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What is blockchain? - Explained in a simple and understandable way

The Blockchain, also known as Distributed Ledger Technology (DLT), is probably one of the greatest economic innovations in recent history. The titles of newspaper articles, such as "Blockchain will revolutionize the internet"From Bayerischer Rundfunk,"The huge potential of the digital data register"From ConsultantsNews or"Great expectations for blockchain technology”From Deutschlandfunk, testify to this.

At first glance, a blockchain (German forBlock chain) but nothing more than a digital ledger or, better, a database. This is not necessarily new or special.

Digital ledgers have been around since online banking was established, and digital database systems have been around for even longer. What is true about the revolutionary potential of this technology? This will be discussed in more detail below.

The origins of blockchain technology

To understand the technology, it is useful to take a cursory look at the history of the development of the technology Bitcoin (What is bitcoin?) Toss. The cryptocurrency Bitcoin, which is primarily used as an investment, and blockchain technology are closely linked. The emergence of blockchain technology in scientific discourse goes back to a time when the Internet, as it exists today, did not yet exist.

A starting point can be set in 1979, when Ralph Merkle came across the Merkle Tree principle. Another event can be dated to 1983. That year was David Chaum's first Whitepaper published, which describes an electronic currency. A decade later, W. Scott Stornetta and Stuart Haber described the basics of a cryptographically secured chaining of individual digital hash blocks, which today make up the individual components of a block chain.

In 1997, Adam Back proposed the basis of Bitcoin's Proof-of-Work algorithm in order to be able to implement the concept of a digital currency. The proof concept was originally used against denial-of-service attacks and email spam. The development steps described above are part of a scientific discourse. This discourse paved the way for the cryptocurrency Bitcoin. This digital currency was created in 2008 by Satoshi Nakamoto described in a white paper. What is certain is that blockchain technology is an essential part of Bitcoin. But in the following article we want to show you what Merkle trees, hash blocks, proof-of-work algorithms and cryptocurrencies have to do with the blockchain.

Blockchain definition and explanation

The blockchain is a new type of technology that enables any kind of information in a publicly viewable database to store, process, share and manage. In a continuous list of data records, also referred to as blocks or blocks, these are linked by means of cryptography. The beginning of any blockchain is made by the Creation block or rather the Genesis block.

The blockchain is an incorruptible digital ledger of economic transactions that can be programmed to capture not just financial transactions but virtually anything of value

Don & Alex Tapscott, authors Blockchain Revolution (2016)

The idea

The original idea of ​​the blockchain is described in the Bitcoin white paper. The person or group behind the pseudonym Satoshi Nakamoto describes existing, serious problems in dealing with monetary values. Centralized institutions such as banks, insurance companies or governments are accused of abuse of trust in dealing with monetary values.

For example, banks use the money entrusted to them to conduct inefficient and costly business with it. A conceivable example of this is the burst real estate bubble in the USA in 2008, which had negative effects on the global economic system and caused thousands of people to find themselves in existential hardship. This new technology was developed to prevent an abuse of trust and the associated abuse of data on a systemic level. Misappropriation of funds, abuse of trust or simply fraud is made more difficult by this new technology.

The functional principle of a blockchain

The starting point of blockchain technology is to shift the control of monetary values ​​or information. Control over monetary values ​​and information is decentralized, so to speak. This means that the information that a bank has at its disposal is made publicly available to everyone.

First and foremost, it sounds foolish because it allows everyone to see each other's data. If Lisa has an account with the Sparkasse, Paul can see how Lisa's finances are doing. At the same time, Lisa can also see Paul's account details. This data could be misused by anyone.

Anonymity and pseudonymity

Because of this, the accounts are within a blockchain anonymized. Each account has its own address, which consists of a sequence of numbers and letters. This way, while anyone can look at each account and see how much money is being transferred to the account, how much money is being transferred from that account, and what the current balance looks like, the account cannot be assigned to a real person. A blockchain is usually used anonymously.

The anonymity of the users of the blockchain is removed when the public address (comparable to an IBAN) can be assigned to a name. If this is the case, all further transactions of the person can be viewed from the public address and anonymity gives way to a weakened form - the Pseudonymity.

Decentralization

Furthermore, the information about individual accounts is no longer stored centrally. For example, Paul and Lisa's account information is no longer stored only on a Deutsche Bank server. The blockchain, viewed as a book of accounts, is stored within a decentralized computer network. This means that many different computers around the world are connected to one another via the Internet. Each of these computers kept the entire ledger.

transparency

If Karsten enters into the blockchain on his computer that there are one million euros in his account, although he does not have it, Paul and Lisa can automatically detect the fraud. Because they can check the account book on their computers to see whether Karsten really had one million euros in his account. You can soon see that Karsten wants to cheat and exclude him from the common network.

security

This way, fraudsters can be found quickly. Fraudsters can be found via the decentralized network by comparing the respective blockchain versions and excluded from the network. In the same way, a bank's customers could see when their own money is being used for wrong purposes by their banker. This creates security. Anonymity, decentralization and security are three important characteristics of blockchain technology.

A blockchain is usually used anonymously

The technical functioning of a blockchain

The way a blockchain works can be described by the Bitcoin blockchain. Bitcoin describes a digital unit that functions as a value carrier. Bitcoins are generated using the so-called proof-of-work algorithm. This algorithm is integrated in software that can be downloaded and operated by individual computers or entire computer pools within the Bitcoin network. The algorithm is used to offset transactions (transfers) from one account to another account with other transactions in such a way that the entire data set can be integrated into the blockchain in encrypted form. This computing process is also commonly called mining.

Cryptography

When Paul transfers a bitcoin to Lisa, Johann transfers a bitcoin to Paula and Peter transfers a bitcoin to Sophie, all transactions are cryptographically encrypted using a hash function and combined in a transaction block. The transactions are offset against each other because this saves time and storage space. For each new block created, miners, i.e. the operator of a computer within the Bitcoin network that uses the hash function to offset transaction data, receive a reward of currently 6.25 Bitcoin. After 740,000 completed blocks, i.e. probably in May 2024, this reward will be halved to 3.125 BTC. The miners can sell the newly generated bitcoins immediately to make a profit.

algorithm

The algorithm with which Bitcoin mining is operated is the SHA-256 algorithm. It converts the transaction information into hexadecimal numbers and assigns it to a place within the block chain. The newly generated hash blocks contain information from the previously inserted hash block, referred to as the so-called nonce. Since the blocks are linked to one another through this approach, one speaks of a blockchain.

From a technical perspective, the blockchain is nothing more than a string of hash blocks. This is like a banker taking € 10 from Paul and making a “+” in his own account book, where all deposits are entered. The “+” stands for the amount of 10 €. The banker encrypts the amount because nobody but him should know how much Paul has deposited into the bank. The banker uses a different symbol for each new deposit, which, however, has a certain similarity to the previous symbol. If Lisa also deposits € 10, the banker enters a “-” instead of a “+”. In this case, “-” means that Lisa deposited € 10.

The more, the ...

The more transactions are made within the Bitcoin network, the more blocks have to be generated by mining. Likewise, the more blocks are integrated into the blockchain, the larger it becomes and the more bitcoins were generated. And finally, the more bitcoins that have been generated, the more transactions can be made. With every newly created block, an update is saved on every computer on which the Bitcoin blockchain is stored.

What is a blockchain? - The bottom line

Blockchain technology is revolutionizing the social and economic handling of sensitive information and monetary values. Technology will make information flows faster, safer and more reliable. It works anonymously and in a decentralized manner.

However, we are currently only at the beginning of this new technology. Weak points such as scalability and the difficult integration into existing systems will likely be resolved in the foreseeable future. Cryptocurrencies such as IOTA are already researching further developments of the blockchain, such as the Tangle.

If you are interested in getting into the most famous crypto currency “Bitcoin”, you should read our Bitcoin details & purchase instructions as well as our stock exchange overview to heart.