The Blockchain - The Technology behind Bitcoin

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© Jerome Kehrli @ niceideas.ch
http://www.niceideas.ch/roller2/badtrash/entry/blockchain-explained-beta
The Blockchain
The Technology behind Bitcoin

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INITIAL DEFINITION
The blockchain is the technology running the bitcoin.
Some Definitions
WIKIPEDIA DEFINITION
A blockchain is a distributed database that maintains a continuously-
growing list of records called blocks secured from tampering and revision.
MY DEFINITION
The blockchain is a secured protocol enabling peer-to-peer exchanges on a
distributed network in a secured, public and non-repudiable way.

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A tiny little bit of history
Architecture and principle first designed
for Bitcoin
A solution to make the database both
secured and widely distributed
Actually the main innovation of the
Bitcoin
Conceived in 2008 and implemented in
2009
Satoshi Nakamoto
As of 2014 : “Blockchain 2.0”
Evolution over the initial blockchain
From simple transactions to actual
Software Programs
From simply a distributed transaction
ledger to a globally decentralized, un-
ownable, digital computer

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Introduction Example
Bob is an online web
surfer and is looking for
a suite. He wants to buy
it online.
Sally runs an online
shop and sells clothes.

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2. Problem(s) solved by the blockchain

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Usual Situation (1)
Recall the introduction problem
This is what happens in practice

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The financial system is opaque and lacks transparency and fairness.
All these intermediates are no volunteers. They work for money and get paid for
their services.
The transaction costs money to both the buyer and the seller.
There are interest rates, fees, surcharges, etc.
EFTs in Europe can cost 25 euros.
Credit transactions can cost several percent of the transaction.
All these exchanges are error prone.
Credit card informations are often stolen.
Banks make mistakes.
An account holder is eventually not even the actual owner of his account.
The bank really owns the account.
Funds can be garnished, even frozen completely.
Banks and other payment processors like PayPal, Visa, and Mastercard may refuse to
process payments for certain legal entities.
Financial exchanges are slow.
Checking and low cost wire services take days to complete.
The problems with this model

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A clearing house
is a financial institution that provides clearing and settlement services for financial
and commodities derivatives and securities transactions
stands between two clearing participants / firms (banks)
reduces the risk of one (or more) clearing firm failing to honor its trade settlement
obligations.
It nets offsetting transactions between multiple counterparties.
Clearing House

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Clearing House (1)
Buyers and sellers use intermediaries because they may not trust the other
party, but they trust that the intermediary will assure the transaction is
completed faithfully. This is the fundamental role of a clearing house

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When one bank sends money to another, no physical currency changes hands.
Banks and settlement systems use central electronic ledgers to track assets.
But such central ledgers - or clearing houses - can be slow and inefficient, often
relying on faxes or manual input.
That not only wastes time but racks up fees.
The system is also open to hacking and fraud.
These central institutions gets fees to cover such risks of course as well as
many other services. The price is high
It prevents, for instance, micro-payments services who are not able to support the
charge asked by these central structures.
The problems with Clearing Houses

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Distributed Ledgers
OTHER DEFINITION
A blockchain is a type of distributed ledger, comprised of unchangeable,
digitally recorded data in packages called blocks.
A distributed ledger (also called shared ledger) is a consensus of replicated,
shared, and synchronized digital data geographically spread across multiple
sites, countries, and/or institutions.
Every node in the decentralized system has a copy of the ledger.
No centralized "official" copy exists and no user is "trusted" more than any other.

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Distributed Ledger instead of Central Ledger

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3. Operation of the blockchain

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Blockchain overview (1)
The blockchain itself is a list of blocks.
These digitally recorded "blocks" of data are stored in a linear chain.
Each block in the chain contains data (e.g. bitcoin transaction) and is
cryptographically hashed.
Each block includes the hash of the prior block in the blockchain, linking the
two, ensuring all data in the overall "blockchain" has not been tampered with and
remains unchanged.
This has the effect of creating a chain of blocks from the genesis block to the
current block.
Each block is guaranteed to come after the previous block chronologically because the
previous block's hash would otherwise not be known.

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Blockchain overview (2)
The blockchain network is a peer-to-peer network of independent nodes
communicating together by message broadcasting.
A node is not necessarily connected to every other node, but at least some of
them.

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Blockchain principle (1)
The operation principle of is pretty straightforward to understand. We’ll illustrate it
her on the Bitcoin blockchain.
Principle is as follows :
1. A user wants to pay another user some bitcoins, he broadcasts a transaction to the network.
2. Miners add the transaction as they receive it to their current block, the one they are currently
working on
3. Randomly, one of the miner may win the lottery and "mine" the block (we'll get back to that)
4. At that moment, this new "definitive" block is broadcasted to the network and added to
everyone's copy of the blockchain

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In order for a block to be accepted by network participants, miners must
complete a proof of work which covers all of the data in the block.
The proof of work is a piece of data which is difficult (costly, time-consuming) to
produce but easy for others to verify and which satisfies certain requirements.
Producing a proof of work can be a random process with low probability so that a lot of
trial and error is required on average before a valid proof of work is generated.
Bitcoin uses the Hashcash proof of work system.
For a block to be valid it must hash to a value less than the current target; this
means that each block indicates that work has been done generating it.
Each block contains the hash of the preceding block, thus each block has a
chain of blocks that together contain a large amount of work.
Changing a block (which can only be done by making a new block containing the
same predecessor) requires regenerating all successors and redoing the work
they contain.
This protects the block chain from tampering.
The amount of successors is relevant when qualifying the validity of a block : at least 6
successors are required to consider a block valid
Proof of Work

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Blockchain structure
The blockchain data structure is an ordered, back-linked list of blocks of
transactions.
Every block contains a hash of the previous block. This has the effect of creating a
chain of blocks from the genesis block to the current block.
Each block is guaranteed to come after the previous block chronologically because the
previous block's hash would otherwise not be known.
Each block is also computationally impractical to modify once it has been
in the chain for a while because every block after it would also have to be
regenerated.
New transactions are constantly being processes by miners into new blocks
which are added to the end of the chain and can never be changed or removed
once accepted by the network.

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Block Structure
Each block contains, among other things :
a record of some or all recent transactions,
and
a reference to the block that came
immediately before it.
It also contains an answer to a difficult-to-
solve mathematical puzzle, the hash or
Proof of Work.

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Mining
In the Bitcoin world, transactions are broadcast to the network by the sender,
and all peers trying to solve blocks collect the transaction records and add them
to the block they are working to solve. This is called Mining.
Mining is the process of adding transaction records to Bitcoin's public ledger of past
transactions. This ledger of past transactions is called the block chain as it is a chain of
blocks.
Mining is intentionally designed to be resource-intensive and difficult so that the
number of blocks found each day by miners remains steady. Individual blocks must
contain a proof of work to be considered valid.
The primary purpose of mining is to allow Bitcoin nodes to reach a secure,
tamper-resistant consensus.

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The difficulty is the measure of how difficult it is to find a new block compared
to the easiest it can ever be.
It is recalculated every 2016 blocks to a value such that the previous 2016
blocks would have been generated in exactly two weeks had everyone been
mining at this difficulty.
This will yield, on average, one block every ten minutes.
Difficulty Adjustment

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Mining is also the mechanism used to introduce Bitcoins into the system:
Miners are paid any transaction fees as well as
a "subsidy" of newly created coins.
These both serves the purpose of disseminating new coins in a decentralized
manner as well as motivating people to provide security for the system.
It gives miners incentive to put their computation power at the disposal of the
blockchain network.
Because there is a reward of brand new bitcoins for solving each block, every
block also contains a record of which Bitcoin addresses or scripts are entitled to
receive the reward.
This record is known as a generation transaction (or a coinbase transaction) and is
always the first transaction appearing in every block.
Miner retribution

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In the specific case of the bitcoin, Satoshi had very soon the idea of limiting the bitcoin supply.
In a centralized economy, currency is issued by a central bank at a rate that is supposed to match the
growth of the amount of goods that are exchanged so that these goods can be traded with stable
prices.
The monetary base is controlled by this central bank.
In the United States, the Fed increases the monetary base by issuing currency, increasing the
amount banks have on reserve, and more recently, printing money electronically in a process called
Quantitative Easing.
In a fully decentralized monetary system, there is no central authority that regulates the monetary
base.
Instead, currency is created by the nodes of a peer-to-peer network.
The Bitcoin generation algorithm defines, in advance, how currency will be created and at what rate.
Any currency that is generated by a malicious user that does not follow the rules will be rejected by
the network and thus is worthless.
Bitcoins are created each time a user discovers a new block.
The rate of block creation is adjusted every 2016 blocks to aim for a constant two week adjustment
period (equivalent to 6 per hour.)
The number of bitcoins generated per block is set to decrease geometrically, with a 50% reduction
every 210,000 blocks, or approximately four years.
The result is that the number of bitcoins in existence is not expected to exceed 21 million.
Speculated justifications for the unintuitive value "21 million" are that it matches a 4-year reward
halving schedule; or the ultimate total number of bitcoins that will be mined is close to the
maximum capacity of a 64-bit floating point number.
Bitcoin limited supply

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A wallet is basically the Bitcoin equivalent of a bank account. It allows you to
receive bitcoins, store them, and then send them to others.
The name "Bitcoin wallet" is a bit of a misnomer. Bitcoin wallets don't hold actual
Bitcoins, those are essentially stored on the blockchain.
Instead, Bitcoin wallets hold the private keys that give users the right to use those
coins.
Each Bitcoin wallet comes with at least two keys : one public, and one private.
A Bitcoin address, or simply address, is an identifier of 26-35 alphanumeric
characters, beginning with the number 1 or 3, that represents a possible
destination for a bitcoin payment.
Addresses can be generated at no cost by any user of Bitcoin.
Bitcoin Wallet Cryptography

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A Merkle Tree is a tree constructed by hashing paired data (the leaves), then
pairing and hashing the results until a single hash remains, the merkle root.
The construction of the Merke tree is such that if any single leaf transaction is
changed, all hashes along the branch would be changed and ultimately the
merkle root as well.
This is a key property ensuring security of the blockchain.
Merkle trees in bitcoin use a double SHA-256, the SHA-256 hash of the SHA-
256 hash of something.
Merkle Trees

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Merkle Tree
This procedure repeats
recursively until we reach a row
consisting of just a single
double-hash.
This is the Merkle root of the
tree.
First from the top row of the tree
with the ordered double-SHA-
256 hashes of the byte streams
of the transactions in the block.
Then the row below it consists of
half that number of hashes.
Each entry is the double-SHA-
256 of the 64-byte concatenation
of the corresponding two hashes
below it in the tree.

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Replication (1)
Both new transactions and newly mined blocked are broadcasted to the peer-to-
peer network using the Flood Protocol.

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It's possible for the blockchain to have temporary splits
for instance, if two miners arrive at two different valid solutions for the same block at
the same time, unbeknownst to one another.
The peer-to-peer network is designed to resolve these splits within a short
period of time, so that eventually only one branch of the chain survives.
The client accepts the longest chain of blocks as valid.
The "length" of the entire block chain refers to the chain with the most combined
difficulty, not the one with the most blocks.
This prevents someone from forking the chain and creating a large number of low-
difficulty blocks, and having it accepted by the network as "longest".
Orphaned, Extinct and Staled Blocks

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The Blockchain 2.0 is an evolution of the blockchain protocol enabling not
only to exchange transaction but rather code and programs in the form of Smart
Contracts
Now developers are allowed to build programs and API's on the Blockchain Protocol.
This relatively new concept involves the development of programs that can be
entrusted with money.
Smart contracts are programs that encode certain conditions and outcomes.
By developing ready to use programs that function on predetermined conditions
between the supplier and the client, smart programs ensure a secure escrow
service in real time at near zero marginal cost
Apart from Financial transactions, smart contracts makes the blockchain
technology entering a whole lot of different industry.
For instance in the Legal System, companies like Empowered Law use the public
distributed ledger of transactions that makes up the Block Chain to provide Multi-
Signature account services for asset protection, estate planning, dispute resolution,
leasing and corporate governance.

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The Blockchain 2.0 and its applications -
“From Bitcoin Transaction
to Smart Contracts”
- will be the topic of a next article on my blog
and a future presentation

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