Nick Darlington. Or one where you store money in an online wallet not tied to a bank, meaning you are your own bank and have complete control over your money. This is not a world of the future; it is a world that an avid but growing number of early adopters live in right now. And these are just a few of the important blockchain technology use cases that are transforming the way we trust and exchange value.
Yet, for many, blockchain technology is still a mysterious or even intimidating topic. This post demystifies blockchain technology. A complete, easy-to-understand, step by step beginners blockchain breakdown. Blockchain technology is the concept or protocol behind the running of the blockchain.
Blockchain technology makes cryptocurrencies digital currencies secured by cryptography like Bitcoin work just like the internet makes email possible. The blockchain is an immutable unchangeable, meaning a transaction or file recorded cannot be changed distributed digital ledger digital record of transactions or data stored in multiple places on a computer network with many use cases beyond cryptocurrencies.
Immutable and distributed are two fundamental blockchain properties. The immutability of the ledger means you can always trust it to be accurate. Being distributed protects the blockchain from network attacks. The information contained in a block is dependent on and linked to the information in a previous block and, over time, forms a chain of transactions. Hence the word blockchain.
Public blockchains are open, decentralized networks of computers accessible to anyone wanting to request or validate a transaction check for accuracy. Those miners who validate transactions receive rewards. Public blockchains use proof-of-work or proof-of-stake consensus mechanisms discussed later.
Private blockchains are not open, they have access restrictions. People who want to join require permission from the system administrator. For example, Hyperledger is a private, permissioned blockchain. Consortiums are a combination of public and private blockchains and contain centralized and decentralized features. Some make a distinction between the two, while others consider them the same thing. A sidechain is a blockchain running parallel to the main chain.
It allows users to move digital assets between two different blockchains and improves scalability and efficiency. An example of a sidechain is the Liquid Network. For a complete and more detailed deep dive check out our article: A Concise History of Blockchain Technology.
The first blockchain-like protocol was proposed by cryptographer David Chaum in Later in , Stuart Haber and W. Scott Stornetta wrote about their work on Consortiums. Cryptography is a deep and fascinating discipline with a history that goes back further than blockchain. For a richer understanding of how cryptography helps blockchain technology, check out: Why Cryptography Makes Blockchain Unstoppable.
Because blockchain technology is the technology behind the blockchain, it cannot be owned. But anyone can use the technology to run and own their own blockchains. Nakamoto sent ten bitcoins to Hal Finney, who built the first reusable proof-of-work system in For a more in-depth account of the next section, check out the thorough discussion in: What is Blockchain Technology and How Does it Work?
As a society, we created ledgers to store information—and they have a variety of applications. We also use ledgers in bookkeeping to record all the transactions a company makes. Bookkeeping mostly relies on double-entry accounting to store transactions. Records stored using traditional ledgers are also easy to tamper with, meaning you can easily edit, remove, or add a record.
Public blockchains solve both these problems — and the way we trust — by evolving the traditional bookkeeping model to triple-entry bookkeeping : transactions on a blockchain are cryptographically sealed by a third entry. This creates a tamper-proof record of transactions stored in blocks and verified by a distributed consensus mechanism. These consensus mechanisms also ensure new blocks get added to any blockchain. When sending Bitcoin, you pay a small fee in bitcoin for a network of computers to confirm your transaction is valid.
Your transaction is then bundled with other transactions pending in a queue to be added to a new block. The computers nodes then work to validate this list of transactions in the block by solving a complex mathematical problem to come up with a hash , which is a digit hexadecimal number. Each new block added to the network is assigned a unique key via cryptography. As new blocks are continually added through the ongoing mining process, they become increasingly secure and harder to tamper with.
Anyone caught trying to edit a record will simply be ignored. All future blocks then depend on information from prior blocks—and this dependency from one block to the next forms a secure chain: the blockchain. You can see this depicted below for house records stored on the blockchain. For example, Block 2 provides a key after taking all the information from Block 1 into account including the key and inputting it into a formula.
Block 3, in turn, provides a new key after taking all the information from Block 1 and Block 2 into account including the key and inputting it into a formula. And so, the process repeats itself indefinitely. A public blockchain functions through consensus mechanisms: the process for validating transactions without a third party like a bank.
PoW and PoS are two such mechanisms. While their goal—to reach a consensus that a transaction is valid—remains the same, how they get there is a little different. PoW, the technical term for mining , is the original consensus mechanism. It is still used by Bitcoin and Ethereum as of writing but, as mentioned, Ethereum will move to PoS by PoW is based on cryptography, which uses mathematical equations only computers can solve.
The example in the previous section of how blocks get added to the Bitcoin Blockchain explains this system. The two big problems with PoW are that it uses a lot of electricity and can only process a limited number of transactions simultaneously seven for Bitcoin. Transactions typically take at least ten minutes to complete, with this delay increasing when the network is congested. PoS still uses cryptographic algorithms for validation, but transactions get validated by a chosen validator based on how many coins they hold, also known as their stake.
The results are faster transaction times and lower costs. The NEO and Dash cryptocurrencies, for example, can send and receive transactions in seconds. Most blockchain projects are built around three core properties: decentralization, scalability, and security. But they often have to sacrifice one for the others. Instead, decisions are made via consensus over a distributed network of computers. There is, however, one significant tradeoff: speed. Sending transactions takes longer because multiple confirmations are required to validate a transaction.
Hence why Bitcoin is slow. Scalability is the ability of the system to cope with a growing number of transactions. Scalability is crucial for mass adoption because any system needs to operate efficiently as more people use it.
Below is a rough breakdown of how many transactions Ethereum, Bitcoin, and credit card companies can process per second:. But achieving scalability often comes at the expense of decentralization. EOS, for example, promises a maximum of TPS but has come under criticism for being too centralized. Security is the ability of a blockchain to be protected from attacks. Unfortunately, exchanges and source code have been hacked on many occasions, suggesting that many developers focus on scalability and decentralization at the expense of security.
Bitcoin and Etherum are the two biggest cryptocurrencies and blockchains, so discussing and comparing them makes sense. The Bitcoin network is a public, decentralized peer-to-peer payment network that allows users to send and receive bitcoins without a bank getting involved. The digital currency or bitcoin token uses the ticker symbol BTC, and is the only cryptocurrency traded on the Bitcoin network.
Transactions are recorded using a digital ledger, and nodes ensure the PoW consensus mechanism is followed or that mining happens. The Ethereum network is a public, decentralized peer-to-peer network. Like Bitcoin, it uses nodes and allows users to send and receive cryptocurrency—in this case, Ether. The network is much more than a payment system—it was primarily created to deploy decentralized applications dapps and smart contracts. Smart contracts , however, operate on the Ethereum blockchain, and are contracts that automatically execute without an intermediary once certain conditions written into computer code are met.
For example, a smart contract could be programmed to send a designated person a portion of your Bitcoin when you die. In summary, Bitcoin and Ethereum networks are public, decentralized peer-to-peer networks with their own tokens: bitcoins and Ether.
Both rely on cryptography, and both use digital ledger technology. For a complete Ethereum vs. But they differ significantly in purpose and capability. Bitcoin is a decentralized payment system and a store of value. The crypto domain has taken on a life of its own. Due to the relative ease of cryptocurrency creation and quick access to capital, Ponzi schemes have infiltrated the cryptocurrency market. Also, some engineers have brought silly cryptos to life just because they could.
Many crypto projects will probably suffer the same fate as the now-defunct internet startups of the dot-com era. But the ones whose networks grows the biggest will be able to stay relevant in the long term. Protocols are the underlying code that dictate how cryptocurrencies work. The internet uses different protocols on which sites run.
Internet apps can use the same protocols. Conversely, cryptocurrency protocols also called blockchain protocols are unique from one another. Cryptocurrency protocols allow just a single or a few apps to run on them. Internet protocols, on the other hand, let thousands or even millions of apps function.
Also, protocols set the rules for achieving consensus when validating transactions and incentivizing network participants. You can expect everyone to behave accordingly. They go through updates to scale and keep up with demand. Generally, the community makes decisions through deliberation, persuasion, and volition. Many engineers draw inspiration from open-source blockchain software.
Others create entirely new cryptocurrency protocols from scratch. Taking the path less traveled is an effective way to introduce unseen innovations. Every cryptocurrency uses a decentralized communication model where peers also called nodes can exchange data without a central server.
In other words, global networks of computers validate and add records to blockchains. Node operators participate in cryptocurrency networks to earn incentive. They get paid for ensuring the integrity of their chosen blockchains in the form of block rewards, transaction fees, etc. Such mechanisms are necessary to keep the blockchains updated and to ensure everybody in the network has identical records. Ideally, any party with an ordinary computer should be able to join any crypto network.
However, devices designed for everyday use are no match to the computing power of mining-optimized hardware. Mining pools groups of independent miners who agree to work together dominate the current Bitcoin network. They combine their resources to increase their chances of earning rewards and then split the profits they rake in accordingly.
Maybe the only downside to highly decentralized cryptocurrency networks is the threat of cryptojacking malware. The more not-so-tech-savvy individuals can actively participate in crypto networks, the more vulnerable they are to hackers. Crypto is native to the internet. The most tangible representations of cryptocurrencies are the pieces of hardware storing the private keys to them.
Cryptocurrency and blockchain are inseparable. As long as you control and secure the private keys to your crypto assets, nobody could steal your funds. Your cryptocurrency wallets contain privacy keys to your assets and enable you to do transactions. They allow you to sign transactions, encrypting them in the process. Private keys generate their corresponding public keys.
The latter generate wallet addresses, which are what other parties need to send cryptos to you. Once decrypted, network participants can verify if your private keys without exposing them were used to sign the transactions initiated. Then, the nodes can check whether you have sufficient funds, confirm the transactions, and permanently record them on their respective blockchains.
Like fiat currencies , cryptocurrencies enable you to obtain goods, services, or both. How efficient one is as a medium of exchange and where you can spend it is another story. You can use some cryptocurrencies for payment without a centralized intermediary. Bitcoin is the best example. Unlike every fiat currency, bitcoin is beyond the control of any government and knows no boundaries. Its censorship resistance makes it convenient to send to or to receive from any party located in any jurisdiction.
Bitcoin is pseudo-anonymous. Anybody can use this crypto money without discrimination. On average, it takes 10 minutes to confirm a bitcoin transaction. In times of extraordinary network congestion, transactions could go unconfirmed for days or even weeks.
Bitcoin Cash is more scalable. Litecoin delivers faster transaction processing and charges cheaper fees. Furthermore, some cryptos are protocol tokens. Also, there are app coins. These cryptocurrencies are valuable only in their corresponding apps, which are built on top of protocols. Likewise, utility tokens are cryptocurrencies that work similarly to digital coupons. Usually, investors can get them during ICOs. Holders can spend them to access services offered on the crypto platforms on which the utility tokens natively reside.
By , some merchants had been accepting bitcoin and some altcoins. People in countries experiencing high inflation, however, have been gravitating more toward cryptos as mediums of exchange. Cryptos are divisible, countable, and fungible. You can use them for valuing goods and services, calculations, and recording financial transactions like payments or debts.
Every asset in the world experiences price fluctuations. But the historical price performance of bitcoin has been exceptional. It can actually preserve your wealth, despite being known for its boom-bust cycles and bubbles. The purchasing power of most altcoins is unreliable because of their small valuations.
The majority of them are speculative assets at best. The few exceptions are stablecoins. These altcoins are collateralized. Cryptocurrencies are liquid assets you can hold to generate returns. Security tokens, a category of altcoins, give you a voice in the governance of the corresponding crypto projects. Some of them function like company stocks and provide dividend payouts. You can do spot transactions to get your crypto-assets instantly.
Or, you can do bitcoin trading using derivatives like options, futures, or swaps. These high-risk financial instruments can be useful for hedging against risk. They can help offset any losses if you take opposite positions on the same cryptos. If you want to know how to invest in bitcoin and altcoins with less risk, strongly consider exchange-traded products.
Many governments classify cryptocurrencies as property. So, selling them at a profit is a taxable event under certain jurisdictions. Cryptocurrencies can satisfy the traditional definition of financial assets, which should be subject to securities laws. In , some officials of the U. But the same agency initiated a lawsuit against Ripple for its alleged unregistered sales of XRP tokens. The regulator could still change its position on bitcoin and ether and spread doubt.
The Bitcoin community believes that the top crypto is the best hedge against inflation. They also view it as superior to the US dollar as a reserve asset. The Ethereum community is made up of individuals that support the decentralization of the internet and open-source collaboration. Blockchain currencies with large followings tend to accumulate considerable capital through social proof. They seem more newsworthy than others, so they frequently hit the headlines in cryptocurrency news sites and not only.
Good or bad press, they regularly get tons of media mileage. And the more popular they get, the more obscure others become. Keeping the Libra brand could end the crypto project for good since it roused the ire of governments years ago. Bitcoin has endured more brand assassination attempts throughout its history. Other than its solid fundamental qualities, the mystery surrounding its creator Satoshi Nakamoto has made Bitcoin harder to attack.
Nakamoto walked away from the project on December 10, Since then, the network has had no single prominent figurehead. The facelessness of Bitcoin makes it seem more egalitarian than most cryptocurrency networks. So, no one could accuse this legendary character of a profiteer.
As discussed in this cryptocurrency for dummies guide, cryptos operate distinctively from one another. Each one of them tries to be unique and accomplish different things. In general, the nature of crypto is decentralized and private. One uses a P2P network to maintain its distributed ledger. Network participants can sanction transactions privately and securely. The network checks whether the sending party does have sufficient funds before approving the transfer.
A consensus mechanism keeps individual network participants honest. The majority has to agree during the data verification phase before permanently adding it to the blockchain. This system prevents double-spending. In a PoW system, miners invest in expensive hardware and consume enormous amounts of electricity to participate in a cryptocurrency network. They make money through transaction fees on top of the crypto reward they receive for their work. Cryptocurrencies are made up of interdependent foundational technologies.
If one is missing, everything could crumble. Blockchains store small batches of transactions in blocks and chain them together chronologically. Not all blockchains are public. Staunch crypto advocates look down on private blockchains. These ledgers can have overpowered operators that can deny access to participants and can tamper with data records. Basically, all you need is an internet-connected electronic device.
Then, download and set up a software cryptocurrency wallet and begin depositing funds. However, not all software wallets support the use of the US dollar and other fiat currencies.