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Blockchain: Simple Explanation
Oleg Mazonka, 2016
Abstract—This paper presents a step by step introduction to
what blockchain is and how it works.
Index Terms—Blockchain, Hashchain, Bitcoin, Cryptocur-
rency.
I. INTRODUCTION
Blockchain is a buzzword. You have probably heard it so
many times you feel like you should undersatand what it is.
By the end of reading this article you just might.
The original problem comes from the idea to have some-
thing represented as digital entity that can be passed securely
from one party to another. Imagine you have some money in
your bank account, and you would like to securely transfer
some of it to another person. This ususally goes through a
digital transaction – no physical money is passed around.
This is nice and simple. But, it requires trusting the bank.
Is it possible for some digital entity stored on my computer,
representing money, to be passed securely to someone’s else
computer, without a bank? Yes it is possible. However, re-
gardless of representation any digital sequence can be copied.
This creates the well-known problem of “double-spending”:
one person makes an electronic transaction more than once
using the same money. This problem was not solved properly
until the first blockchain cryptocurrency, Bitcoin, appeared in
2009.
Many other cryptocurrencies appeared in the following
years and followed the same principle of blockchain tech-
nology, which solves the double-spending problem without a
bank. The digital sequences, which are linked to a person, are
passed around without possibility to copy and double-spend
by placing one hashchain inside another hashchain. What is a
hashchain? Let us first recall what is hash.
II. HA SH FUNCTIONS
Hash function is a method to convert data of arbitrary size
into a digital string of predefined fixed length, called hash.
One of the simplest hash functions is the modulo operation.
Any digital string can be converted into a number (possibly
very big); this number can be divided by a constant; and the
remainder of that division is the result, hash. Obviously the
result is less than the constant, because its size is no greater
than the size of the constant. This hash function is simple but
at the same time not used too often because people want to
have another property – one way computation. It should be
easy to compute the hash, but finding any input to the hash
function must be difficult, or better virtually impossible.
Hash functions with such a property are sometimes called
cryptographic hash functions, if necessary to distinguish from
others. Such functions digest the bits of the input data in
a very convoluted way to make the reversible computation
impossible. The best known cryptographic hash functions are
MD5, SHA1, SHA2. An example of MD5 is this
MD5(”abc”) = 900150983cd24fb0d6963f7d28e17f72
The result is a 128-bit string shown here in the hexadecimal
format.
If the hash value, represented in some form, is fed again
into the hash function, a new hash is obtained. If this process
repeated and the results are combined into a sequence of
hashes, one obtains a hashchain.
III. HASHCHAINS
Hashchain is a sequence homogeneous data chunks, or
simply blocks, linked together by a hash function. Figure 1
schematically shows a simple hashchain.
Figure 1
Payload
Hash
Payload
Hash
Payload
Hash
Payload
Hash
Each data block consists of the hash and the payload. The hash
of each block is calculated out of the whole previous block.
Payload in each block is arbitrary data. This hashchain has
the important property: no data can be modified at any block
without affecting the integrity of the subsequent blocks. For
example, if the payload of the first block is changed, then the
hash of the second block must be changed as well, and hence
the hash of the third, and so on.
Next step is to authorise only one person to create a
new block in the chain. One way to do it is Public Key
Cryptography (PKC).
IV. PUBLIC KEY CRY PT OG RA PH Y
The basic idea of PKC is similar to hash functions – one
way computation. Given some data m(mfor message) anyone
can compute encrypted value Enc(m). But, only the one who
knows a special key related to this encryption can compute in
the opposite way, i.e. find mfrom Enc(m). The latter process
is called decryption.
To achieve PKC, one must first create a so-called pair of
keys: public and private. The public key is used to encrypt
data and can let be known to anyone. The private key is used
to decrypt and must be kept in secret.
Figure 2 shows schematically the arrows of computation.
The top arrow represents the theoretical possibility to decrypt
without knowing the private key upfront. For example, RSA
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encryption is based on mathematical property of big number
factorization.
Figure 2
m
Public Key
Enc(m)
Not possible but
theoretically imaginable
If someone finds a way to factorize a big number (which is the
public key), then that person would be able to decrypt without
knowing the private key, in fact breaking the cryptography.
There are two main scenarios where PKC works. The first
is when one party wants to send a secure message to another.
In this case the first party encrypts the message by the public
key of the second party. The encrypted message can be made
public because only the second party is able to read the
message encrypted with their key. The only vulnerability of
this method (apart from the theoretical one by cracking the
math) is knowing and trusting the public key in the first place.
To attack this problem a whole system of hierarchical public
certificates exists, for example, in the Internet https protocol.
The second scenario is quite opposite to the first. Given
some data, Alice encrypts it using its private key (or encrypts
only hash from the original data) and then publishes both data:
the original and encrypted. Anyone knowing the public key
can verify that encrypted data is actually computed using the
private key that is paired with the public key used for decryp-
tion. This verification works as a validation Alice actually did
that. That process is called digital signing and the encrypted
part is called digital signature.
Figure 2 shows the first scenario. In the second scenario the
private and public keys are swapped. Let us follow this again.
Alice takes a hash from a document mand encrypts this hash
using his private key, then makes both the document and the
encrypted hash public. Anyone else can take the hash of the
document and decrypt the encrypted hash using the public key
of Alice. If these two values are the same, then it means that
Alice has indeed signed the document m. This scenario with
digital signatures is the one which is useful in hashchains.
V. SECURING HA SH CH AI N WI TH PUBLIC KE Y
CRYP TOGRAPHY
Now, let’s go back to the question of whether it is possible
that only one person is enabled to add a block to the hashchain.
If the last block (Figure 1) contains the public key of the
current owner and the digital signature of the previous block
owner, then creation of the next block will require the signature
of the current block, i.e. of the person who has the private key.
When creating a new block the current owner places another
public key in the next block and signs that block. So the
next block will be owned by whoever keeps the private key
corresponding to the newly published block. And the signature
proves that only the previous owner could have done that.
Figure 3 (from the original Bitcoin paper of Satoshi Nakamoto)
Figure 3 shows how PKC can be used in hashchains.
Hashchain with PKC authorisation can perform as a func-
tion for secure transfer of digital objects, called tokens.
Suppose that one hashchain represents a token. It may be
something to which the real world assigns a value. The owner
of the last block is the owner of this value because only he
is able to pass it to somebody else. However this kind of
hashchain implemented as-is would require a central place
where the blocks are actually created, stored, and can be
verified. We come back to the concept of a bank – a place
which is required to be trusted.
VI. BLOCKCHAINS
Imagine that there is a place (possibly in virtual reality)
where a continuous process exists that constantly creates new
blocks for some global hashchain. And imagine that you can
place any data you like into the payload of the blocks of that
global hashchain. If such a place and process would exist, then
you can insert the blocks of a hashchain representing values
into the blocks of this global hashchain. In other words that
would be one hashchain inside another hashchain. Essentially
this mechanism is called blockchain technology.
Figure 4
Hash Hash Hash
Figure 4 shows an external hashchain where block data
consists of blocks of internal hashchains. The blocks of the
internal hashchains can chaotically appear in the external
hashchain. The obvious condition is that older internal blocks
cannot appear in newer external blocks.
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Different solutions exist on how to organise that global
hashchain. And one particular solution proposed in the original
Bitcoin paper made Bitcoin popular.
VII. SOCIAL INCENTIVE
In Bitcoin network the global hashchain is a database dis-
tributed among many computers. This global hashchain con-
sists of many internal hashchains representing some valuable
tokens called bitcoins. New blocks created on those internal
hashchains are called transactions, because they represent
changing ownership of bitcoins. The owner of a particular
bitcoin creates a new block on the corresponding internal
hashchain and publishes this block as a new transaction to
be included into the next block of the external hashchain.
Publish means sending to all other known participants of P2P
Bitcoin network. When a new block of the external hashchain
is created it is published in the same way.
Any participant can create a new block for the external
hashchain including published transactions into the block. But
this is not easy. To avoid chaos all participants follow a
particular set of rules – the protocol. And whoever does not
play by these rules is ignored. The protocol is based on three
principles:
1) creating a new block requires significant computational
effort;
2) creating a new block is rewarding, so many would make
en effort to successfully create a new block, and
3) when branching occurs, the longest branch wins.
The first one simply requires that the hash taken from the block
plus some random data, starts with a number of zero bits. So
this random data is modified and the hash is calculated until
the condition of zero bits is achieved. That requirement makes
block creation difficult.
On the other hand whoever creates a block receives a num-
ber of newly created internal hashchains representing some
value, bitcoins. That also is part of the protocol. Moreover
since the bitcoins represent a kind of currency and internal
hashchains represent transactions with that currency, the trans-
action owners can give a small portion of the transaction value
(fees) to the creator of the new block of the global hashchain.
So the creator of the new block receives the newly created
bitcoins plus all fees collected from the transactions placed
into the block.
The third rule ensures that there is only one current valid
copy of the database distributed among many computers.
It is obvious that since many parties try to create blocks,
some different blocks are created independently. Since the
propagation is not instant, new blocks may be created on top
of those independently created blocks. That makes the global
hashchain branch. The third rule makes sure that only one
branch which is the longest is considered to be valid. This
rule works fine because block creation is difficult, hence the
probability of two or more branches surviving die out very
quickly.
We can see that the external hashchain plays the role of
the central repository effectively replacing an authority entity.
Since the external hashchain is global, it stores bits and
pieces of internal hashchains uniquely and reliably binding
the tokens with their owners, at the same time making double-
spending impossible. The database of the external hashchain
is distributed among many not trusting each other parties, so
it makes it more difficult to enforce the whole community
of those parties to follow some externally applied regulations
such as political laws.
VIII. SOWHAT IS BLOCKCHAIN?
Blockchain is a particular organisation of hashchains inside
another hashchain. The external hashchain has to be based on
a set or rules that make balance between usability, simplicity,
incentive, and trust and authority. Its purpose is to replace
the central access point that can be controlled and possibly
abused by a human. Internal hashchains are required to have
authorisation mechanism so one party can own something
of particular value. The authorisation mechanism may not
necessarily be PKC. For example, Hasq hashchain is a much
simpler hashchain using only hash functions as authorisation.
