What is Blockchain and how does it work?

This article was originally written on 10 January 2018 in Hungarian. 

Blockchain is undoubtedly one of the most significant technological solutions in the 21st century that’s going to disrupt whole industries and make fundamental changes in the world we live in. This process is ongoing, we can see in many fields how blockchain takes out the power from the hands of traditional giants. Easy to see this process, but very hard to understand blockchain as a technology. In this article, we go through the basics and try to define this disruptive technology from an understandable perspective.     

Professional explanation 

Blockchain is a distributed ledger, which works on a proof of work consensus with 10 minutes block timing. When someone sends Bitcoin from one address to another, then the transaction gets into the so-called "Mempool". The miners, who act like nodes, select them and in the Merkle tree structure, with hashing process, transform them into one hash. The first miner, who verifies the transaction, receives transaction fee and a fix amount of Bitcoin as a reward. All the other nodes import the new block, and attach it to its chain end. 

Understandable explanation 

Blockchain is a technology, which contains all the transactions made on the network. There are several Blockchains out there, like Bitcoin, Ethereum, EOS and so on. Now, in this article, we will analyze the first ever Blockchain, the Bitcoin. The first (genesis) block was created by Satoshi Nakamoto who wrote the following message in the source code: "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks". Referring to the fact that Blockchain was created against the current financial system, as an answer to the economic crisis in 2008. 

Blockchain works in peer-to-peer network, so it's decentralized, which means everyone can join the chain and everyone has the same permissions, possibilities to mine (At least theoretically. Nowadays, you cannot use your laptop at home to mine Bitcoin, because of the huge mining farms in China or Iceland.). Anyone who joins, act like a node/server. They are the miners, they and the developers are responsible for the operation. This is reason one (beside a lot others), why Bitcoin is better than banks. Your money is stored on all the servers, if a hacker would steal it, he/she should attack and hack 51% (at least) of all the nodes.  

How does the Bitcoin transfer work?

Alice decided to make money with crypto, because she read in the New York Times it was like the Dotcom bubble. She creates a wallet, buy some Bitcoins and transfer it to his friend, Bob. Alice's transaction gets into the unprocessed transaction pool, into the Mempool. Transactions are waiting there for a miner to process them. Normally, it takes a few minutes, but we all saw in December 2017, January 2018 how overloaded the Bitcoin Blockchain was, so it took a few hours or even days. For processing the transactions, the miners receive transaction fee, paid by the sender, and the Coinbase reward (this is how the circulating supply grows). This is what we call proof of work. There are other protocols as well, like proof of stake.  

Let's see how new blocks are generated 

In case of Bitcoin a new block is created in every 10 minutes by a miner. In the example above, a miner selected Alice's transaction beside many others from the Mempool and put it in its block. For this, it must complete the hashing operations. Hashing is a cryptography, Mathematics exercise, which must be resolved by the miner to get the transaction key until the Root Hash is generated. This is what we call Merkle tree.    

A block contains the following information: 

• Sender Address 
• Receiver Address 
• Amount - Block Hash 
• Previous Block Hash 
• Date of Transaction    

Miners compete with each other for creating the blocks. When one of the nodes creates a new block, all the other nodes attach it to the chain's end and verify it. This why we call it a decentralized system.