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How traditional payment systems work

As anticipated, our goal here is to discuss how the participants in a blockchain network ensure that the double entry accounting principle is taken care of. We'll also show how this solution is different from the other existing solutions of the legacy financial system.

In the Bitcoin blockchain, payments are settled through a so-called consensus mechanism, which works based on economic incentives rooted in game theory. Confused? We will explain it in simpler terms in the following paragraph.

The consensus process aligns the interests of all network participants, so that their best course of action is to support the truthful verification and record-keeping of all transactions. We'll cover the consensus mechanisms in more detail later on. For now, here's what Satoshi himself wanted to share about this issue:

"The problem of course is the payee can't verify that one of the owners did not double-spend the coin. A common solution is to introduce a trusted central authority, or mint, that checks every transaction for double spending. After each transaction, the coin must be returned to the mint to issue a new coin, and only coins issued directly from the mint are trusted not to be double-spent. The problem with this solution is that the fate of the entire money system depends on the company running the mint, with every transaction having to go through them, just like a bank.
We need a way for the payee to know that the previous owners did not sign any earlier transactions. For our purposes, the earliest transaction is the one that counts, so we don't care about later attempts to double-spend. The only way to confirm the absence of a transaction is to be aware of all transactions. In the mint based model, the mint was aware of all transactions and decided which arrived first. To accomplish this without a trusted party, transactions must be publicly announced, and we need a system for participants to agree on a single history of the order in which they were received. The payee needs proof that at the time of each transaction, the majority of nodes agreed it was the first received."

So, the root of the problem is to secure a consensus process through which all participants in the network are on the same page at any given time. This process must be so robust that all participants trust it with their money. The simple solution is to introduce a trusted central authority to run the ledger of transactions, just like a bank. History has shown many times that such central parties, or middlemen, can present a risk of their own, and have been compromised far too often.

Therefore, Satoshi goes for the more difficult solution: to secure and maintain decentralized consensus in a global payment system. In fact, this problem is so complex that nobody had ever solved it before.

Let's run through a few examples of how different existing payment systems work.