Blockchain Basics

blockchain basics
November 28, 2018
a jargon-free introduction to bitcoin blockchain

our goal today
1. What’s in a wallet?
2. Where do bitcoins come from?
3. Step-by-step examination of a crypto- transaction

PART 1: Wallets
What’s in a wallet?

What’s in a wallet?
• Your private key
• One of more public key(s)
CRYPTO-WALLETS DO NOT CONTAIN COINS
CRYPTO-CURRENCY IS NOT STORED ANYWHERE
ONLY YOUR CLAIM ON THE CURRENCY IS STORED ON BLOCKCHAIN

Types of wallets
Based on where your keys are stored, there are a few different types of
wallets:
• Desktop
• Mobile
• Web
• Hardware
• Paper

Desktop Wallets
• Electrum (intimidating UI, secure, advanced features like address tagging,
fee adjustments, wallet encryption, signed messages, SPV or API option)
• Exodus (modern UI, excellent starter wallet, SPV wallet, altcoin support)
• Bitcoin Code (full node wallet, independent verification)
• Copay (multi-signature, extra security against theft, good option if you can’t
afford a hardware wallet)
• Armory (secure, features a variety of encryption and cold-storage options)
• Jaxx (easy to use, excellent starter wallet, altcoin support)

Mobile Wallets
• Electrum (bitcoin only, watch-only option)
• Mycelium (tried and tested security, >100,000 users, iOS and
Android, linked debit-card support)
• Mobi (support for over 100 fiat currencies, instant cross-border
payments, bitcoin only)
• Coinbase (>8M users, multisig support, intuitive UI, simple to setup
and use)
• Blockchain.info (14M users, minimalist design and options)

Web Wallets
• Coinbase
• Green Adress
• BitGo
• Xapo
• Copay

Hardware Wallets
• Ledger Nano S
• Trezor
• Keepkey

● Simply a public key and private
key printed together
● https://walletgenerator.net/
Paper Wallets

Hands-on Lab
Setting up a wallet (or two)
Exodus.io Jaxx.io

Part 2:
Where do bitcoins come from?

Where do bitcoins come from?
Fiat Currency Crypto-currency
Controlled by Central Authority (Governments) No Central Authority
Printed when Government decides to print more Miners (human) use special software to solve math
problems are issued new bitcoins in exchange
The special software is called Miner (software)
This special software can be run on specialized hardware
to speed up mining and generate more bitcoins.
This specialized hardware is called Miner (hardware)

Mining in early days
● Math problems were simple
enough
● Anyone with a computer and
miner (software) could mine
bitcoins
● Bitcoins mined at this time
are sometimes referred to as
‘CPU-mined bitcoins’

Mining in early years
● Gamers figured out that
mining with GPUs was
faster
● GPU mining took-off
● But, GPUs consumed more
electricity and produced
more heat

Mining in mid years
• Companies started building
Application-Specific Integrated
Circuit (ASIC) chips to perform
mining operations
• ASIC hardware is faster and
more energy efficient than GPUs

Mining today
● Contribute your hardware to
solving math problems in
concert with others
● Purchase into a specialized data
center specifically designed for
mining
● Share profits in proportion to
your contribution

Why are miners rewarded?
Miners are required to validate bitcoin transactions on the network,
thereby providing a critical service to the network.
If 51% of the network approved the validity of a transaction, it is
cleared (added to the blockchain)

Miners provide valuable services
• Book-keeping: The bitcoin miner client downloads and syncs in real
time the entire blockchain of the bitcoin network
• Network guardians: Miners safeguard the network against hacks
and validate each transaction
• Settlement and Clearing: Blocks validated by miners are added to
the blockchain without dependence on a trusted 3rd party
• Creation of new bitcoins: Miners are rewarded with bitcoins for
contributing processing power and keeping the network safe

Part 3: Under the hood
step-by-step examination of a bitcoin transaction

Hash Functions
● A function that takes an input (of any size) and converts into an
output (of fixed size)
● It’s a deterministic function: The output will always be the same
for a given input

Cryptographic Hash Functions
● The qualifier ‘Cryptographic’ implies that the hash function
○ is computationally efficient - apply transformation quickly,
○ is collision resistant - hard to find 2 inputs that result in the
same output
○ hides information - hard to infer the input by examining the
output
○ looks random - well-distributed output - should look random
● Sometimes referred to as a mathematical meat grinder
● Examples include MD5 (Message Digest 5), SHA-256 (Secure HAsh
256)
● Applications include - Digital Signatures, Cryptocurrencies

Digital Signatures
• Digital signature is a way of combining a public sequence of numbers
with a message
• Examples include RSA, DSS
• Each Signature includes 2 keys:
• signing key (sk) or private key, and
• verification key (vk) or public key
• It is hard to come up with the signing key if you have the verification
key

https://exonum.com/blog/09-27-17-digital-
signature/

What is a transaction?
Transaction is a digitally signed declaration by one party of it’s
intent to transfer some bitcoins they posses to another party

Transaction Workflow ● Everybody can see the ledger
● This is what a network looks like except...
BTC LEDGER (State of the Network / Account of all Coins)
Ashley 10
Berk 12
David 13
Emre 50
Karen 26
Marie-Louise 70
Nani 123

● No one knows your name
● Your identity is represented by your
public key / verification key
● This is what a network looks like,
except...
MIIBOQIBAAJAT+qwrlMhJOkn3VSQQK... 10
FsPkKavfDcE19SFZnuJ4HHA0XMn3xD... 12
TtWttB/pfSh5FT/Wr6B3bRoM7nzWpeq... 13
AiEAnnIGwnywSjvpsecRrp9RTpVqgirn... 50
DesPyX5YO5eXSieI8cV5xs+nDsz6KwIh... 26
WdqKfiE5+YcBAiBP0aaBTe8xk5TNW0h…. 70
wi4V/2ZlZnl6kn+QgtKx+hQC8ZWKvBcb... 123

● No one knows your name
● Your identity is represented by your
public key / verification key
● No one knows who you are unless they
transact with you in person
Governments and Financial Institutions do not
like this.

Transaction Workflow Node with public key , digitally signs a
declaration announcing to the network, it’s
intent to transfer 10 bitcoins they possess to
node with public key .
Network’s job is to verify that node with public
key , does possess 10 or more bitcoins.
10

Transaction Workflow At any given time, there are multiple
declarations of transactions being proposed to
the network.
Several of these proposed transactions are
combined to form a Merkle Tree.
10

Merkle Tree
https://hackernoon.com/merkle-trees-181cb4bc30b4
10

Using a Merkle tree allows for a quick and simple test of whether a specific
transaction is included in the set or not.
https://hackernoon.com/merkle-trees-181cb4bc30b4

Why hash transactions?
• Reduce the amount of data that needs to be downloaded by a node
for verification purposes
• Validation proofs are computationally easy and fast

Why Merkle tree? Why not hash all transactions
at once?
• One branch can be downloaded at a time
• Integrity of each branch can be immediately verified even if the rest
of the tree is not downloaded yet
• If a small block file is damaged, it can be individually downloaded
without having to download all the blocks
• Merkle tree can reside locally or on a distributed system

Transaction Workflow Merkle tree is created from a set of proposed
transactions.
Transaction from to is included.
Merkle Root summarizing all the transactions is
created and stored in the block header.
10

What’s in a block?
● List of Transactions
● Merkle Root
● Timestamp
● Difficulty Target
● Nonce
● Hash of previous block

Difficulty Target
● Difficulty target is a number that regulates how long it takes for miners to
add new blocks to transactions to the blockchain
● The difficulty target adjusts every 2016 blocks (roughly 2 weeks)
Why is Difficulty Target important?
● It ensures that blocks of transactions are added to the blockchain at regular
intervals, even as more miners join the network

1. Difficulty adjusts every 2016 blocks. Let’s assume it takes 2 weeks
(20160 minutes) to add 2016 blocks. This means that each block is
expected to be added in 10 min.
TExpected = 10
2. Let’s say more miners joined the network and it took miners, an average
of 9 min per block.
TActual = 9
3. Calculate (TExpected /TActual) = 1.1
4. New Difficulty (DNEW) = DCURRENT X 1.1
Difficulty Target Calculation

How does Difficulty control time between
blocks?
Let’s play a simple math game.
Assumptions:
● You are given a range of numbers 1-100 where 100 is the RANGEMAX
● You randomly generate a number between 1 and 100 every minute
Objective:
● Generate a number below my TARGET

blocks?
TARGET = 50
How long will it take (on average) for you to find a number below my TARGET?

blocks?
TARGET = 20

blocks?
TARGET = 10

blocks?
The lower the TARGET, the longer it takes for us reach our objective
TARGET Time to find reach objective
50 2 min
20 5 min
10 10 min

If instead of providing you the TARGET, I provided you ANOTHER_NUMBER by which
to divide the RANGEMAX , we would get the the same result
This ANOTHER_NUMBER is called DIFFICULTY_TARGET
ANOTHER_NUMBER TARGET
(RANGEMAX/ANOTHER_NUMBER)
Time to reach objective
2 50 2 min
5 20 5 min
10 10 10 min
blocks?

● Our assumptions from previous activity are ridiculous for real-world
implementations
● Miners are able to generate thousands of numbers (hash values) per minute
as opposed to our measly 1 per minute
● To make things worse, there are many miners working on the problem
concurrently
● To make DIFFICULTY_TARGET work, MAX_RANGE needs to be big
● Real world MAX_RANGE looks more like:
8972345609248750982347034985702348957202938547029438750928349847
Real World Numbers

● Real world DIFFICULTY_TARGET looks something like this: 13498.928322
● Since MAX_RANGE is a big number, we use hexadecimal system to
represent numbers as opposed to decimal. In reality, MAX_RANGE range
looks more like this:
000000000003ba27aa200b1cecaad478d2b00432346c3f1f3986da1afd33e506
Real World Numbers

● Difficulty targets control the time it takes to add a block
● Miners are tasked with finding a hash lower than TARGET, as calculated
based upon the MAX_RANGE and DIFFICULTY_TARGET
● Hashes are just numbers represented in Hexadecimal
Summarizing Difficulty Targets

NONCE (number used once)
Nonce is a random integer between 0 and 4,294,967,296

How is a block made?
Hash of the previous block
(publicly known)
+
Current transactions
+
Nonce
(randomly selected)
HASH IT
Miners are expected to
get a valid hash for
their candidate block
such that the hash of
their block headers is
below the TARGET

Revisiting Nonce
• Nonce is a random integer between 0 and 4,294,967,296
• Miners have to ‘guess’ the nonce when they’re trying to get the hash of
their block headers below a TARGET
• Typically they do this brute force by incrementing the nonce until they get
a valid hash

When a miner succeeds in guessing the nonce…
• They can send the block to the network
• The network can easily verify if the nonce is correct
• Once majority of the network agrees, everyone will add the new
block to their blockchains
• Miner will pick up the block reward for their efforts

It’s essentially a guessing game
In some ways, the miner to guess the right nonce is just lucky
to be the first to find the nonce.
Once a nonce is found, it can be easily verified.
The miner can therefore, easily ‘prove’ that they have
performed the ‘work’ to find the correct nonce.

Proof-of-Work
● Has been in use for many years prior to bitcoin
● Applications include: Denial of Service attack prevention,
SPAM prevention

Transaction Workflow Transaction, once verified, will change the
ledger state to below.
10

Blockchain is a chain of blocks

What is a blockchain?
• is a chain of digital signatures that reflect each bitcoin’s path through
the bitcoin network
• is a chain of blocks
• is a database
• is a distributed database
• is a distributed ledger
• is an immutable distributed ledger

Blockchain Basics

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