I have been reading “The Age of Cryptocurrancy” by Paul Yigma and Michael J. Casey. They provide this simple to understand image of how a blockchain operates.
A Practical Example of Farmer John selling Betty some oranges for $1.50
Betty goes to the Saturday morning farmers market in her town and wants to purchase $1.50 worth of oranges from Farmer John. Betty will use a cryptocurrency for this transaction (Bitcoin). Farmer John presents Betty his payment address as a quick response code:
Betty uses a Bitcoin wallet on her smartphone to scan the code. She is presented a screen where she can enter an amount to send to John’s address. She types ‘$1.50’ and presses send. A moment later John’s tablet notifies him that there is an incoming payment pending, which is not confirmed yet. About ten minutes later, the payment is finalized when it gets confirmed.
Why 10 minutes? Will be left for another discussion.
Under the hood
1) The Payment Transaction:
The software on Betty’s smartphone checks whether she has a sufficient balance and then creates a payment transaction. This transaction is composed of three pieces of information: Which “coins” to spend, the recipient, and a signature.
Betty’s wallet is connected to other participants in the network. The wallet passes the transaction to all of them, who in turn pass it on to all of their connections. Within a few seconds, every participant in the network has received notification of Betty’s payment order. Each and every participant checks whether the listed “coins” exist, and whether Betty is the rightful owner.
So far, Betty’s payment is only a promise, because it is still unconfirmed.
To change that, some network participants, which we’ll call miners, work on confirming these transactions. The miners grab all the unconfirmed transactions and try to pack them into a set. When their set doesn’t fit the requirements, they reshuffle it and try again. At some point, somebody finds a set with the right properties: A valid block.
Just as with the transactions before, they send this block to all their connections, who in turn forward it to theirs. Everyone checks the work (to confirm that the block follows the rules) and when satisfied, they apply the included transactions to their own ledger: The transactions get executed and the “coins” that were used by Betty get transferred to Farmer John as ordered by the transactions. Betty’s transaction (and all the others) is now confirmed. Betty can now eat her oranges and Farmer John can now spend his “coins”.
Miners are compensated for processing transaction through the issuance of newly minted cryptocurrency coins by the blockchain. Neither Betty nor Farmer John incur any cost for this transaction.