For Crypto HODLers

Blockchain fundamentals

Lesson in Course: Crypto (beginner, 6min)

What is the underlying technology that makes cryptocurrencies possible?

Eureka!

What it's about: Knowing the basics of how blockchains work is essential to being an informed investor in crypto.

Why it's important: Being familiar with blockchain will help us understand the risks involved with crypto.

Key takeaway: Blockchains contain information that's public and are very difficult to change.

How blockchains work

To start, let's look at a single block. A block is a collection of information and the data in this block could be anything. For cryptocurrencies like Bitcoin, it contains transaction information; who's sending, who's receiving, and the amount. Each block has limited storage, so they get linked to the end of the previous block once they're filled.

A blockchain is a string of these blocks. To create the chain, each block also contains its own unique hash and the hash of the previous block. We can think of the hash of a block as a fingerprint, a unique marker for identifying that block and the information it contains. The information is public for everyone to see, but it's very difficult to change the data once added inside of a blockchain. 

Every block in the chain has a unique "fingerprint" called a hash

Blockchain security

If the information in a block changes, then the hash changes, and it's no longer the same block. Holding the hash of the previous block is what creates the chain, and it's also what makes them so secure. If someone tries to tamper with a block in the chain, that block will change, causing the hash to change - invalidating all blocks after it in the chain. 

Hashing alone doesn't make it secure. Blockchains use mechanisms called Proof-of-work (PoW) or Proof-of-stake (PoS) to validate new blocks that are added. This validation ensures there is consensus among everyone using the blockchain. Everyone has to agree which blocks are valid and which aren't - invalid blocks get ignored.

Check out this short video overview of blockchains
https://youtu.be/SSo_EIwHSd4
 

Smart contracts

Blockchains are often called smart contract platforms because complex financial contracts (or simple ones, like transferring money on someone's birthday every year) can be encoded into one of the blocks. 

What is Smart contracts?

Smart contracts are inflexible programs that live on the blockchain and are run when predetermined conditions are met. Smart contracts require the input of the utility token native to that blockchain to make changes or execute the transaction.  

Decentralized finance runs on smart contracts

Running a protocol based on smart contracts gives us greater self-sovereignty since we no longer need to rely on a centralized entity, like a bank, to perform the same transaction. In our example of the recurring birthday money, we would need to pay ETH if the smart contract is on the Ethereum blockchain.

 

Actionable ideas

You don't have to become an expert, but take the time to familiarize yourself with how blockchains work. It will help you understand the risks of owning crypto so you can decide if it's right for you.

All you need are the basics if you decide to start owning coins, using DApps, and getting involved in the rest of the decentralized crypto world.

Supplementary materials

Here is a great visual resource for understanding how blockchains work

Using the analogy of a bus station:
Each person at the station represents a transaction happening in real-time while the houses they come from are different types of transactions. Each bus represents a future block and the bus leaves when a block is validated. To get on the bus, each transaction pays a gas fee. Gas fees are based on supply and demand - the gas price increases when there are lots of transactions that need to be processed.

https://txstreet.com/
Top 100 Richest Bitcoin Addresses

Remember, the information on a blockchain is public so we can see all the information in them. A site like this one combs through the blockchain and can show us the biggest accounts; though, we don't know who owns them which is where the privacy comes in.

https://bitinfocharts.com/top-100-richest-bitcoin-addresses.html

Glossary

What is Smart contracts?

Smart contracts are inflexible programs that live on the blockchain and are run when predetermined conditions are met. Smart contracts require the input of the utility token native to that blockchain to make changes or execute the transaction.