The basic nuts and bolts of bitcoin
It is scary when your friends and acquaintances think 10 times before investing in mutual funds but are willing to bet on bitcoins in a split second. Most of who are jumping on the bitcoin bandwagon right now may not know the nuances of cryptocurrencies. And the reason for the interest is bitcoins, despite their lack of awareness, and is largely driven by the price movement that has been touching all-time highs almost every week. This week, bitcoin crossed the $10,000-mark. We know that bitcoins are created using encryption techniques. If you are one of those who are looking to understand a little bit more about bitcoins and what goes into these techniques, here is a look at some of the jargon that is essential to understand bitcoins.
Block: Once a bitcoin is created, it gets added to a public ledger. “The records are grouped and stored in blocks. Each block contains a timestamp and a link to a previous block, so that the blocks are chained together, thus the name ‘blockchain’. The blocks are mined in sequence and once recorded, the data cannot be altered retroactively,” wrote David Lee Kuo Chuen, economics professor of fintech, Singapore University of Social Sciences, in his paper ‘Cryptocurrency: A New Investment Opportunity?’ carried in The Journal of Alternative Finance, which was shared with Mint. A complete record of transactions can be found on the main chain. Each block on the chain is linked to the previous one, and can be traced all the way to the very first one, which is called the genesis block. “However, there are also blocks that are not part of the main chain, called detached or orphaned blocks. They can occur when more than one miners produce blocks at similar times, or they can be caused by attackers’ attempt to reverse transactions. When separate blocks are validated concurrently, the algorithm will help maintain the main chain by selecting the one with the highest value,” said Lee. The common concept of blockchain is of a traditional book ledger, explains Sreekanth C.S., chief operating officer, Coinome. “Traditionally in a book ledger, you write a single line item, which is actually a transaction. Once the page is full, you have to flip to the next page. Now what if someone tears the page? How will you realise it. One option is page number. But someone can erase that too. Hence, traditionally people wrote the net total of the page at the bottom and carried forward to the next page. At any point, one has to look at the topmost entry, the carry-forward number, and the previous page’s bottom-most entry. This is how a blockchain works. You have a block that can be compared to a page in a book ledger. You can look at a block as a set of transactions,” said Sreekanth.
Hash: Another term that often comes up while talking about bitcoins is ‘hash’. What is a hash in the world of bitcoins? “Hashes are integral in bitcoin mining and the creation of new bitcoin. A hash comes from a hash algorithm and is created from a large amount of fixed data, and truncated into a fixed set of numbers. Generally those numbers are written out as hexadecimals,” said Samuel. You can imagine it as a signature that is used in text or a data file and generates a unique size. It is a one-way function that can’t be decrypted. Simply put, “We know that block is a set of transactions. In a book ledger, you will have an entry at the bottom of a page and the top of the next page. Just like bringing a carry forward, each following page’s header or block will be the hash of the previous block,” said Sreekanth. Technically there are two kinds of hashes—unidirectional and bidirectional. “We use unidirectional hash. This means you can give an input and get an output. However, you can’t get the input back. You take a content, hash it, you will get a string or a hash but when you look at the hash, you will not know what the input is. But you can be certain that given the same input you will get the same output. Hash is a unique signature print of an output (which is a block here),” said Sreekanth
Nodes: Bitcoin nodes ensure transactions are validated and confirmed as well as ensure that there are no double spends on the bitcoin network. “A node for a cryptocurrency is a full client containing the cryptocurrencies’ entire blockchain. This node also broadcasts and shares transactions across the entire network for the cryptocurrency,” said Samuel. A bitcoin node keeps a check of all the transactions. “Nodes send all transactions happening in the bitcoin blockchain to all other nodes. In bitcoin, every 10 minutes, nodes put transactions into a block. The series of blocks is called the blockchain,” said Neppalli. Nodes are a way to keep the transactions transparent.
“It doesn’t make sense if only I have a block and hash. Other people should also have it, which is called decentralization. There should be an entity that is connected to the entire network that distributes this to everyone. Any entity that is connected to blockchain system is a node. A node is just an entity that is connecting into the system. You can’t just randomly add an entry. There are a set of miners who add these transactions to a set of blocks,” said Sreekanth.