This article was kindly provided by www.goodbit101.com
Cryptocurrencies are globally accessible, digital currencies, enabled by blockchain technology.
- Are peer to peer.
- Have low fees.
- Don’t rely on a central authority.
So what’s this blockchain thing anyway?
Simplifying greatly, it acts as a distributed ledger.
- Ledgers are used to organize and keep track of transactions. By recording transactions as they occur, ledgers create an archive detailing who owns what.
- Distributed means that anyone can access it, and anyone can check its validity (if they have the right software).
Because the ledger is held publicly, we don’t need to use a bank or any centralized authority to verify transactions or holdings we can do that ourselves!
Let's take a look at an example to understand how verification works. The nuances are definitely not 'beginner's guides' material (see our in-depth sections for more detail), but to provide a general idea we’ve prepared an analogy.
Blockchain: An Analogy
You live in a town called Cryptonia, which has very strange rules about how you can use money. If you want to make a transaction (let’s say you want to buy a teacup pig from your grandma), you have to announce your intentions to the whole town.
They all know your complete financial history (you can't lie about how much money you have), and before buying anything you must first prove your identity.
Per town rules, you announce your intended transaction to everyone. You provide identification for yourself, and tell everyone the amount of money you’re going to give your grandma.
If everything you say checks out (your identity is verified and you have enough money to buy the teacup pig), then your transaction is completed and recorded by the townspeople. You get a teacup pig, grandma gets some money, and that event is written down on a piece of paper.
The paper is added to a massive pile of papers that contains every transaction that has ever taken place in the town of Cryptonia. Anyone in the town can check the pile to see what has taken place and the papers are frequently checked by each townsperson individually.
Each person in the town verifies all of the above information independently, so there’s no need to trust one person in particular to check your honesty.
Fast forward 100 years. Cryptonia now has computers! So, instead of writing down transactions on a piece of paper, the townspeople write them on a public, digital file. Each person has a separate copy of this file on their computer, and the file is constantly updated with new transactions.
That’s not an easy situation to commit fraud in. No one can make transactions pretending to be you, since you have to verify your identity, and no one can pay for things they can't afford, since account balances are public. No one can fiddle with the digital file either, since everyone has a copy and would notice if yours is different. Cryptonia sounds like a lovely place to live.
A Bit More Technical
Let’s clarify some things about our analogy:
First off, blockchains are pseudonymous. Accounts are identified only by pseudorandom strings of letters and numbers without any personal information. In order to verify your identity, you must enter a personal 'password,' which is another random mishmash of alphanumeric characters.
Most blockchains are not anonymous (as with anything, there are exceptions). If someone finds out which account number corresponds to you, they can follow your entire financial history on the blockchain.
Blockchains are protected by heavy duty cryptography. To date, it’s some of the strongest the cybersphere has ever seen, and how it’s used prevents hackers from doing damage to the network.
People known as miners are analogous to the townspeople we mentioned they go through the record of transactions to make sure everything checks out. Before they do so, their specialized computers do heavy cryptographic lifting that makes it very difficult to disrupt the permanent record of transactions – for more details on how this works, see Proof of Work in our in-depth section.
Miners are rewarded for their work with small transaction fees and newly minted coins (see Mining for more). This is how new bitcoins are created.
Why is it called blockchain? Let’s go back to our analogy:
Imagine the people of Cryptonia put more than one transaction on each piece of paper. When a page is filled, it is permanently added to the stack of papers, and the townspeople move on to the next piece. The pages are numbered, so that each piece of paper indicates which piece comes before it, inextricably linking them.
This new system lumps groups of transactions together. We call those groups blocks, and since they are connected to each other in a permanent, linear fashion, they form a chain. Block + chain = blockchain!
The people of Cryptonia use blockchain technology to verify financial transactions, but blockchains can theoretically be used to verify digital information of any kind.
The first blockchain created was the Bitcoin blockchain, but since then a number of others have popped up, each with their own modifications of the original. Some are currencies, while others allow for information storage, and still more are designed to allow others to build their own use cases on top of them.