A Simple Explanation of Blockchain & Cryptocurrency
If you’re looking for the section on Bitcoin’s energy consumption and its value, I’ve moved and expanded that over here.
Blockhain. The word tumbles out of my mouth as children’s alphabet blocks. What it lacks in eloquence it makes up for in descriptiveness. Blockchain is a sequence of easily verified blocks of data —a chain of blocks.
The blocks don’t have to contain transactions, but most systems are built in terms of transactions. In the case of a transaction based system, the data in each block is viewed as a page of transactions. Each page is bundled up and each page is easily verified by anyone else in the system.
What kinds of systems fit a transactional model? Most social media is really a ledger of sorts, each like, post, message, reaction, or clap is a transaction. Financial transactions are probably the most common example. Because financial transactions are so common, the first application of blockchain was Bitcoin.
Bitcoin as an Example
Bitcoin uses blockchain to create and distribute a verified sequence of ledger items to each person participating on the network. Each participant needs to follow a protocol which ensures transactions can be trusted. If a participant doesn’t follow the protocol, their transactions can’t be trusted. When blockchain is applied as it is in Bitcoin, it allows people to trust a network of untrustworthy computers because they are following a protocol that generates trust.
Let’s examine the parts of Bitcoin. These parts apply to any cryptocurrency:
A token is a type of “coin” used to conduct transactions on the network. This token is really just a serial number which identifies it. Having one or more tokens allows transferring one or more tokens (or a portion of a token in many cases) to someone else.
A transaction takes note of parties sending and receiving a portion of tokens, possibly including some more data.
A ledger is a list of transactions.
A block is a verified list of a few transactions.
The blockchain is a verified list of the blocks which form a distributed ledger of transactions. Each participant in the network has a copy of the complete blockchain. There is a chance the blockchain can split into two or more strands. Soon enough one strand gets longer than the other, and becomes the one true blockchain.
The block height is the number of blocks in the blockchain.
Proof of Work(PoW) is a solution to a problem where the answer is easy to check, but the problem of solving it takes time and energy. PoW is required to add a block to the blockchain. Solving this proves a system is willing to do what it takes to be a part of the network — including spending a lot of money to solve it. In the case of Bitcoin, this gets harder to solve as there is more competition mining for Bitcoin. On average Bitcoin attempts to let one block be mined every 10 minutes.
A miner takes transactions and bundles a few of them into a block. Miners ensure all the blocks and all the transactions are easily verified. It has to compute a PoW to be worthy of adding this block to the blockchain. The work they do is important for making sure the blockchain can keep going on. Miners are paid tokens and transaction fees for the work they do in allowing the transactions to be verified in a secure manner. In order to get paid, a miner’s block has to be the first one mined and verified by over half of the network of verifying nodes.
Miners received amazing rewards for creating blocks when the Bitcoin network was young. In 2008 — when Bitcoin was first created, miners were rewarded with 50 tokens each. In November 2012, the block height reached 210,000 blocks — which meant the reward was halved to 25 tokens. In July 2016, the block height reached 420,000 and the reward was halved again to 12.5 tokens per block. Around June 2020, the reward will half to 6.25 tokens per block mined. This reward will continue halving until the reward is zero.
As Bitcoin became popular, more and more people wanted a chance at getting a slice of the winnings — err, rewards — for mining blocks. Mining machines moved from systems without anything special to systems with many 3D accelerator cards. All of those 3D accelerators were used not for 3D graphics, but for crunching massive quantities of numbers. As time wore on, those accelerators weren’t powerful enough. As a result of all the competition, the difficulty of the problems for the PoW went through the roof. Even more specialized ASIC hardware was created. All this new specialized hardware can ever be used for is mining Bitcoin — or any other coin with the same PoW problems.
In the middle of this evolution, mining pools were invented where many machines could be harnessed to work on solving PoW problems together. This made it so no one would have enough computing power to get a block all to themselves without investing a very large fortune in hardware.
Bitcoin Mining as a Casino-Winnings Syndicate
It’s easy to picture Bitcoin as a token in a casino. People realized they could win money, so they started playing a whole bunch of different machines and kept winning a little — just enough to keep going and getting tokens. Obviously, this was inefficient. People built robots to push buttons and pull levers so they could win more, just like they were sitting at multiple games at once. Others started hearing stories about this and came and gazed upon the site of people winning all these tokens. These newcomers bought the machines and started taking up space in the casino.
Now hundreds of people flocked to the casinos to earn tokens. All of these people were still not satisfied with the odds of winning each with their own machines. They decided to band together and pool the winnings. This lead to more people getting part of the winnings, since they were all filling up multiple casinos with their robots and pooling the winnings together and distributing the winnings according to the effort expended by each miner.
This might seem like an absurd comparison upon first glance. It actually has truth to it. Most PoW problems are brute-forced, meaning a bunch of possible solutions are tried at random. Solving a PoW problem is just like winning the lottery, or getting lucky at a slot machine. More often than not, the random choice is wrong and another random choice has to be made. The only way anything is gained is if the amount of effort, time, and energy put into this process is eclipsed by the value of the result — the value of the tokens.
This means tokens do not have any intrinsic value aside from the energy used to validate transactions and the value validating those transactions has for the network. Tokens in and of themselves are meaningless, but we give them a use and a meaning. The only reason why Bitcoin is worth as much as it is right now is because of the meaning and additional value we give them.