What is a blockchain?
A blockchain is just a record, a ledger of all bitcoin transactions that has ever taken place.
It is similar to a ledger that that a bank would maintain to record all transactions of their customers. However, that’s where the similarity ends. In a bank, the ledger is controlled by the bank itself. Only the bank can see the transactions. The bank has its own security and access system to secure the ledger and to enter transactions.
In the blockchain, a copy of the ledger file is shared between thousands of participants globally, also called miners. Even you can become a miner by simply downloading the open source bitcoin software. New bitcoin transactions are added in the blockchain by a consensus of a majority of the miners, explained below. People do mining because they receive new created bitcoins in return for their efforts. Once a transaction is entered in the blockchain, it can never be erased or modified.
Why is it called blockchain?
Imagine a physical ledger we used to maintain accounting records before computers. It used to a register. At the end of a fixed period, for example, a day, an accountant would typically check all the records, note the balances and then sign at the end of the page. This would mean that transactions till this page are now fixed and no new entries can be made in the past.
Similarly, in the blockchain, this period is fixed at around 10 minutes. Miners collect all the bitcoin transactions globally executed in the last 10 minutes. They then record it together and this is called a block.
In our physical ledger example above, each page is linked with the previous page with running totals. Similarly in the blockchain, each block is also linked with the previous block. Hence, it is said to be a chain of blocks and hence the name, blockchain.
How does the blockchain work?
It would feel common sense that the only way to secure a ledger would be to trust a central authority like a bank or a credit card company. However the blockchain is an invention to securely maintain such a ledger without any such central authority but with a democracy in which miners win to do the right thing.
So miners collect all the transactions in the bitcoin network over the last 10 minutes. The miners then enter into a competition and a winning miner is declared. The miner who wins, creates the new block with all the new transactions. All the other miners then update their blockchain file to this new version and the competition starts all over again. The miner who wins is determined based on 2 conditions.
First, the miner who has the most common version of the blockchain. So for example, if a miner cheats and enters a wrong bitcoin transaction to benefit himself, he will have a minority version of the blockchain as no one else will have that transaction in their version. So he will lose.
Second, the first miner who will solve a complex mathematical puzzle will win. Solving this mathematical problem is a combination of luck and computing power. For example, in a lottery, the more tickets you have (computing power) the more your chances of winning. However, that does not guarantee a win. The miner with even 1 lottery ticket (very low computing power) also has a chance, though much lower than the miner with say, a 1,000 tickets (high computing power).
So the miner with the most common version of the blockchain and who first solves the mathematical puzzle wins, updates the blockchain and in return gets a reward of newly created bitcoins. Currently this reward is 25 bitcoins every 10 minutes. At today’s rate of about Rs 28,000 per bitcoin, that is about Rs 7 lacs.
Why are financial institutions excited about the blockchain?
Before the Internet, to provide for example, voice calling between India and the US would require a multi billion dollar company like AT&T to lay its own cable between the 2 countries and use it. Calls used to be very expensive because this infrastructure would be very expensive. With the Internet, a company like Skype can simply make an app and use the Internet to do voice calls. And now, forget voice calls, even video calls are free.
In the same way, banks, credit card companies and so on have to deploy infrastructure to secure their ledgers. This infrastructure has to be created and maintained by each company separately. And it is very expensive to do so.
Just like the Internet, these companies now have the option to record their transactions on the blockchain at a minimal cost. These transactions are recorded forever and they do not have to worry about its security. Hence, they have the opportunity to save billions of dollars.
Hence, they are excited about the blockchain.
What is a private blockchain vs a public blockchain?
You must have heard about financial institutions wanting to create their own private blockchain. A private blockchain is a bitcoin style ledger but which does not use the bitcoin network and does not use bitcoins as its token to record transactions. They want to do this because this could be a better and cheaper way to secure databases than financial institutions currently do.
But the public blockchain which runs on bitcoins is far cheaper and more efficient and more secure. Private blockchains are like private intranets. Intranets have failed and over time, everyone has realized that it is far better to do everything on the ‘public’ Internet.
I believe it will play out exactly like this with private blockchains. In a short time, everyone will realize it is cheaper and ‘more secure’ to use the public bitcoin blockchain.
Can the blockchain work without bitcoin?
The blockchain powered by bitcoin can only work with bitcoin. And this blockchain is by far, the biggest and most secure blockchain the world currently has. To talk blockchain and bitcoin separately, as is the case recently, is a fallacy. For blockchain to be used for other applications, bitcoins must succeed in its original ‘motive’ first. For miners to secure the blockchain, the only incentive they get is bitcoins. For mining power to keep increasing, bitcoins demand and subsequently its price should keep increasing in value over time. Which means bitcoins needs to continue to fulfil its potential as a global currency.
Note: The above is an oversimplification of the way the blockchain works. There are some finer elements that are consciously avoided. The purpose of this post is to conceptually explain blockchain to non techies.