The world of electronic payment transactions will not revolve in the absence of financial institutions which are serving as trusted third parties. The trust based model is likely to be challenged by disputes. Thus, when a dispute is called for the cost of the overall transaction increases.
To avoid rising costs, financial institutions will want more information about the customers who are transacting. A certain extent of fraudulent activity is unavoidable. And, the fate of the entire transaction mechanism is dependent upon the central authority which prevents the act of double spending.
When there is a desire to eliminate a trusted third part, all the details of the transaction should be publically announced. Timestamp made it possible. Timestamp includes the previous timestamp in its hash, forming a chain with each additional timestamp reinforcing the ones before it.
To implement a distributed timestamp server on a peer-to-peer basis the concept of proof-of-work came in to being.
The network works in such a way that new transactions are broadcast to all nodes. Each node collects new transactions into a block. Each node works on finding a difficult proof-of-work for its block. When a node finds a proof-of-work, it broadcasts the block to all nodes. Nodes accept the block only if all transactions in it are valid and not already spent. Nodes express their acceptance of the block by working on creating the next block in the chain by making use of the hash of the accepted block as the previous hash.
The longest chain is considered to be the correct one. Incentives are provided for the nodes to stay honest. The sooner the pre-determined numbers of coins are reached, the incentive will now become transaction fee and thus the value of the network stays inflation free. A greedy node with more CPU power will find it easy to play by the rules than to undermine and attack the system.
There are other simplified payment verification methods where, payments are verified without running a full network node. However, in such a method the verification will only be reliable for as long as honest nodes control the network. There will be more vulnerabilities when dishonest attackers attack it.
Another limiting factor is privacy, when all the transactions are visible to all, there little privacy. So, there are PoW tokens, privacy systems like Monero (XMR) and other kinds of tokens each of them pioneering an idea ultimately to make peer-to-peer transaction systems efficient. The different payment methods are evolving and are set to get better with more developments and codes.
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