Cryptocurrency 101 Tutorial

The Blockchain Explained

September 24, 2018

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The Blockchain Explained

The Blockchain Explained

Understanding exactly what a blockchain is can be confusing. In this post we break it down step by step, starting with Bitcoin, and then covering some of the other applications of blockchains.

The simplest way to think about a blockchain is to imagine it as a ledger of transactions on a shared spreadsheet that anyone can access. Now imagine that while anyone can view this ledger, new transactions can only be added by those with a password, and past transactions can never be erased or altered.

This is what the Bitcoin blockchain is: an open source ledger that records every transaction and the number of Bitcoin that every address owns. The addresses, or public keys, are like account numbers.

The owner of one address can send Bitcoin to another address, and once they do, the blockchain will reflect a new balance for both addresses (as Bitcoin can never be in two places at once).

Blockchains are also known as distributed ledgers, because the ledger is not stored or controlled by any single entity.

Nodes, blocks, miners and hashing power

To keep the blockchain running smoothly, people known as miners are incentivized to add new transactions to the blockchain. They do this by running a node, a computer that contains a copy of the entire blockchain and the code used to update it. While anyone can download the code and run a node, these days very powerful computers are required to do so.

Transactions are added to the Bitcoin blockchain in bundles called blocks, which consist of approximately 200 transactions. In order to get as many nodes to participate and achieve consensus on the state of the blockchain, node operators (or miners) compete to win mining rewards. Every time a new block needs to be added to the network (every 10 minutes), all the miners attempt to solve a mathematical puzzle. The first miner to solve the puzzle earns the mining reward, or which is currently 12.5 Bitcoin.

Although only one miner is rewarded, the size of the reward causes many participants to compete, arriving  at consensus about the transactions that are added.

As the value of Bitcoin has increased, miners have invested in more powerful computing power to allow them to compete. The computing power required to mine on a blockchain is called “hashing power”, while the combined hashing power of the entire network is known as the “hash rate”. As the hash rate of the network increases, the difficulty of the mathematical puzzles miners must solve is adjusted.

Since consensus requires 51% of nodes to agree, if anyone wanted to manipulate the way transactions are added to the blockchain, they would need to control 51% of the nodes. This would be called a 51% attack, but would be prohibitively expensive to do on a large blockchain like Bitcoin.

Proof of Work and Proof of Stake (PoW & PoS)

The mining process described above is known as a proof of work consensus mechanism. To earn a reward, miners have to prove they have ‘worked’ to solve a puzzle. An alternative mechanism to achieve consensus is known as proof of stake, or PoS, which requires miners to stake a certain amount of a cryptocurrency to update the network. PoS requires less processing power and uses less energy, instead relying on node operators putting up collateral to prove their intentions are good. If they act fraudulently they may lose their stake, or the value of their stake will suffer if the network’s reputation is damaged.

Properties of blockchains

Blockchains, or distributed ledgers, have several unique properties. First, as described above, they are decentralized. That means that no single entity controls them. This is important because it means the blockchain is controlled by the community of users, so that no government, corporation or other entity can take over the network.

Second, in the case of Bitcoin’s blockchain, it is permissionless and public. Anyone can join and participate on the network without requiring permission from anyone else. Some blockchain are permissioned and/or private. These are usually owned and operated by companies and are only made available to clients or partners.

Blockchains are also immutable. This means transactions cannot be reversed or altered – once they are on the chain the are there for good. Even if someone managed to execute a 51% attack, it would be very difficult to alter past transactions. Immutability is critical as it means nobody can steal cryptocurrencies from a wallet or make other changes to the ledger.

The prohibitive cost of executing a 51% attack is exactly what makes the blockchain secure. As the price of Bitcoin rises, more capital is invested in hashing power, which in turn raises the cost of attacking the network. The more valuable the network becomes the more secure it will be.

Other Applications of Blockchain Technology

Cryptocurrencies like Bitcoin are just one application of blockchains.The properties described above allow blockchains to be used to create networks that weren’t possible before. For example, smart contracts are self-executing contracts that exist on a blockchain. A smart contract can be programmed to send a certain amount of a digital currency to an address on a certain day. It could also be programmed to only make the payment if another party agrees that certain conditions have been met.

Since many companies, organizations, and applications can be reduced to a collection of contractual relationships, an entire company can be run on a blockchain using smart contracts. These are called DAOs (decentralised autonomous organizations) or dAPPS (Decentralised Applications) and allow companies and applications to exist with no central owner or controller.

Blockchains are ideal for storing and transmitting data which is useful in many industries. Intellectual property can be stored on a blockchain to prove an individual created something like and invention or a song. Healthcare records can be stored on a blockchain and made available to healthcare professionals only when the patient gives consent.

Blockchains can also be used to create networks of connected devices. It is increasingly likely that the IoT (internet of things) industry will rely on blockchain technology to connect devices to one and other and to the internet. Artificial intelligence applications can also use blockchain technology to source, transmit and share data.

These are just a few of the potential applications of blockchain technology. There are many more, with new applications inevitably emerging in the coming years.

Conclusion

There is a lot more to blockchain technology than cryptocurrencies. Blockchains allow people all over the world to collaborate and transact quickly and securely, allowing entrepreneurs to create a new generation of companies and applications that could never have existed before. Ultimately the economy will change as intermediaries and boundaries fall away, and everyone gains access to a new global, connected economy.