Before I answer your question, let me ask you something.
What are Bitcoins?
If you don’t know the answer, read on, since understanding
the blockchain is only possible with an example.
Bitcoin
Bitcoin is a decentralized cryptocurrency, which is exchanged
over a peer-to-peer network. When people speak about “bitcoin”,
they mean the network which supports bitcoin or the cryptocurrency
exchanged on the bitcoin network.
It is a cryptocurrency because it uses cryptographic techniques to
prevent fraud and counterfeiting. The bitcoin network is said to be a decentralized one because:
- No single person/organization controls the production or exchange of bitcoins.
- The bitcoin network is a peer-to-peer network.
- The database/ledger storing the records is present in each node on the network.
When referring to bitcoins as a cryptocurrency, people usually
mean that the currency is in the form of digital tokens.
These digital tokens may be stored in special physical devices
or programs called cryptocurrency wallets. On a computer, these
tokens are stored as files, but have some special properties.
The purpose of any cryptocurrency (or any currency for that matter)
is to serve as a medium of exchange. Bitcoins can be exchanged for
electronic goods or services. Just like bank notes can be exchanged
for fruits and vegetables. If you aren’t satisfied with bitcoins as
a medium of exchange, let me give an example.
An example
Let’s assume that you had a very hectic day at your school/college/workplace
On your way home, you see a shop selling ice-cream and you feel a sudden,
urge to have a sweet, cold dollop of that delicious stuff.
You have enough money to buy it, so you stop by. After exchanging
the required money, you finally get to enjoy the ice-cream.
From the above example, you may realize that money was used to buy an
ice cream. But in reality, all you did was exchange an item for another
item (in this case, money for an ice-cream).
In an alternate scenario, if you didn’t have enough money, you could
have exchanged something of equal value, such as a wristwatch for that
ice-cream. This type of exchange was in use a long time ago, and is
called the barter system, wherein goods are exchanged directly.
Double Spending
Let’s take a 21st century scenario into consideration, albeit the same one.
Assume that you still need an ice-cream, but the shop is an online
marketplace. In such a case, you can be reasonably sure that your
money will reach the merchant/shopkeeper using existing ways of sending
money using the internet. Your merchant’s identity can be verified
using digital signatures, and the merchant can do the same for you.
However, there is no mechanism in place to prevent someone else,
or even you, from spending the same digital money/currency/token
for some other product or service, say a bowl of noodles.
This is called the double-spending problem.
One way to solve this problem would be to store your money with a
third party, such as a friend or even better, a bank. The bank or
the friend needs to be trusted by both people participating in the
exchange. Now in the modern scenario, your money may be stored
in an account with the bank, and the shopkeeper may have his/her
own account. After you request money to be transferred to the shopkeeper,
your bank transfers that money on your behalf to the merchant’s bank.
Authentication and security of this process is the bank’s responsibility.
Problem solved. Or has it?
The bane of centralization
Your friend can be quite a trustworthy person, but the same may not
hold for a bank. The problem with banks being an intermediary to
online payments is that the security of the entire transaction
rests on the bank’s shoulders. If your friend, who is a mediator
between you and the merchant is threatened by someone to give your money,
he/she may do so. In case of a bank in the role of a mediator, these threats
occur in the form of bad decisions and cyber attacks. Another issue
is that for international money transfers, a significant transaction fee is
charged by the bank. If you search deeper, additional issues crop up
which often don’t have practical solutions. These include reversible nature of
fund transfers, freezing of bank accounts by nation states, etc.
Some historical perspective
Over the past 30 years, various cryptocurrencies were invented
to facilitate trade over the internet. Some of them, such as ecash
and b-money inspired cryptocurrencies like bitcoin.
Most early currencies were unable to solve the double spending problem
in a satisfactory way. Some, such as DigiCash could solve
this problem, but failed due to other reasons.
Bitcoin, using the blockchain was the first cryptocurrency to solve
a lot of existing problems with digital currencies, which has
undoubtedly led to its success among its peers.
The Answer
Bitcoin and other cryptocurrencies owe their success to the underlying
blockchain technology. Blockchain is a technology which enables
people/organizations to create permanent and immutable records in a
distributed way over a trust-less network. These records can store transaction
information, land titles or even vehicle registration details.
Every node participating in the network has knowledge of the state
of the network, and so has a copy of the distributed ledger/database.
Whenever a transaction occurs (or a new record is added), it is broadcast
to all the other nodes on the network. As soon as the other nodes
know about the transaction/record, they include it in
a data structure called a “block”. Each node works to solve a
computationally difficult puzzle as the proof of work. This is
required to prevent fraudulent records being inserted into the network.
Moreover, this mechanism (in literal terms: proof that you have worked)
deters denial of service, spam and other interruptions.
Blocks are added to the network at a specified rate. When a node finds the
solution to the puzzle, it broadcasts the solution to all other nodes.
The remaining nodes accept a block only after verfiying the records in the block.
If the block is accepted, the nodes start working on the next block, using
some special data from the previous block. This special data ensures that
malicious actors cannot change the records in previous blocks, because to do so,
all the computational problems must be re-solved, which is a mammoth task.
Since newer blocks are related to the previous ones in a specific way, this set of
blocks forms a blockchain.
Enfin
Many other services can be implemented on the blockchain. For example, NameCoin is
a service created to improve the decentralized nature of the internet.
Another interesting example is Ujo Music, which is an Ethereum (another cryptocurrency)based platform for artists to directly sell their music/merchandise.
Hopefully, you now have a basic idea of how blockchains work.
For a detailed tour of the innards of blockchain technology, stay tuned.
Techprodezza 
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