Blockchain for beginners
What is blockchain?
The launch of the Bitcoin network in 2008 formed the starting signal of the blockchain revolution. But what is precisely blockchain technology's great promise? What does this technology do better than any other technology? Why is everyone so enthusiastic about blockchain? And why do some people expect this technology to have more of an impact on society than the internet had? We will answer all these and other questions on this page!
Blockchain replaces the element of trust with mathematics
The unique aspect of blockchain technology is that it offers the opportunity to transfer value without the need for intermediaries. Instead of relying on third parties, such as banks, when transferring money, we now put our faith in the algorithms making up the protocol. The combination of technologies that Bitcoin brought together for the first time has enabled us to replace this element of trust with mathematics.
Banks often earn 10% or more when processing international transactions. In principle, the only thing they do is to strike out money on one account and to credit it to another. This involves communication with other banks, but does that reflect its cost? How can it be that sending out an email to transfer information is free, when sending money, the transferring of value, is so costly? Besides the fact that it can be expensive to wire money abroad, the processing of your transaction may also take up a couple of days. Blockchain technology aims to consign such old-fashioned aspects to the history books.
Blockchain as the foundation of the internet of value
Blockchain technology carries the potential to lift our society to the next level. Whereas the internet enabled us to share information with great ease, blockchain technology allows us to share value. When you think about it for a moment, don’t you also consider money essentially just a form of information? Just like stocks, intellectual property, music, books, and so forth?
If the technology reaches a point in the future at which it's able to process thousands of transactions each second — which appears to be just a matter of time — then it will turn the economy on its head. There will no longer be a purpose for intermediaries who extract bits and pieces of value from every transaction without adding anything useful. We would be able to transfer anything directly from one person to another. How cool would that be? Stocks, works of art, intellectual property, music, books and money are all forms of value that can potentially be transferred using the blockchain. You can read more about the inner workings and security environment of blockchain technology on our dedicated mining page. Ultimately, it’s the combination of the blockchain and the ingenious Proof of Work (PoW) consensus mechanism that allows us to transfer value without the need for an intermediary and for only a fraction of the current costs of doing a transaction.
At this moment, cryptocurrencies already allow us to send fractions of a cent to our favourite YouTubers and to thank people for exciting content published on Twitter or other social media platforms. Such was not possible before cryptocurrencies came into being. Transferring only a single cent was simply too expensive and too much of an ordeal to proceed with it. What’s cool about this is that artists and other content creators have now gained access to a completely different revenue model.
What will the future of blockchain hold?
It’s difficult to predict how fast the developments will proceed and whether the technology will be able to meet all of its ambitions, but for now, it certainly looks very promising! Aside from eliminating intermediaries from value transfers and offering the possibility to remain in charge of your assets, the technology also carries the potential to provide a better future for the global poor. At the time of writing, 3.8 billion (!) people lack access to a bank account. The only way for them to accumulate assets is to store them in an old sock or to hide them under a mattress. This is far from advantageous for the economy in those parts of the world, and it offers few chances to, for instance, launch a company.
Cryptocurrencies make the process of opening a digital bank account extraordinarily straightforward and inexpensive. Cryptocurrencies also exist independent of governments. They are namely kept afloat by sizeable decentralised networks. Everyone participating in the open network has stored a copy of the blockchain — the database containing all transactions — on their computers. This ensures that any central authority cannot just amend legislation and change transactions. In a certain sense, it symbolises the democratisation of money and the democratisation of transfers of value. Everyone can participate, and everyone can be involved in the decision-making process concerning the network's development.
It may be difficult for us to realise the importance of this latter aspect, but in countries like Venezuela, Argentina and Zimbabwe, people have become painfully aware how poor monetary police may cause a currency to lose all its value. If governments continue to print extra money to resolve debts, hyperinflation will soon be forthcoming. In many of these countries, people have already switched to using decentralised cryptocurrencies like Bitcoin to secure their assets. After all, Bitcoins cannot be printed just like that; new Bitcoins can only be created through a transparent process called mining. Would you like to know more about this? Then check our page about mining!
How does a blockchain work exactly?
We have already discussed the technology's potential at great length, but what exactly is a blockchain? A blockchain is nothing more than a chain of ingeniously connected blocks. Compare these blocks to a tray of data filled with, among others, transactions and — very importantly — the previous block's fingerprint. This fingerprint ensures that all blocks are connected. If the last block undergoes any changes, its fingerprint will be altered, which also affects the composition of the next block.
We are incredibly enthusiastic about the potential blockchain technology offers but do realise that this technology is only useful when combined with a massive network of miners, who operate according to a consensus mechanism and use this to agree on the shapes of the subsequent blocks. If you want to understand this process, we recommend you to have a look at our dedicated mining page.
Sometimes, people like to talk about blockchain as if it’s some magical technology that will solve every problem the world is facing. Unfortunately, this won't be the case. Blockchain is not even the most exciting innovation that Bitcoin brought along. A blockchain is namely nothing more than a chain of ingeniously connected blocks. As every block contains a fingerprint of the previous block, the entire history of the blockchain (i.e. the chain of blocks) is also stored on every new block. If you change one small aspect of a previous block, you will also alter its fingerprint, which in turn also affects all the fingerprints of the subsequent blocks. When someone changes a transaction, it will immediately be picked up on, because the fingerprints of all subsequent blocks will see alterations as well. This smart mechanism renders it practically impossible to edit recorded blockchain transactions.
In technical terms, we refer to a block's fingerprint as a hash. A hash is a random string of letters and numbers of the same length. To generate a hash, miners employ a complicated mathematical formula containing all information stored in the block. For example:
Input BLOCK 1
Hash previous block: 00000
Pete transfers 1 BTC to Hank
Hank sends 2 BTC to Rita
Rita sends 1 BTC to Pete
Ingrid sends 1 BTC to Hank
Together, this information makes up the hash ‘6U9P2.’ This hash is then again used to generate the next block’s hash.
Input BLOCK 2
Hash previous block: 6U9P2
Hank transfers 1 BTC to Pete
Pete sends 2 BTC to Rita
Ingrid sends 1 BTC to Pete
Hank sends 1 BTC to Rita
The above information generates the hash ‘8Y5C9.’ Now, if we alter the information of the first block, we will also change its hash. Because the hash of the first block is used as input to generate the second block's hash, it will also affect this hash. This is how a blockchain works in principle! You now understand that it quickly stands out when someone attempts to revert transactions or to alter the content of blocks. After all, such alterations affect the hash — i.e. the fingerprint — of the block that was cheated with, as well as all the hash of all subsequent blocks.
You are now entirely up to speed regarding the foundations of blockchain technology and the effect it may have on our society! Have you become enthusiastic, and would you like to go deeper down the rabbit hole? Then we recommend you also to have a look at our page about mining. If you're done reading all about mining, you might want to take a look at our Ethereum and Ripple pages. This particular mining element of technology is vital in guaranteeing the blockchain’s security. The more people involved in the network, the more computers globally containing its full transaction history, the more secure the blockchain. If only ten people would be included in the mining process, you would only have to convince six of them to influence the network. But if tens of thousands of people participate, it will become much more difficult. It becomes even more challenging when you take into account that you have no idea of the identity of these people and also no means to contact them. In short, this is what decentralisation looks like.