What is Blockchain Anyway?
— Blockchain is the foundation of cryptocurrency. It enables peer-to-peer transactions by eliminating intermediaries.
— We rely on banks and financial institutions to ensure our transactions are secure. But, we need to pay the price if in case these institutions are imperfect and the whole system itself crashes.
— Crypto emerged in the wake of the 2008 financial crisis. It offers a way for regular people to overcome the faults of traditional finance.
— Cryptocurrencies are powered by blockchain technology. This combination created a completely autonomous monetary system, which anyone can access and hold complete control over their assets.
In the last article, we introduced the concept of Web 3.0 and the big changes that are currently underway. We’ve even discussed how blockchain is driving that transition by enabling digital and financial sovereignty.
In this article, we focus on the blockchain itself to help you understand this technology and the problems it solves.
The Origin of Blockchain
In 2008, the world watched in horror as our financial system collapsed. It was followed by years of mismanagement by the banks, regulators, and central entities running the system. That period devastated millions of people and left them unable to trust the system ever again.
Amidst the panic and anger of the era, a quiet event took place that gradually came to overshadow all of it – Bitcoin genesis. A white paper titled Bitcoin: A Peer-to-Peer Electronic Cash System was published by a mysterious creator called Satoshi Nakamoto. It was the blueprint for a system that promised to do something that had never been done before – create an autonomous public financial system.
This system enables the transfer of value between individuals without the need for intermediaries like banks and other third-party providers. In short, it proposed to make financial institutions obsolete.
Four months later, on the 3rd of January 2009, the “ Genesis Block ” of the Bitcoin blockchain was created. A secret message was embedded within its data that says “ The Times 03/Jan/2009 Chancellor on brink of second bailout for banks .” This is a headline in the same-day edition of The Times about the British government’s failure to react to the financial crisis.
The message was clear – this system isn’t working, here’s your alternative. And that is how the original cryptocurrency, “Bitcoin” and its underlying technology, “Blockchain” were born.
Why does Blockchain matter?
You might be wondering why all this is such a big deal – we make digital transactions all the time. But sending money digitally is not the same as sending an email and sending digital money is definitely not the same as sending fiat money digitally.
For a currency to have value, its supply needs to be finite. To make a digital transaction successful, value needs to be received by one party and the exact same amount needs to disappear from the sender. If it doesn’t happen that way, it’s called the double-spending problem. Though you might’ve never heard the term “double-spending”, it’s the lynchpin for our entire financial system and our reliance on banks.
With no way of keeping a ledger of sent and received money for ourselves, we rely on financial institutions and trust them to take care of the problems like double-spending. As we discussed in the last chapter, our dependence gave financial institutions a lot of power.
To break free of this centralized system, we needed a way to track our value transfers accurately without a middleman. And blockchain is the only technology that has ever been able to do this.
What is a blockchain?
In simple words, a blockchain is a distributed digital ledger. It digitally keeps track of value as it moves around between users within the system. Blockchain technology stores transactional information or data in the form of blocks that are linked to one another.
Let’s assume Alice and Bob are both transacting on the blockchain network and Alice wants to send Bob 10 Crypto Coins. Once Alice takes an action on her end to transfer the funds, the blockchain autonomously takes 10 Crypto Coins from her balance and adds them to Bob’s.
Normally this would be the bank’s job. But by using the blockchain, Alice can make the transfer without depending on any financial institution. Both Alice and Bob don’t need to share their private information and can be sure that the transfer will happen securely.
How does Blockchain work?
A blockchain is a network that is made up and managed by two key entities – nodes and miners. In order to understand how the network functions, let’s take a look at these entities and their contribution to the network.
A node is a computer that has a copy of all the transactions that have ever taken place on a blockchain network. There are thousands of nodes in a blockchain network (anyone with a computer and an internet connection can operate one) and their job is to collectively ensure that new transactions are genuine. Nodes validate the transactions by checking them against the information they already have.
For a new transaction to be added to the blockchain, the majority of these nodes must reach a consensus that the information is correct.
- Why be a node?
Nodes contribute to the security of the network by taking part in the transaction validation process. Anyone can operate a node. Generally, people performing this function have a genuine interest in the value and ethos of blockchain and want to be a part of it. There is no financial reward for doing this, and the costs of running a node are minimal.
Miners (or validators, depending on what sort of blockchain you’re talking about) generate new blocks and add them to the existing blockchain. While the job of the nodes is to verify information, the job of miners is to organize all the incoming transactions into blocks and then add them to the blockchain.
- Why be a miner?
The reward for running a node is simply the knowledge that you’re contributing to a system you believe in, but miners have a different motivation. In exchange for mining new blocks and adding them to the network, miners get incentives in the form of crypto. That means we can get paid in cryptocurrency by working as a miner. Sounds like a good idea, right?
However, it’s not that simple. For every new block added to the blockchain, the network itself selects a miner to execute the task (and get the reward). The network has its own system for selecting the miner to generate the next block. This is known as its “consensus mechanism,” and we’ll come back to that later.
To summarize, a blockchain is a secure digital network that is able to run autonomously with the help of nodes and miners. Nodes keep records of their activity, and the miners (or validators) are incentivized to continually update the chain as new transactions come in.
Is blockchain secure?
You might be wondering “what’s to stop a node from lying about the state of the network for their own gain?” And this is the cleverest part of blockchain – there are millions of nodes scattered across the planet, and the majority of them must reach a consensus about each new transaction before it is confirmed to the blockchain.
Decentralization means security
With the management of the blockchain ledger distributed so widely, it is impossible for any one entity to gain control of the network or validate false information. To do so, it requires them to coordinate 51% of all the network miners (millions of different entities across the planet), making it impractical and prohibitively expensive.
This is why the distributed nature of the blockchain ledger makes it incredibly secure. It ensures that all our transactions are carried out accurately.
Welcome to blockchain!
If you’ve come this far, congratulations! You just went from an absolute beginner to a blockchain intermediate.
In the beginning, all of this might feel new and complicated. But, awareness and knowledge about new technologies are important. It is even more crucial in the world of Web 3.0.
So let’s press on with our mission – in the next section, we’ll talk about cryptocurrency, its use cases and different varieties. See you there!