Wednesday, January 7, 2015

Bitcoin, Altcoin, Dodgecoin… Who Cares? Only the Block Chain Matters

A very good article to understand the basis of the Block Chain protocol has been released at Wired : Block Chain 2.0: The Renaissance of Money.

Taking the example of the Bitcoin, here is how the Block Chain is explained there :

A Bitcoin network is a decentralized network. Hence, every time a transaction occurs between the members of this network, it needs to be verified and validated so as to ensure that every transaction occurring within the network is between two individual accounts and that there is no risk of double spending.

This process of verification is carried out by some members of the network called miners. The miners use specialized and easily available software along with the processing power of their computers to verify the transactions. This sounds simple enough, but the processing power required to do so is quite herculean. And since the miners are using their bandwidth and electricity to do the verification process, they need to be compensated.

This is where the Block Chain begin to take shape. Every few minutes a ‘block’ of all the transactions occurring over the Bitcoin network is created by a miner. Essentially the miner has created a verified transaction file which holds a copied record of all the transactions that have occurred in the network over the past 10 minutes. The word to highlight here is verified. The miner uses the computational power of his computer to assure all members of the network that each transaction is between 2 parties only and that there is no problem of double spending.

For his efforts, the miner is compensated in Bitcoins. This is where the math’s of the currency and the way that it differs from the normal fractional banking system kicks in. The total amount of Bitcoins that can ever exist is fixed at 21 million. As the quantity of money is fixed, the payment made to the miner is much like mining currency out of a reservoir.

As each transaction in every block is made at a specific time, each block is linked to the previous block of transactions. By grouping these blocks we get what is referred to as the Block Chain. And since this grouping of blocks occurs as per the protocol dictated by the algorithm underpinning the creation of Bitcoins, this protocol is defined as the Block Chain protocol.