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Abu Bakr, his father-in-law, became the first Caliph, and was followed by Umar and Uthman, both early converts to Islam, both friends of Muhammad. Uthman was Caliph for 12 years. The first six were great, but the last six things got bad as the military ran out of easy conquests and started thus having to transition to a governing function rather than a military function.
There was a civil war under Uthman, and many wanted to replace Uthman with Muhammad's son-in-law, Ali. The civil war was eventually cooled without much bloodshed, but soon after, Uthman was murdered by a mob of Ali supporters. Even so, Muslims chose Ali as the new Caliph.
After four years of bad times, Ali was assassinated, and the caliphate passed on to a military man with no direct connection to Muhammad, and this started the Umayyad Dynasty. Meanwhile, the followers of Ali were pissed, and refused to reconcile with those who had killed Ali. The split was deeper than just the person of the Caliph, it involved pre-conquest regional differences, as well as issues of new converts versus original Muslims, and a lot of other things.
Ultimately the backers of Ali tried to set up their own caliphate under Ali's sons, Hassam and Hussein. The Alid armies were defeated, and both sons were killed at different battles, even though the youngest was just a child. These three deaths-- Ali, Hassam and Hussein-- are the subjects of the so-called Shi'a Passion Plays. It is also why Najaf and Karbala are holy-- because those are the battle sites where Hassam and Hussein were "martyred."
After these loses, the Alids became a non-threat, mostly, as their forces were defeated or else rejoined the main Muslim armies. So the followers, rather than reconcile, stayed apart, and began to look on Ali as the proper Caliph after Muhammad (excluding the other three), and that after Ali, his sons should have followed. I've forgotten the terminology, but they basically believed that although Muhammad was the last prophet, the descendants of his family had a sacred element, and were somehow guided directly by Allah. The wound up with a few of these types of geneological ideas after a while. The Mahdi is a term that implies a divinely chosen descendant, as does Ayotolla, though I've forgotten exactly the definitions.
The Sunnis are those who followed Abu Bakr's line of government. They are in some ways more like Catholics, with fairly ritualistic views of religion, believing mostly that a Muslim is a Muslim by doing the right, proscribed duties. Shi'a have a more mystical outlook, believing, almost like protestants, that the relationship with Allah is more spiritual, and that Allah can be revealed to the people through revelation as much as through the Qur'an and the Traditions of the Prophet.
That's a fuzzy line, of course, as Sunni and Shi'i can both be mystical at times, or ritualistic. But that's a basic summary of the history. The Shi'i believe that the Sunni rejected and slaughtered their saviors, just as Christians (in general) blamed the historical Jews for rejecting and slaughtering their savior.
As for on-the-ground differences, I don't know much. They follow different schools of law, different traditions, and different people, and of course Islam (like Christianity or Buddhism) takes on the character of the cultures it is practiced in, so there are also differences between Persian and Arabic culture, and these all blend to make them very different from each other to each other, but not as different from each other to outsiders.
It is quite a feat that we have united them, although it has happened to varying degrees when faced with other invaders. The idea that the Midle East has been fighting for over a thousand years and won't stop soon is just bigotry. There have been long periods of peace and soaring cultural achievements, and periods of war, just as in Europe or America.
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