and by now very popular use of blockchain. You can read that much more is possible with blockchain in my next blog.