Blockchain seems confusing. But break it down into its constituent parts, and it’s nothing more than money LEGO.
Imagine a publicly-available, downloadable financial ledger. All the transactions ever made by each anonymous user are scrawled on it with indelible e-ink. And the whole thing’s powered by a vast, decentralized network of computers scattered across the world.
That’s Blockchain.
Blockchain is the technology that powers cryptocurrency, volatile internet-money that some call digital gold (and Warren Buffett calls “rat-poison squared.”) There are hundreds of cryptocurrencies, but the best known is Bitcoin. This guide aims to help you understand Bitcoin and be better able to navigate the world of cryptocurrency.
What is blockchain technology?
Blockchain, put simply, is a system of decentralized record-keeping for cryptocurrency transactions. It’s also known as “decentralized ledger technology” (usually by large companies who want to distance themselves from the wild stories that come from the cryptocurrency market).
This blockchain ledger is structured so that its books cannot be cooked. That’s because, instead of, say, a shopkeeper tending to the only copy of its ledger whose curled pages tell the story of all the tuna cans and lollipops and bottles of gin ever sold in the shop, everyone has a copy of the blockchain ledger. You can download Bitcoin’s ledger here. It’s over 300 gigabytes.
Imagine that you send your friend one bitcoin. For it to go through, the blockchain sends your transaction to a network of so-called miners; computers that run special software to validate transactions. Once the miners have nodded in assent—confirming that you’re good for the transaction and aren’t trying to trick the network into crediting your friend with bitcoin you do not have—your friend will receive the bitcoin and the transaction will become enshrined on the bitcoin blockchain, forever.
Anyone can set up a miner and there are thousands of them scattered across the globe in internet cafes and basements—in some countries, there are warehouses full of them. Bitcoin miners earn bitcoin for the tiresome work of processing all these transactions. These miners help secure the blockchain. You can’t fake transactions and send your friend two bitcoins if you only have one, because miners won’t validate that transaction on the blockchain.
Validating transactions is hard work. To validate a block, they have to run software that solves a very complicated mathematical puzzle. The network rewards miners for this back-breaking work with a small cut of the transaction, proportional to the work they did in verifying the transactions.
The ‘block’ in blockchain refers to groups of these transactions. A single block might contain all the details of transactions which occurred between 10 a.m. and 10:10 a.m. on Christmas Day. This ‘block’ would then be ‘chained’ to other blocks, which have other data in them, such as the transactions between 10:10 a.m. and 10:20 a.m., 10:20 a.m. and 10:30 a.m. and so on, ad infinitum.
Another thing: blockchains are anonymous. Take the case of your kind gift of a single bitcoin to your friend. Although everyone’s ledger will show that a single bitcoin has been transferred between two accounts, they can’t link that transaction to you. You don’t have to tell anyone, like a government or a bank about your crypto account. Privacy advocates love it.
That’s because each blockchain user has their own wallet with a unique address—a series of alphanumeric characters (consider it like a bank account number). Users access these wallets using private keys, which are known to the user and the user alone (consider it like your credit card PIN number). If you forget this private key, you write down a seed phrase: 16 random words that you can use to log in (consider this the equivalent of your mother’s maiden name).
A brief history of blockchain
Blockchain as a concept dates back to 1982, when a cryptographer named David Chaum wrote a dissertation entitled “Computer Systems Established, Trusted, and Maintained by Mutually Suspicious Groups”.
Chaum would later develop DigiCash in 1989. It was one of the first attempts ever at creating a truly anonymous, cryptographic payment system. It used cryptography and private keys to provide anonymity and security, and the platform’s ‘CyberBucks’ was the first ever cryptocurrency. It wasn’t decentralized, however; it relied on banks for a money supply. Nor did it take off: Digicash filed for bankruptcy in late 1998; the platform struggled to get merchants to accept CyberBucks.
Digital cash was on the backburner until 2008, when a pseudonymous programmer called Satoshi Nakamoto authored “Bitcoin: A Peer-to-Peer Electronic Cash System,” also known as the Bitcoin Whitepaper. This outlined a schema for a blockchain; a system for verifying transactions powered by its own currency and backed by miners. On January 3, 2009, the Bitcoin blockchain network went public and Satoshi mined the first block in the blockchain. Nakamoto’s true identity remains unknown.
Bitcoin took off shortly after. One common illustration of its success, mythologised as a parable of bad luck, is Laszlo Hanyecz’s purchase of two Papa John’s pizzas for 10,000 Bitcoin in 2010. That Bitcoin would be worth over $130 million CAD today.
It quickly became the currency of the Silk Road, a popular online black market that operated from 2011 until the FBI shut it down in 2013. That’s about the time Bitcoin really started to take off. By 2013 Bitcoin had a market cap of $1.3 billion CAD. (A cryptocurrency’s market capitalization, or market cap for short, is the total of all of that cryptocurrency in circulation multiplied by the value of one of that cryptocurrency.)
A brief bubble in 2013 spiked Bitcoin’s market cap $13 billion CAD. In 2017 things started to get crazy. At the end of the year, a single Bitcoin was worth about $26,000 CAD. The price later crashed, but has spent the years since hovering at about half of that.
Bitcoin’s success spawned countless other blockchain spinoffs, many of which deviate from Bitcoin’s original purpose of a digital and decentralized currency of limited supply. There are thousands of them. Other notable cryptocurrencies include Ethereum, a blockchain network that supports applications; Tether, a cryptocurrency whose value is pegged to the US dollar; and Ripple (also known as XRP), a cryptocurrency built for payment networks.
What is blockchain used for?
Cryptocurrency
Cryptocurrency was the first practical application of blockchain technology, and it’s probably what most people think of when they think of blockchain. But blockchains make possible a whole new world, one that avoids reliance on centralized ledgers.
Some of the largest corporations and governments in the world use blockchain technology: Walmart uses its immutable ledgers to track supply chains, for instance, and 80% of the world’s central banks are considering some sort of ledger-based technology for digital cash (Though, obviously, these are mutations of blockchains that generally involve centralized ledgers).
Smart contracts
One of the most important technologies imported from Bitcoin is the “smart contract,” which is a bit of code that can automatically verify an agreement on the blockchain. They outline a set of conditions which, when met, automatically fulfill a contract.
You might want to rent out your apartment, but want a deposit in return. Likewise, the renter wants a code to enter the apartment but isn’t certain about sending off a deposit to someone they don’t know. The smart contract acts as a trustless third party. It could withhold the deposit until the renter enters the door code. If the door code isn’t entered in time, the deposit is refunded. The point of all of this is that you don’t have to rely on, say, a letting or escrow agency. It’s all enshrined in code.
Tokenization
One major use-case of blockchain is tokenization. Rather than just representing Bitcoin, Ethereum or any of the other cryptocurrencies plucked from thin air, tokens can represent real-world assets. What it represents could really be anything, including a cow or a gold bar. It doesn’t matter: the point is you get some real world asset and tokenize it using a smart contract.
You can then trade these tokens on an exchange, with the value reflecting that of the underlying asset. This is, for instance, how stablecoins work. Take USDC, one of the most popular US dollar-pegged stablecoins. Each USDC represents a US dollar held in a vault somewhere. That means that this coin, at all times, represents the US dollar.
Ethereum is the second largest cryptocurrency by market cap and perhaps most important blockchain in terms of infrastructure; it is not just a cryptocurrency, it is a platform on which people can build all of these blockchain applications.
Advantages and disadvantages of blockchain
Advantages | Disadvantages |
|---|---|
| Trustless | Hard to edit |
| Stable | Inefficient |
| Distributed | High storage |
There are a few advantages to a blockchain.
The main one is that you don’t have to trust other users. This removes the reliance on intermediaries for processing transactions (like a bank for transactions or a border agent for processing a passport). Often, this reduces costs that you’d have to shell out to those middlemen (like paying an auditor to check your books, for instance).
Second, it is also almost impossible to reverse blockchain transactions. Once they’re on the system, they will stay there forever, providing stability. Third, there’s no one single point of failure on a blockchain. By distributing the blockchain to the various users of a blockchain, users are protected against technical failure or a hack that could bring down a single server.
There are drawbacks to blockchain, however, some of which are consequences of its advantages. As mentioned, it’s hard to change past blocks, which could be a problem in certain databases if retrospective changes need to be made. Errors stay on a blockchain forever.
Second, mining only yields one winner, and mining is very competitive. This means that there’s a lot of wasted energy on the part of the miners who didn’t win, and also is a reason why people view bitcoin as environmentally unfriendly. A study last year estimated that the Bitcoin network used 87.1 TWh of electricity per year, equalling that produced by the entirety of Belgium.
Finally, blockchain ledgers can rack up some serious storage space. The complete Bitcoin ledger is over 300GB.
How to invest in Blockchain
Wallets
To invest in blockchain, you’ll need a cryptocurrency wallet to store your cryptocurrency. There are two different sorts of wallets. One type is a software wallet—these are usually free. However, since they’re online, there’s always the chance that a hacker could, say, log your keystrokes online and steal your password. Software wallets are generally used for smaller amounts of cryptocurrency.
The alternative is a hardware wallet, produced by a company such as Ledger or Trezor. These are like small USB drives for crypto. You will have to pay for these and keep track of them; if you lose them, you will also lose your cryptocurrency. However, since they’re not connected to the internet, they are more secure; for larger amounts of cryptocurrency, they’re often the better choice.
Exchanges
You can invest in blockchain by buying cryptocurrencies on exchanges. The largest exchange by volume is Binance. There are many different strategies for trading cryptocurrencies, but you don’t have to trade regularly to use an exchange; you could also use it to buy and hold a cryptocurrency. You can trade cryptocurrencies in tons of different ways, just like regular finance, but the most common way is to the trade cryptocurrencies for other cryptocurrencies and hope you make a profit.
ICOs
The earliest stage at which you can invest in a cryptocurrency is during an “initial coin offering.” This involves a cryptonetwork selling tokens ahead of launch; they’ll distribute these tokens to investors once the network goes live. Investors, in turn, hope that these tokens will rise once the network launches. Sometimes this works, but there are plenty of horror stories relating to ICOs, which are largely unregulated. Companies such as Bitconnect or Plexcoin promised incredibly high returns, enticing investors into fraudulent ICOs. Due diligence is important.
Risks
Cryptocurrencies are notorious for their volatility. In 2020, Bitcoin has ranged from $7,500 CAD up to $16,300 CAD. In addition, they’re new and largely unregulated. The stock market is generally the safer option.
Still, blockchain has come a long way since it was first envisioned in the early ‘80s and set into motion a little over a decade ago. Now, it’s the system behind countless projects, extending well beyond its first use case.
