WHAT IS BLOCKCHAIN TECHNOLOGY
Bitcoin, cryptocurrency, blockchain, ethereum- the new cool kids in town.
You must have heard one of those buzzwords at least a few times per day. Even people who have never been interested in finance or investments are talking about putting their life savings into cryptoassets.
After seeing so many questions on Quora about how blockchains work and being asked by numerous friends, I decided it’s time to finally write about it.
WHY USE BLOCKCHAIN?
Before I define what blockchain is, let me tell you why more and more people are using it.
Yesterday my sister called and asked me to send her some money.
We have all been there- a friend or a relative reaching out for help. Of course, we send them money. But cross-border (cross-currency) wire transfers can take up to a few days to arrive, whilst services like Western Union have terribly high fees.
Meanwhile unless another person on the same trip is generous enough to lend them some money, our friends sit there twiddling their thumbs.
This is where blockchains come into play. They are quick to transfer, fees are low and every price surge increasing adoption.
Great! Seems like a solution to a fundamental problem, but what is blockchain?
The short answer would be: blockchains are a distributed ledger technology underlying bitcoin, ethereum and other cryptocurrencies.
The longer answer explores the concept from a wider perspective.
Imagine you transfer $5 to your friend Jack. What happens then? You order your bank to take out $5 and send it over to Jack’s bank. In turn he can order his bank to withdraw the money. Here you have an intermediary- the bank.
You and Jack have trusted this intermediary to handle your finances. The main point here is there was no physical movement of that $5 bill.
All you did was to enter an order into a database, a database neither you, nor Jack can control.
“What is the problem here?”- the trust into that intermediary. There are not many banks out there, and all it takes to weaken society’s trust is a small sign of destabilization such as corruption, fraud or theft.
The greater the power, the more dangerous the abuse. – Edmund Burke
Now imagine you could maintain the database yourself with the help of some peers.
Sounds a bit odd, but relieving, right?
Societies have proven over the years that humans do not like to be overly controlled and oppressed. The bigger the control, the bigger the resistance.
HOW DO BLOCKCHAINS WORK?
Okay, so now how does it work?
#1 condition for this technology to work is to be able to gain enough supporters, i.e. enough people tired of 3rd parties.
Blockchain is a database that is being updated by multiple people and stored on multiple servers.
When your friend Jack wants to transfer $10 to you on the blockchain network, everyone will create a record of this transaction (imagine they put the record on a page). Then they will check if Jack has sufficient funds, if he has, the transaction will go through.
As a result, more and more people will want to transfer funds, but our current page is running out of space.
So, what do we do?
Exactly, we need another one. But before that we need to “seal” that page so no one can make changes to it. To do so we will need to generate said seal.
Generating happens through something called a hash function. Let’s say our input is the number 10 then after “running” it through the hash function we get a new name for the number 10 generated- let’s call it 12c1ef.
Once the number is generated, everyone can use it to check if the content has been altered. Everyone in the network calculates this and the most popular number assuming majority did the correct computations. In real life tasks are much more complex.
If everyone solves the same problem on the network, then why are people not just waiting for someone else to do all the work?
Here comes the part with incentives.
The first to successfully solve the problem and seal the page gets rewarded with free money, while no one’s account has dropped.
When enough people own bitcoin (or any other cryptocurrency), the value per coin grows. This way more people will want those bitcoins and further push the value and price up.
BLOCKCHAINS ARE IMMUTABLE
How do you make sure no one is altering the content?
It’s simple- imagine we have 3 “pages” (1,2,3). Page 2 contains the output for page 1 and page 3 contains the output for page 2 and so on keeping the chain consistent.
If someone tries to cheat by generating new output, they are creating a new network on top of the existing one. But that new fraudulent network will never be able to keep up with the existing one as the efforts of 1 cannot beat the efforts of 20. Hence, the longest chain is the honest chain.
What if more people try to cheat with the fraudulent network?
Well, then the protocol fails, a.k.a. the 51% attack. That is the only way the network can ever collapse. Given the current incentives, it is unlikely to happen as long as everyone is rewarded accordingly for their work.
SHARE YOUR THOUGHTS
Do you feel more confident about the new world of blockchains and crypto? If you do, that is great! And don’t worry if you don’t – feel free to leave your questions and recommendations in commentary below.
If you ever find a friend lost in the world of crypto, you know where to point them out to. Bookmark the page, subscribe to the blog. We have more up our sleeves!
“Don’t forget to share the knowledge. Knowledge is power. Information is liberating. Education is the premise of progress, in every society, in every family.” – Kofi Annan
Article by Ana-Maria Yanakieva