Sending fund to an existing bitcoin address
How does the blockchain know that BTC address1 got 3.5 BTC?

It doesn't know anything, it's just a list
Wallets and other software know by looking through the whole list of transactions from the beginning of time† and adding up all the amounts received by address 1 and subtracting all the amounts spent from address 1.

† Bitcoin time effectively started 12 January 2009