Processing a financial transaction

Before we dig deeper into blockchain-based transactions, it is helpful to know about how financial transactions actually happen and the functioning of fiat money.

Fiat money is entirely based on the credit of the economy; by definition, it is the money declared legal tender by the government. Fiat money is worthless without a guarantee from the government.

Another type of money is commodity money; it is derived from the commodity out of which the good money is made. For example, if a silver coin is made, the value of the coin would be its value in terms of silver, rather than the defined value of the coin. Commodity money was a convenient form of trade in comparison to the barter system. However, it is prone to huge fluctuations in price.

Commodity money proved to be difficult to carry around, so, instead, governments introduced printed currency, which could be redeemed from the government-based banks for actual commodity, but then, even that proved to be difficult for the government to manage, and it introduced fiat-based currency, or faith-based currency.

Having fiat-based currencies incurred a lot of third-party consensus during its time; this would help eradicate fraud from the system. It is also necessary to have a stringent consensus process to make sure that the process, as well as the privacy, is maintained within the system. The following diagram depicts the process of a credit card-based payment process:

The process of a credit card-based payment and the need for multiple third-party reference points to maintain trust.