Blockchain and cryptocurrencies 101

ELI5 (explain like I’m 5) cryptocurrencies and the technology behind them.

Blockchain technology and its killer app, cryptocurrencies, are the newest craze, but very few people understand what it is and how it works.
This is a quick guide to what the blockchain is and the types of blockchains behind your favourite cryptocurrencies.

What is the Blockchain?

The Blockchain is a digital ledger that stores transactional data across a network of nodes. Each of the nodes serves as storage and validation of transactional data in the blockchain.
You can have public blockchains, such as cryptocurrencies like Bitcoin and Ethereum or private blockchains within closed networks, deployed by various business organizations like banks.

Types of Cryptocurrency Blockchains

There are 2 types of blockchains, Permissionless and Permissioned.

Permissionless blockchains like Bitcoin, Ethereum, Litecoin and many others, allow anyone to create a node and actively participate in the network. Think of it as a discussion group where anyone can join, like Reddit or Facebook.

Permissioned blockchains are closed networks where the ability to participate and run a node is restricted by a central entity.

Consensus or General Agreement

One of the most important concepts to understand when it comes to blockchains is Consensus. A consensus is basically a general agreement on all blockchain transactions between the nodes to maintain validity, security and truth. Think of it as a group of people in constant communication, trying to keep each on the same page.

To achieve and maintain this consensus, which is crucial to the blockchain’s integrity, they use a consensus algorithm. A way to keep every participant node honest and interested in the blockchain activity.

There are a few types of consensus algorithms and I’ll quickly go over the most commonly used, without going into too much technical detail.

Proof Of Work(POW)

Bitcoin, Ethereum and Litecoin, are cryptocurrency blockchains based on the proof of work consensus system.
What does that mean?
It means that in order for the transactions to be processed, the nodes have to “mine” or better said, race to process the transaction by first solving mathematical equations, which will vary in difficulty over time.

“Proof of work makes it extremely difficult to alter any aspect of the blockchain, since such an alteration would require re-mining all subsequent blocks. It also makes it difficult for a user or pool of users to monopolize the network’s computing power, since the machinery and power required to complete the hash functions are expensive.”

Proof Of Stake(POS)

In this type of consensus system, instead of mining by solving mathematical equations to validate transactions, validators use a stake(or a deposit) in the currency of the blockchain (Ether could be an example). This way minimal computer power is being used to validate transactions and the selection for transaction processing depends solely on the amount staked as percentage chance. Also, this improves security as well, by forfeiting the stake of any validator trying to corrupt the network in any way.
To make a simple analogy, say we have 10 people each making a bet between $1 and $10 dollars to be selected for a job. The chances of each to be selected for the job, depends on how big their bet is. Someone that bets 10 dollars has a much higher chance than the person that bets $1. Anyone trying to be dishonest in any way, loses their money instantly.

The holy grail of blockchain technology is represented by 3 main attributes: security, scalability and decentralization. These are given by the type of consensus mechanism implemented by each blockchain.

Most of today’s popular crypto blockchains, like Bitcoin(BTC) or Ethereum(ETH), can satisfy only 2 of the 3 ideal attributes, security and decentralization, but not scalability, even though they’re both working hard at it. They currently use a POW consensus system.

Another blockchain, like Ripple(XRP) on the other hand, is secure and scalable, but highly centralized and mostly controlled by a single entity.

The race is on for a complete system and whoever’s will be the first to implement all 3 in a viable manner, could potentially be the big winner in the blockchain space.

The blockchain technology is still in its infancy and evolving all the time, but the basic principles behind it stay true and are important to understand if revolutionary mass adoption is to be ever achieved.

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