A Guide to Consensus Algorithms on Blockchain Networks Part 5

How blockchain networks operate without relying on third parties.


With the creation of Bitcoin, Satoshi Nakamoto introduced the world to a payment system in which people can send digital money to anyone at any time and do so without having to rely on any third party.

The Bitcoin network has solved the issues of double spending and transaction finality by recording all the transactions onto the decentralized Bitcoin ledger that is impossible to modify. Each transaction, as it goes from a person sending the funds to a person receiving the funds, gets a digital signature impossible to hack because of the cryptography. For this reason, digital cryptocurrency funds are chains of data with digital signatures. In a way, a coin on a digital network is a ledger with notes by every person that has ever been in the possession of the coin.

When you want to send funds on the Bitcoin network to someone else, the network checks the history of previous transactions to make sure that the funds you are sending are legitimate and are only being sent once.

On the Bitcoin network, transactions are publicly visible to anyone. The network does not depend on any third parties. You can see the transactions as they are happening in real time by visiting Bitcoin blockchain explorer at https://blockchain.info/unconfirmed-transactions

This means that anyone with access to the Internet can see all the transactions that have happened on the Bitcoin network since it went live in 2009.

Many people think that the Bitcoin network is anonymous, but this is simply not true. On the network, the data about transactions does not contain names or any personal information, but if someone knows a Bitcoin address, they will be able to see all the transactions associated with this address. Information about all the transactions is available to anyone for inspection, which means that if someone knows that a party is expecting a payment of a certain amount, they can monitor the network for payments in these amounts, they can monitor the times of payments and so on. This is not anonymity in its true sense.

When you send funds on the Bitcoin network, the entire network gets information about the transaction. If you were to try to send the money for the second time, this would simply not be possible because the network already knows that you are trying to send the funds to someone.

To process transactions, blockchain networks use what is known as consensus algorithms. Generally speaking, a consensus algorithm is a series of steps that parties agree to take to reach a decision about digital data. On the financial digital blockchain networks such as Bitcoin the goal of this algorithm is very simple: to decide which transactions are valid and which transactions are not valid. To answer this question, the Bitcoin network and many other networks use a consensus algorithm called proof-of-work.

Simply speaking, the Bitcoin network and other blockchain networks are software. They exist because people choose to run the software. When Satoshi Nakamoto created the software for the Bitcoin network, he made it open-source. This means that anybody can download the software, inspect it, dissect it, see how it runs, or use any part of that software for whatever purpose.

This is very different from how software from private companies, be it Google, Microsoft, Amazon or Facebook works and there’s a reason for that. For example, if everybody knew Google’s search ranking algorithm, people and organizations would be interested in getting to #1 in Google because for businesses being #1 means increased profits and for people being #1 means increased visibility and, ultimately, more money. For example, if someone is searching for an “Italian restaurant near me” on Google, chances are very high that they are looking to have a meal at an Italian restaurant in the very near future and all the Italian restaurants that need customers would be interested in getting visibility. Google has to protect its search algorithm just like Facebook has to protect the way it designs the newsfeed just like Amazon needs to protect the algorithm that decides which results to show to visitors of Amazon.com. The way public blockchains work is exactly the opposite.