Assume you want to spend all your US$100 to buy goods in a shopping mall. At the checkout, you say that you will send an email promising to pay US$100 (i.e., an electronic IOU). The merchant happily accepts the email and goes to the bank. The bank also accepts the email and credits US$100 to the merchant’s account.
To understand how this could ever be possible, let’s add a group of customers in the mall. Now, when you say that you will send an email IOU, the people will ask to receive the same email. There are some “special” customers in the crowd that will compete to be the first to validate the email (e.g., the sender, the receiver, the exchanged amount, the real possession of the claimed amount). All special participants follow a rule: The first to solve an electronic puzzle, say a Sudoku, wins the race. The winner is compensated for the hard work and effort to solve the Sudoku. There is an incentive for the contenders to win the next time. After checking that the Sudoku was properly solved, contenders accept the winner’s validated email as the “version of the truth.” The email is then sent to all the people in the mall, which now all have the same copy, acknowledged as valid and immutable. With the version of the truth publicly accepted, everyone in the mall will know that you owe US$100 to the shop and that you have no money left. The US$100 bill in your hands is worth nothing.
You now move to the next store in the mall and try to buy other goods worth US$100. You again promise to pay via email. This time, your offer will be refused because this store also received the email, so it knows perfectly well that you don’t have any money. Both your bank and the owner’s bank are also in the loop, so there’s no need for any intermediary (e.g., a clearinghouse or the central bank) to tell parties how much each owns and if the transaction is acceptable.
When the store that received the valid IOU uses it (or a portion of it) with some other party in the mall, the entire population in the mall will be informed exactly of what is happening. The history of the IOU will never be lost and, at any time in the future, someone will be able—if duly authorized—to trace the transactions backward and know that on that certain day at that certain time you passed your “electronic IOU” to buy goods for US$100.
This history repeats for all transactions between all parties in the mall. On a regular schedule, Sudoku puzzles are solved and validated IOU emails disseminate. With no centralized control.
In blockchain jargon, the “electronic IOU” is called “bitcoin.” When you promise to pay US$100, it’s as if you are writing on a ledger that the title to redeem a value worth US$100 is transferred from your account to the seller’s account. If you try to spend it again, someone will shout out loud that you are cheating.
You, the stores in the mall, the crowd of customers, the “special” participants, and the banks, constitute the blockchain infrastructure. There is no centralized control; every party can transact with any other, and it’s the system itself that controls the validity of the exchanges. The “special” participants are called “miners.” They collect valid transactions in a “block.” Anyone can track back the history of a transaction because the blocks are connected (i.e., chained). So, in a nutshell, blockchain is a chain of blocks, each with a recorded ledger of validated electronic IOUs. All network members have a copy of the blockchain, which represents the agreed upon version of the truth.