Okay, but WTF is blockchain really?
Can you explain what blockchain is to your non-crypto friends? What about your parents, or your grandparents?
Why do we need blockchain? What problem is it solving?
It’s all about trust. Commerce relies on 3rd parties and central authorities (like banks) for several things:
- Issue and control the supply of money
- Verify the transactions are true
- Mediate disputes and fraud
This gives them a lot of power. Like, a lot. It also raises the cost per transaction. The fact is, having a middleman handling everything means there’s a limit to how many and how fast transactions can be processed.
So — the question is, how can we make payments without trusting a 3rd party?
Let’s start by completely ignoring the definition when you try to Google what blockchain is.
“Distributed ledger system” means nothing if you’re not familiar with accounting or distributed computing. Instead, let’s start with a simple explanation.
Let’s say you have 3 friends. Manda, David, and Weber. You often pay for each other for dinners, movies, drinks, etc.
Unfortunately, you also don’t trust each other AT ALL. Because of this, you settle in cash as soon as possible. But exchanging cash every single time gets really annoying.
One day, Manda has an idea. “What if — instead of settling immediately, we tracked the transactions somewhere and settled in cash at the end of each month?” Here’s what she comes up with:
“Manda’s Rules for Handling Money”
1. Track all transactions (ie. David pays Manda $5) on a record
2. Settle in $USD at the end of each month
3. Anyone can add a record
Also, some crypto terms you should know:
- “Rules” = “Protocols”
- “Record” = “Ledger”
Unfortunately, there are a couple problems with Manda’s protocol.
Problem #1. If anyone can add a transaction, what prevents someone from adding a transaction that wasn’t real?
Weber can add “Manda pays Weber $5” as many times as he likes.
What if we introduced the idea of signatures to solve this? Anytime there’s a transaction that involves you, you would have to sign off on it for it to become valid.
This solves Problem #1, now let’s tackle the next.
Problem #2. If we’re settling at the end of every month, what prevents someone from racking up a bunch of debt and then ghosting everyone when it’s time to settle?
David could owe $500 over the course of the month and then vanish when it’s time to settle. Jeez, David.
We need a leap of faith to solve this. Instead of settling in $USD, what if we “invented” a new currency. Let’s call it “Friend Dollars” (FD)
Let’s assume everyone starts off with 100 FD at the start of the month. Transactions in the record are logged in FDs.
As soon as a transaction is signed, the FDs are exchanged.
For example, Manda pays Weber 5 FDs. Once Manda signs off on this transaction:
1. Manda’s Total automatically decreases by 5 FDs
2. Weber’s Total automatically increases by 5 FDs
No need to settle in cash, problem solved.
Now, you might ask, “How can you just invent a currency like that?”
All money is based on trust, it’s a social contract. Why is cash, gold, or any piece of paper valuable? Why don’t the same items hold value in different country?
In this case, the record IS the currency. The existence of the record, and all its transactions IS the currency. It’s what gives the currency value. This, and the fact that there are limited supply of friend dollars to begin with, scarcity!
Manda’s protocol now looks like this:
1. Track all transactions in a record
2. Parties involved must sign off for transactions to become valid
There are still a couple questions remaining though. Where will the record live? Who’s going to maintain it? How can we trust that person? We definitely can’t keep it on one computer or give the responsibility to one person. Remember — you don’t trust your friends.
What if the computer crashes? What if the person owning the computer messes with the records? Enter “Decentralization”.
Instead of keeping the record on a single computer, let’s keep a copy of the record on *all 3 computers*. Everyone involved gets a copy. If someone wants to add a transaction, the two parties sign and broadcast it to everyone else. Everyone else then updates their copy.
This “decentralized record” system that we came up with is called the blockchain! Why? In reality, the record of transactions is literally split up into blocks to make processing easier. The blocks are “chained” to each other to preserve the order of transactions.
And that’s it! You now have an intuitive understanding of what blockchain is, and why it’s useful.
Of course, I didn’t touch on the more complex part of blockchain. Things like, the security of digital signatures or consensus protocol (reaching a consensus on the “right” record copy to keep). This will be saved for a later time!
That’s all for now. Hasta La Vista, baby!
The following video was the base and inspiration for this, check out the video for a more technical explanation of the concept.
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