What is a blockchain? Definition & a simple, understandable explanation

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To understand Blockchain technology, it is important to understand the backgrounds and motivations behind the invention of the Blockchain. In this context, most people have probably already heard that the blockchain technology goes back to Bitcoin and its inventor, Satoshi Nakamoto. We will answer the following questions in this report:

• Why was Bitcoin or the Blockchain invented?
• What problems does blockchain technology solve that were previously not digitally feasible?
• What measures and means are used for the implementation?
• And what potential does the blockchain offer beyond the topic of cryptocurrencies and means of payment?
• Will the blockchain really bring a new decentralized monetary system, without central banks and middlemen?

The development of the blockchain

The history of the Blockchain and the Bitcoin are inseparably linked. In order to understand the potential of blockchain technology, it is essential to understand why Bitcoin was invented because of the close connection.

Our current financial system and all industries that make use of it in any way are based on trust in third parties. For example, the citizens of a country trust that the national currency represents a countervalue with which they can buy goods and services.

When paying by credit card, buyers of a good trust the bank to debit the amount that the good costs and not more than this amount. The seller trusts the bank that the purchase price will be transferred to his bank account. Both, buyers and sellers, trust that they can fully access their assets in the form of money on the bank’s “virtual” account and that this represents a stable countervalue.

The global financial crisis in 2008, during which the Bitcoin Whitepaper was published, was also a crisis of confidence because the confidence described above was shaken and neither citizens nor banks trusted each other. Satoshi Nakamoto recognized this problem and developed the Bitcoin as an alternative to the established financial system.

The Bitcoin and the blockchain do not require the aforementioned trust in third parties because no third parties, for example in the form of banks, are required to carry out transactions. However, Satoshi Nakamoto wanted to create a digital currency that had no central point that could be controlled or destroyed by state power.

The solution was therefore a completely decentralised computer network, a so-called peer-to-peer network, in which there is no central coordination point. In contrast to centralized systems, where the components are arranged around a main component that takes over the coordination, the components in decentralized systems form a network of interconnected components (also called “nodes“).

What problems does Bitcoin Blockchain technology solve?

Even if one or more components fail, a peer-to-peer (P2P) network can easily continue to exist and function. The idea of a P2P network was not a new invention in 2008, when Satoshi Nakamoto created Bitcoin.

Even before Bitcoin, there were successful peer-to-peer networks, such as the BitTorrent file-sharing platform, where users could exchange files and large amounts of data directly with each other. However, a P2P network was not enough to realize the idea of digital money.

The core problem was that numerous attempts before Bitcoin failed to duplicate (or infinitely copy) digital goods very easily. This problem is also referred to in specialist circles as the “double-spending problem“.

The technical term describes the problem that, in contrast to physical objects that can only be issued once, digital goods can be used several times, in two different places (simultaneously).

Satoshi Nakamoto’s solution for this was the Blockchain technology (which consists of various components, as we will explain later). To prevent double spending, Satoshi requested a distributed ledger in which each transaction is stored and stored by all participants of the network.

Protection of the blockchain from attackers

However, another problem was that in a network with an unknown number of nodes with unknown reliability and trustworthiness, a common consensus had to be defined to ensure that data integrity in the database was achieved and maintained. After all, malicious nodes in the network could try to manipulate it.

The simple and ingenious demand of Satoshi is therefore that the majority of the participants of the network (each “Full Node“) must agree on a common consensus. Only if a decentralized consensus is reached in the P2P network about which transactions are valid, these are also included in the database and thus verified as valid.

The solution to the double-spending problem

The solution to the double-spending problem

Before Satoshi invented the blockchain, the double-spending problem was considered an insurmountable problem for decentralized payment systems. Nakamoto explained in the Bitcoin white paper that “the recipient of the payment cannot verify whether the sender has not spent the money twice”, which is why a central control point was previously the only solution for Bitcoin’s predecessors.

But how exactly did Satoshi solve the double-spending problem without creating a central instance?

Satoshi developed the blockchain as a distributed database, which is not located on a central server, but is jointly maintained by the participants of the P2P network. The distributed ledger (blockchain structure) can actually be imagined as a chain of blocks linked by cryptography.

Each new block contains a certain amount of new transaction data and is linked to the previous block by a hash value (a kind of checksum that confirms the integrity of the data). In addition, each block also contains a hash value for the entire block chain.

This makes the order of the blocks forgery-proof. The transaction data, i.e. the data on the sender, receiver and the amount of coins sent, are therefore almost irrevocable after a few blocks.

The creation of a decentralised consensus

The predecessors of the Bitcoin Blockchain already pursued the idea that each node in the network must store the entire transaction history in order to be able to guarantee the validity of a transaction. However, the requirement means that every person must know about all transactions on the network. Accordingly, each node must know and store each transaction.

However, there is also a problem with this approach. Such a network is not protected against “Sybil” attacks (also 51% attacks). This means that a malicious actor in the network could acquire so many false identities until he owns the majority of the nodes. With this majority, the attacker could manipulate the transaction history at his discretion (even retroactively).

To prevent manipulation, Satoshi invented the continuous chain of hash values (the blockchain) as described above. However, this also raises the question of how a uniform consensus is found and how the hash values are generated. This is where the so-called “proof of work” comes into play.

The consensus mechanism of Bitcoin: Proof of Work

The term describes very well the functionality of the Bitcoin Blockchain. Similar to gold mining, resources must be used to mine (mine) new units (gold or bit coin). Bitcoin is computing power. Computing power is a resource that is not as easy to forge as a digital identity.

In order to include a valid transaction in the blockchain, you must prove that you have used up computing power or pay a fee for it (“Miners Fee“). The miners try to solve a cryptographic puzzle by repeating and trying a certain calculation operation over and over again.

The generation of a new block, which is also called “mining” in the context of the block chain, takes place in the following sequence:

1. Summary of all transactions in one block
2. Checking by the miners whether the transactions are legitimate (through proof-of-work calculations)
3. The “first” miner who has solved the calculation receives the block payment.
4. The confirmed transactions are appended to the block chain by a new block.

The puzzle works as follows: The Miner takes all available transactions (or the “Merkle tree“) that are to be inserted into the block. For this he adds a random character string, the so-called “Nounce“.

The Miner processes both components into a hash and compares this value with the target value (also called a hash value). The Miner repeats this until the two values match and the proof of work is fulfilled.

The Proof of Work prevents Sybil attacks. The “Miner” consensus replaces a central institution.

The architecture of a blockchain

Since the invention of Bitcoin, blockchain technology has evolved significantly. Originally, the Bitcoin blockchain was solely intended to meet the requirement of being digital and decentralized cash.

However, there are countless projects on the crypto market that pursue far more functions and goals than “just” one of value transport. At the latest with the development of Ethereum the full potential of the Blockchain technology has been revealed.

Ethereum added the ability to run decentralized applications and smart contracts on the blockchain to the blockchain concept. Ethereum thus laid the foundation for a peer-to-peer system to continue and expand not only the global financial system, but every industry and every company.

Based on the blockchain, which is predominantly active as a mediator of intangible, digital goods and services, the blockchain offers undreamt-of possibilities. The elimination of intermediaries leads to a considerable potential to save costs on the one hand. On the other hand, communication and transactions can be significantly accelerated.

The often colloquially used term blockchain technology refers to an architecture in the actual sense, which consists of the blockchain data structure, a blockchain algorithm and cryptography as well as security technologies. Essentially, the blockchain represents a new paradigm for the way information is shared and stored.

It is important to know that not every blockchain works the same and is not built the same. Bitcoin’s basic technology has been further developed through numerous new crypto projects. In order to achieve decentralised consensus, other mechanisms such as the Proof of Stake (to be used from 2020 by Ethereum), the Delegated Proof of Stake (used by EOS, TRON, adnd Lisk), the Delegated Byzantine Fault Tolerance (from NEO) or the Tangle (from IOTA).

In the basic principle, however, all (public) blockchains have to overcome the same challenges:

• Creation of a peer-to-peer network that must accommodate an indefinite number of nodes with unknown trustworthiness and reliability.
• Storage of data in a distributed general ledger
• Building a decentralised consensus
• Solution to the Double Spending Problem
• Protection against Sybil attacks
• Protection of user accounts

Public vs. private blockchains

There are public blockchains that can be used by any person and company. The opposite is private blockchains.

While there doesn’t seem to be much difference at first glance, the difference between the two types will ultimately help you understand how blockchain networks work as a whole.

Public blockchains

Everything you’ve read so far refers to public blockchains like Bitcoin and Ethereum. They enable anyone to participate in their network and operate a node. A public blockchain network is therefore completely open. The network usually has incentives to encourage more participants to participate (e.g. the Bitcoin Mining Reward).

The big disadvantage of a public blockchain can be the openness (for companies), since there is basically no complete privacy for transactions.

(An exception are the Privacy Coins, like Monero, ZCash and DASH.)

Private Blockchains

The other kind are private blockchains. In contrast to public blockchains, they are only accessible to a certain circle that can access and participate in them. A private blockchain network requires an invitation and must be approved by a central authority (a company such as Facebook at Libra).

This limits who can participate in the network. The central instance can also influence the nodes. For example, Facebook may not execute or prohibit certain transactions.

General Definition: What is a Blockchain?

What is the potential of blockchain technology?

In principle, blockchain technology has the potential to revolutionize all industries in which there is a central intermediary. In addition, the blockchain can provide more transparency in many areas. The technology can be used as a decentralised booking system to digitally document all types of property rights. Read access to the decentralized database is the same for everyone.

The potential of the blockchain lies above all in gaining efficiency in established processes for companies, whereby considerable cost savings are predicted.

In addition, the costs could also be significantly reduced for the end-user, since the sometimes substantial price premiums charged by intermediaries (e.g. for the transfer of smaller or larger amounts abroad) would no longer apply. In the following industries and processes, the blockchain holds a great potential (the list is not complete, but is only intended to show by way of example which areas of the economy could be changed).

Finance and banking

The industry that is likely to be most influenced by blockchain technology is finance and banking. While bank transactions worldwide currently still take several days and cause considerable costs, the blockchain offers the potential to reduce the transaction time to a few minutes and the costs to tiny amounts. (Ripple or Stellar Lumens have set themselves the goal of processing cross-border transactions quickly and cheaply)

In addition, the block chain never sleeps while banks and financial institutions are tied to business hours. At least the banks only process transactions Monday to Friday until the amount is visible on our account.

Use in Supply Chain Management

Using the blockchain, customers, suppliers and even end customers can trace the origin of a product and the individual materials in detail and in real time. The blockchain is forgery-proof and almost impossible to manipulate.

This enables companies and also customers to check whether certain products actually meet certain labels, such as “organic”, “local” and “fair trade”. In the food industry in particular, but also in clothing retailers, there is great potential for use.

Applications in the real estate sector

As described, the blockchain is predestined to record property rights and their transfers and to make them comprehensible for everyone. Logically, the real estate sector is a large market that can benefit greatly from the blockchain.

By means of the blockchain, the elaborate process that arises through physical deed and its certification by notaries could be replaced by the blockchain that verifies the transmissions. The owners can be confident that their deed is correct and permanent.

Healthcare applications

In health care, medical records, which are kept by each hospital and each doctor on their own, could be standardised. When a medical record is created, the data can be written to the block chain.

The patient thus receives proof and the certainty that the file cannot be changed. These personal health records could be stored encrypted in the blockchain so that they are only accessible to certain people.

Internet of Things

The blockchain will serve as the backbone of the emerging Internet of Things industry to secure new, decentralized networks and process huge amounts of information in real time. In order to cope with the huge amounts of data that networked devices produce on the Internet of Things, the blockchain will be much better suited than centralized communication systems.

Votes and elections

Today’s electoral systems are among the most outdated, inefficient and manipulative aspects of modern democracies. The blockchain technology can be implemented to encrypt the validity of the ballots of individual citizens and make them tamper-proof.

Even though there are already many cases of blockchain use in practice, the development is still in its infancy. Companies worldwide are only beginning to understand how the blockchain can help their company and save costs and time in the process. The next time will show, into which further areas of our daily life and everyday life the Blockchain will penetrate.