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The Blockchain

All Bitcoin transactions are recorded into the blockchain. Throughout the remainder of this book, we'll refer to the Bitcoin ledger as the blockchain. The reason for its name is that new transactions are appended to the ledger in large chunks, or blocks. Whenever a new Bitcoin transaction is broadcast to the network, computers on the network add it to a growing pool of other new transactions. Then, about every 10 minutes, the transactions in that pool are bundled into a block and added to the blockchain (see Figure 2-9). To function properly, all Bitcoin wallet programs need access to an up-to-date copy of the blockchain, and every time a block is added, the wallet programs copy and add the block to their own blockchain.

Bitcoin transactions are grouped into blocks that are added to the blockchain every 10 minutes.

Figure 2-9: Bitcoin transactions are grouped into blocks that are added to the blockchain every 10 minutes.

The thousands of computers on the Bitcoin network that collect transactions and add them to the blockchain are called miners. We'll explain miners and the details of what they do later in the chapter. For now, keep in mind that anyone can be a miner (including you) by running open source Bitcoin-mining software on a computer that is connected to the Bitcoin network. At any given moment, tens of thousands of miners are connected to the Bitcoin network. All volunteer their computers for the purpose of adding new transactions to the blockchain (we'll explain why they do this in a moment).

Every block added to the blockchain is added by a single miner on the network. Then everyone else on the Bitcoin network follows suit and updates their own copy of the blockchain (this includes other miners and Bitcoin wallet programs). Why does only one miner add a block, and how is it decided which of the thousands of miners it is? This is where Bitcoin gets interesting—and a little technical.

Let's first consider why anyone would want to update the blockchain. Certainly, if you wanted to complete transactions, your Bitcoin wallet program would need the latest copy of the blockchain. However, you might not want to send or receive bitcoins for months, so why bother updating your copy of the blockchain in the meantime? For the Bitcoin system to work, many people need to keep up-to-date copies of the blockchain. The reason is that if only one person had the latest copy, she could manipulate the number of bitcoins people had on record. Therefore, good will alone isn't sufficient to keep the system running. But the lure of a reward is always an attraction.

The Blockchain Lottery

As an incentive for users to update the blockchain as frequently as possible, Bitcoin uses a lottery-based reward system. Many people become miners and try to be the first to add a block to the blockchain. Then, based on some probability, a winner is chosen and gets to add a block.

What is the purpose of using a lottery like this to run Bitcoin? Well, let's imagine Crowley wants to buy a $10,000 car from Clarice. (You'll learn more about our friend Crowley the Crocodile in the comic in Chapter 5.) Using traditional currency, two people engaging in this transaction would probably go to a bank and have the money transferred between their bank accounts (or use a cashier's check, which is analogous to this; see Figure 2-10).

Crowley sending $10,000 to Clarice through a traditional bank

Figure 2-10: Crowley sending $10,000 to Clarice through a traditional bank

They would do this at a bank because they need a trusted third party (a "banker") that manages a "money ledger" and moves the money on the ledger from one person's account to another. The banker's job is to make an announcement that Crowley and Clarice can trust; that is, to affirm that the ledger has been updated correctly. (The banker may or may not be sporting a monocle, wearing a top hat, and smoking a cigar.)

With Bitcoin, we also need a person to adjust a ledger, which in this case means adjusting the blockchain by adding a block to it. It turns out anyone can fill this role, as long as he is not connected with either party in the transaction, because that could lead to a conflict of interest. Picking a person randomly through a lottery helps accomplish this. So with Bitcoin, a lottery picks a random miner, who then announces to the network that certain Bitcoin transactions are valid (see Figure 2-11).

Of course, there's always a small chance this miner does know one of the persons involved in a recent transaction. This is why blocks are arranged in a chain: In roughly 10 minutes, when the next lottery winner is announced, this winner also confirms, as part of her announcement, that she agrees with all the transactions of the previous lottery winner (see Figure 2-12).

A random person running Bitcoin-mining software is chosen to confirm Bitcoin transactions.

Figure 2-11: A random person running Bitcoin-mining software is chosen to confirm Bitcoin transactions.

In the process, each winner in the Bitcoin-mining lottery receives a reward, which is a certain amount of bitcoins. The reward includes all of the transaction fees for the transactions in that block, which motivates miners to collect as many transactions into a block as possible, increasing their reward. To be eligible for the reward from the next block, which is added 10 minutes later, a miner needs to have the latest copy of the block-chain to participate in the next round. This process is done automatically by open source Bitcoin-mining software that runs on computers controlled by the people involved in mining. Because of this incentive structure, thousands of miners constantly help process the transactions of Bitcoin users, making sure that the blockchain is always up-to-date.

The reward lottery is run by the community; no central authority exists to choose a winner. We'll skip the technical details for now (they're covered in Chapter 8) and just say that miners generate random numbers continuously, until they find a winning one. This takes about ten minutes. The community then verifies (also through cryptography) that the number found by the individual miner is the winner, and the miner adds a new block to the blockchain and collects the reward. When this happens, the phrase commonly used is that a miner has found a block.

With Bitcoin, each lottery winner confirms not only her own block of transactions, but also all the preceding blocks (that she considers to be valid).

Figure 2-12: With Bitcoin, each lottery winner confirms not only her own block of transactions, but also all the preceding blocks (that she considers to be valid).

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