This is written for somebody who is new to the system of the Bitcoin/Blockchain. I was thinking about the best way to explain how it works, and I came to a conclusion that it helps to describe how money flows in modern banks at first. I don’t go to the mathematical part of the system in this piece, but you will be able to picture how it looks like. I hope this is entertaining :)
First, let me take you to the world of Harry Potter.
Imagine the time when Harry was thrown into the world of magic for the first time. Hagrid took him to the Gringotts Bank in Diagon Alley. There were hundreds of goblins, who whispered in a language he couldn’t understand. After an unfriendly conversation, one of them guided Hagrid and Harry to their storages on a tram, and Harry was surprised to find a gold and a treasure his parents had left for him.
In the Gringotts, each wizard has his own storage. If Harry wants to send his money to Hagrid, goblins would physically move the money. This might not be a lot of work for a single transaction. But considering thousands of transaction happens in a day, it’s laborious work and nearly impossible to make the whole transaction.
Modern banks are way more efficient than the Gringotts Bank. The thing is, they don’t really transfer money. Instead, they just change the number on their ledger. Say, Harry and Hagrid came to the world of muggle to enjoy this service. When Harry sends his money to Hagrid, the bank just subtracts the number from Harry’s, and adds the number on Hagrid’s. Then it authorizes Hagrid’s account to withdraw the amount of money he owns. We feel as if we have our own storage, but the reality is, there is just a record. The banks merely authorize each person how much money she can withdraw/send based on their record. Compared to ancient banking system just like the one in Harry Potter’s world, it is magically efficient. Thanks to this system, we can send money quickly from our browser now.
Obviously, it is critical for the modern banks to securely manage their ledger. If somebody manipulates it, the world is in trouble. The question is, how they can prevent people from doing it.
One of the crucial functions for a financial entity over the years has been to solve the double spending problem; they never know that somebody spends the money twice which he doesn’t own by copying it. The Gringotts Bank doesn’t have to worry too much about this manipulation because they deal with the physical gold which is difficult to copy, but when the form of money is digital, this is a big problem. The problem/beauty of the Internet is that the person can send the same thing to the millions of people and copy.
Here is how they do it. They simply keep track of all the transaction in their ledger where all the digital record of who owns how much and who owe how much to whom are kept. Then they verify all the transaction by standing in the middle of two parties.
The problem with this system is that it is proprietary system that is owned by a few, and it’s reversible so there is a large fee and time associated with it.
So how does Bitcoin work? While modern banks own a private and central ledger, Bitcoin Blockchain system distributes the ledger to the public and yet maintains the system that allows strangers to make a secure transaction with almost no fees. A network of computer(a peer-to-peer network) manages this public ledger; anyone in the world have the same record of all the transaction of the past. This means public ledger is synchronized between users in real time.
Anybody in this world can volunteer to keep the blockchain up to date with all the new transaction. This works because a lot of people are keeping track of the same thing, to make sure all the transaction are accurate.
Imagine Google Docs. A lot of transaction is written in this public document, and everybody has an access to the single version of it. If somebody edits the sheet, you can see the modification almost in real time.
But how does this exactly work? Why is it secure when everybody has the access to it?
Let me answer those questions in the next parts.