Blockchain - Introduction

In recent years, there is a lot of buzz on Blockchain. Many have described this as a most disruptive
technology of the decade. Especially, the financial markets could be the most affected ones.
The technology is being adapted into many verticals like Healthcare, Medicines, Insurance, Smart
Properties, Automobiles, and even Governments.
However, so far the most successful implementation of Blockchain is the Bitcoin - A Peer-to-Peer
Electronic Cash System, which incidentally is also the first implementation of blockchain technology.
Thus, to understand blockchain technology, it is best to understand how Bitcoin System is designed and
implemented.
The blockchain architecture is not so trivial and many have written good articles, tutorials including
several videos. These range audience from Novice to Professionals. In this tutorial, I will focus on the
conceptual understanding of blockchain architecture, keeping both Novice and Professionals on mind.
Before delving into the blockchain, it is important to know why the need for this new technology
emerged? The answer to this question lies in what is known as Double − Spending.

Blockchain - Double Spending

Consider a situation shown in image −

As clearly seen here, Bob is tendering a $10 bill to Lisa in exchange of a book. Once the Lisa receives
this physical $10 bill, there is no way for Bob to re-use this money for some other transaction, as the
physical currency is now in Lisa’s possession.
Now, consider a situation where the money is paid in Digital form. This is illustrated in image −
As the format for money exchange is in the digital format, it is essentially a binary physical file stored
somewhere on Bob’s device. After Bob gives this file (digital money) to Lisa, he can also a give a copy of
the file to Alice. Both now think that they have received the money without having any means of
authenticating the digital coin and would thus deliver their respective goods to Bob. This is
called double-spending where the sender spends the same money at more than one place for
obtaining services or goods from multiple vendors.
To solve this problem of double-spending, one would employ a centralized authority to monitor all the
transactions. This is illustrated in image −

The centralized authority, which in common terms is your bank, maintains a ledger book recording all the
transactions. Now, Bob has to send his digital money to the bank who would make an entry into its
ledger debiting Bob’s account. After ensuring that Bob has sufficient balance to pay for the digital money
which he wants to send, would send the money to Lisa crediting her account in its ledger.
Now, it is guaranteed that Bob cannot double spend the money. If every digital transaction is routed
through a centralized authority like this, the problem of double-spending would be solved. This also
provides another benefit in validating the authenticity of each coin (digital money) that it receives in the
transaction. So the fake money (duplicate money as in the case of Bob paying to Alice using a copy)
would be easily detected and prevented from the circulation.
The introduction of centralized authority though it solves the double-spending problem, introduces
another major issue - the cost of creating and maintaining the centralized authority itself.
As the banks need money for their operations, they start cutting commissions on each currency
transaction they do for their clients. This sometimes can become very expensive, especially in overseas
transfer of money where multiple agents (banks) may be involved in the entire deal.
All the above issues are solved by the introduction of digital currency, called Bitcoin. I will now give you a
brief background on what Bitcoin is before delving into its design and architecture.

Bitcoin - Brief History

The Bitcoin was introduced in this world by Satoshi Nakamoto through a research-style white paper
entitled Bitcoin: A Peer-to-Peer Electronic Cash System in the year 2008.
The Bitcoin not only solved the double-spending problem, but also offered many more advantages, One
such advantage worth mentioning here is the anonymity in the transactions. Satoshi who created the
system and did transact few coins on this system is totally anonymous to the entire world.
Just imagine, in this world of social media, when the privacy of each individual is at stake, the world is
not able to trace out so far who is Satoshi? In fact, we do not know whether Satoshi is an individual or a
group of people. Googling it out also revealed the fact that the bitcoins Satoshi Nakamoto holds is worth
about $19.4 billion - that money now remains unclaimed in the Bitcoin system. So what is Bitcoin - let us
have a look!

What is Bitcoin?
As you saw earlier, the bank maintains a ledger recording each transaction. This ledger is privately held
and maintained by the bank. Satoshi proposed that let this ledger be public and maintained by the
community.
The moment you make such a ledger public, several considerations would come to your mind. This
ledger has to be tamper-proof so that nobody can modify its entries. As each entry in the ledger is
publicly visible, we will have to figure out how to maintain the anonymity - obviously you would not like
everybody in the world to know that I paid you one million dollars.
Also, as there is only one single ledger keeping track of each and every transaction in the world, the size
of ledger would be another great concern. Providing a solution to these intricacies was not trivial and
that’s what I am attempting it here to make you understand underlying architecture of Bitcoin in simple
words.
This underlying architecture is the Blockchain and that’s what this tutorial is about. To understand the
Blockchain architecture, you need to understand a few key features on which it is based on. So, let us
get started with PKI - Public Key Cryptography.

Blockchain - Public Key Cryptography

Public Key Cryptography or in short PKI is also known as asymmetric cryptography. It uses two pairs of
keys - public and private. A key is a some long binary number. The public key is distributed worldwide
and is truly public as its name suggests. The private key is to be strictly held private and one should
never lose it.
In case of Bitcoin, if you ever lose the private key to your Bitcoin wallet, the entire contents of your
wallets would be instantly vulnerable to theft and before you know it, all your money (the contents of your
wallet) would be gone with no mechanism in the system to trace out who stole it - that is the anonymity
in the system that I mentioned earlier.
The PKI accomplies two functions - authentication and the message privacy through
encryption/decryption mechanism. I will now explain both these functions −

Authentication
When the two parties exchange messages, it is important to establish a trust between the sender and
the receiver. Especially, the receiver must trust the source of message. Going to our earlier scenario
(depicted in Figure 1) of Bob sending some money to Lisa for purchasing of some goods from her, let us
see how the PKI builds this trust between Bob and Lisa. Look at below image −

In the first place, if Bob wants to send some money to Lisa, he has to create a private/public key of its
own. Note that both keys are always paired together and you can not mix the private and public keys of
different individuals or different instances.
Now, Bob says that he is sending $10 to Lisa. So he creates a message (a plain-text message)
containing Bob’s (sender) public key, Lisa’s (receiver) public key, and the amount ($10).
The purpose of this remittance such as “I want to buy pumpkin from you” is also added into the
message. The entire message is now signed using Bob’s private key. When Lisa receives this message,
she will use the signature verification algorithm of PKI and Bob’s public key to ensure that the message
indeed originated from Bob. How the PKI works is beyond the scope of this tutorial. The interested
reader is referred to this site for a more detailed discussion on PKI. This establishes the authenticity of
the message originator. Now, let us look at the message privacy.

Message Privacy
Now, as Lisa has received her payment, she wants to send the link to her ebook which Bob wants to
buy. So Lisa would create a message and send it to Bob as shown in image −

The Lisa creates a message such as “Here is the link to my ebook which you had requested”, signs it
with Bob’s public key that she has received in Bob’s request message and also encrypts the message
using some secret key which is shared between the two during HTTPS handshake.
Now, Lisa is sure that only Bob can decode the message using the private key that is held by Bob alone.
Also, somebody intercepting the message would not be able to recover its contents because the
contents are encrypted by a secret key held only by Bob and Alice. This guarantees to Lisa that access
to her ebook is granted only to Bob.
Having seen both the features, Authentication and Message Privacy, implied by PKI, let us move ahead
to see how Bitcoin makes use of PKI to secure the public ledger that I mentioned in the chapter “What is
Bitcoin?”.
For your knowledge − The most popular PKI algorithms are RSA and ECDSA, Bitcoin uses the latter
one.

Bitcoin - Mining
When Bob creates a purchase request for Lisa, he does not send it to Lisa alone. Rather the request
message is broadcasted on the entire network to which he is connected. Bob’s network is depicted in
image.

The message goes to all the connected nodes (machines). Some of the nodes in the diagram are
marked as miners. These are the machines which run a piece of software for mining the bitcoin
message. I will now explain you what this mining means.

Mining Process
As the entire network is widely distributed, every miner in the network is expected to receive multiple
messages from multiple vendors at any given period of time. What the miner does is he combines these
messages in a single block. This is illustrated in image −
After a block of messages is formed, the miner creates a hash on the block using the hashing function
described earlier. Now, as you know if any third party modifies the contents of this block, its hash would
become invalid. Incidentally, each message is time-stamped so that nobody can modify its chronological
order without affecting the block’s hash value. Thus, the messages in the block are perfectly secured
from tampering. How this fact is used in securing all the transactions in the network is explained further.

Blockchain - Network & Mining

I will now summarize the steps described above; this is what happens in the network −
 Anybody who wants to obtain services from the third party who has advertised on the network first
creates a transaction (message to the desired recipient).
 Over a given period of time, there could be many senders (buyers) and receivers (sellers)
creating such transactions.
 All transactions are broadcast on the network to all nodes. Note that it is not necessary that a
given transaction must reach each and every other node in the network.
 Each node assembles the new transactions into a block. Note that the set of transactions in each
block is independent of the set in blocks created by others and will naturally be different than
others. This does not matter; the system ensures that every transaction broadcast on the network
gets included in some block over a reasonable amount of time. Generally, the sender will
incentivize the node by offering a certain amount of bitcoins to the miner for its efforts. The miner
may opt for giving priority for inclusion in the block to those with higher incentives.
 The node now works on finding the proof-of-work for its assembled block.
 When the node finds a proof-of-work, it broadcasts the assembled block on the network.
 The nodes that receive the new block will accept it only after verifying that all transactions in the
block are valid and not already spent.
 If the block is accepted as valid, the node which is working on its own new block will have to re-
assemble the transactions in its block ensuring that the transactions are not duplicated. The node
now works on finding the proof-of-work on its newly created block; while doing so it will take the
hash of the accepted block as the previous hash.
  Likewise, the blockchain continues growing for ever.
Blockchain - Privacy
As the ledger which is recording all the bitcoin transactions is made truly public, the privacy is at stake.
Anybody in the world would be able to know who paid whom? The traditional banking system is able to
maintain this kind of privacy by keeping its records confidential.
Privacy in Bitcoin system is achieved by a different strategy. Note that we said that the sender of a
bitcoin needs to know whom to pay. So he asks for the public key of the vendor to which he desires to
make the payment. This public key can be anonymous.
In the sense, as a vendor of some services, when somebody asks you where to send the payment, you
would simply send him your public key. The association of this public key with you is not recorded
anywhere in the ledger. That way anybody outside of this transaction would only know how much money
is transacted and to which public key the money is paid out.
To achieve a higher degree of privacy, for every transaction, you may generate a new private/public key
for each transaction so that multiple transactions made by you cannot be grouped together by a third
party. For an outsider, this would simply mean that multiple transactions of smaller values were made
and they will never will be linked to a common source.
Lastly, any online internet based system is vulnerable to abuses. I will now describe few possible types
of attacks on Bitcoin system and how those are mitigated.

Bitcoin - Mitigating Attacks

I will discuss three different types of probable attacks in the Bitcoin system −

Race Attack
As an attacker, you may send the same coin to different vendors in rapid succession, probably by using
two different machines. If the vendors do not wait for the block confirmation before delivering the goods,
they will very soon realize that the transaction was rejected during the mining process. The solution to
this kind of attack is that the vendor must wait for at least one block confirmation before sending out the
goods.

Finney Attack
In this case, the attacker is the miner. The miner mines a block with his transaction and does not release
it in the system. He now uses the same coins in a second transaction and then releases the pre-mined
block. Obviously, the second transaction would be rejected eventually by other miners, but this will take
some time. To mitigate this risk, the seller should wait for at least six block confirmations before
releasing the goods.

The 51% Attack

In this kind of attack, we come up with an impractical assumption that somebody owns 51% of the
computing power of the network. The attacker in this kind of attack mines a private blockchain where he
double-spends the coins.
As he owns the majority of computing power, he is guaranteed that his private blockchain at some point
of time would be longer than the chain of “honest” network. He then releases his private blockchain in
the system making all the transactions earlier recorded in the honest blockchain to be invalid.
This kind of attack is fictitious as it is very expensive to acquire computing power which equals or
exceeds 51% of the computing power of the entire network.