Blockchain Explained

 In Cryptocurrency

What is Blockchain?

The term blockchain has been thrown around a lot recently because of the craze around Bitcoin and cryptocurrency. As a result, many people need to have blockchain explained.

You may have had a conversation with a friend or co-worker where you had to nod your head as they talked (at length) about the importance of blockchain for the future, and finally you decided to give in and give it a Google Search.

If you want blockchain explained, you’ve come to the right place.

What is this blockchain and why is everyone talking about it?

History of Blockchain

The history of blockchain and the history of cryptocurrencies, particularly Bitcoin, are deeply tied together. The concept was first discussed in its current form in a 2008 white paper written under the pseudonym Satoshi Nakamoto. The identity of Satoshi remains a mystery to this day. For more on the history of Bitcoin, read my article here.

This white paper provided the foundation for Bitcoin because of what the blockchain allowed cryptocurrencies to do, as we’ll discuss below.

As a note, the idea of so called “secured chains of blocks” was originally described by W. Scott Stornetta and Stuart Haber in 1991. The next year another paper was released by the group incorporating so-called Merkle trees. Merkle, or hash, trees are a way of improving the efficiency of stored information.

The first usage with cryptocurrency was for Bitcoin in 2009 when blockchain served as the public ledger for the Bitcoin network. You can read Satoshi’s paper here. It’s helpful if you want blockchain explained in technical terms.

So what does that mean?

We’re getting there. To have blockchain explained, you need to understand the purpose it serves.

The Role of the Bank

Before Bitcoin in 2009, you needed a third-party to verify transactions so that people weren’t spending coins twice or otherwise falsifying transactions. That might sound complicated, but it’s not. That third-party role is the role usually fulfilled by a bank.

Banks acted as those trusted intermediaries to ensure that the supermarket knows you have money in your account when you use a credit card or that the $100 you were given isn’t counterfeit. That’s the fundamental purpose of a bank: to establish a system people can trust.

Bitcoin was the first application to find and implement a solution to ditch the third-party. It does so by using a distributed network.

Blockchain Explained

Distributed Networks

Essentially, a distributed network works by recording all transactions in a public ledger. That public ledger is distributed across a large number of computers to form a network. As “work” is done, or as the ledger is updated, blocks, or bunches of data, are linked in chronological order into a so-called chain. Transactions added to the version of the ledger that contains the most amount of “work” are considered valid.

Deep breath. Read the paragraph one more time. You’re not done having blockchain explained, but we’re working out way down to more technical levels.

The Public Ledger Function

Basically, the ledger with the most work is the presumably the most recent. As data accumulates, blocks are added to the chain. Transactions can be verified against the blocks in the chain.

To alter the record would require the incredibly difficult task of altering all the subsequent records. This would also require massive collusion of the network. This effectively removed the double spending (spending the same coin twice) problem.

At its most basic level, a block holds batches of valid transactions that are grouped together and encrypted. This process is called hashing. Hashing essentially means taking an input, which could be any length, and giving a fixed length output. So an input any length from “Hello” to the entire Magna Carta becomes exactly 200 character long. This standardizes, uniquely identifies, and cuts down on storage.

So all of these transactions are grouped together and properly formatted so to speak. Then, they’re grouped with the previous hash. The prior hash and new hash are turned into a new block. This is the “chain” part of block chain.

Imagine Block 0 has Hash A and Hash B. You complete a bunch of purchases and they’re grouped together in Hash C. A new block, Block 1, is created to record these transactions. Block 1 contains Hash C, the new information, and Hash B, which is the “hook” that “links” it to the previous block, Block 0. And block by block, the chain is built.

That’s blockchain explained.

The Philosophy

The entire idea behind cryptocurrencies, the thing that the blockchain enables, is the ability to have economic interactions take place without intermediates like banks. Money and information remains between buyer and seller. This has huge implications for privacy, as well as for our entire model of economics.

It’s important to consider philosophy in the discussion of blockchain. As we looked at in our Altcoin article, the technologies utilized by a particular cryptocurrency are often reflections of the philosophy of the coin. Coins like Ripple are unusual in that their source code is privately-owned. Almost all other currencies use open-source code.

Much of the background of the philosophy of blockchain is strongly libertarian. That being said, as Ripple shows, that may change over time.

Blockchain 2.0

Also important to having blockchain explained is understanding how it may evolve.

One of the major ways blockchain is evolving is by adding additional capabilities. One such capability is the versatile, secure smart contract. These contracts can act in ways that are difficult for current contracts. They can maintain privacy between parties in a way that’s difficult now. These contracts can also self-execute when certain conditions are met.

On the other hand, the newer iteration of blockchain technology will have to deal with some of the major drawbacks of blockchain.

Limits to Blockchain

Blockchain has several issues. Among these are energy consumption. In December 2017, energy spent on Bitcoin mining reached 32.36 Terawatt-hours per year. That’s higher than the energy usage of some countries. In addition, blockchains can require massive amounts of data, individual transactions can be slow, and a decentralized system can make recovery of lost funds impossible. To really have blockchain explained, understanding the negatives is important.

The Future of Blockchain

Senegal and Tunisia have both adopted blockchain-based national digital currencies. And the Bill & Melinda Gates Foundation has launched the Level One Project. The project hopes to use blockchain technology to allow the two billion people without bank accounts to interact with the economy.

And in September 2015, a World Economic Forum report predicted that up to ten percent of global GDP would be stored on blockchain technology by 2025!

Finally, last year two professors from Harvard Business School – Marco Iansiti and Karim R. Lakhani – published an article in the Harvard Business Review arguing that blockchain is not a disruptive technology, but a foundational one. Rather than undercutting he cost of an existing business practice, blockchain “has the potential to create new foundations for our economic and social systems.”

Blockchain, rather than merely disrupting economies, may be the beginning of something entirely new with profound implication for how we live.

Matt Cameron

About Matt Cameron

Hard-working, dedicated, and passionate are three traits that describe me. I've spent my entire life learning the skills that I need to be able to be a successful entrepreneur. Whether I'm doing work for my companies, or writing content for my blogs, I'm always giving it my best effort.

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