Explanation of the Blockchain
Blockchain is a system of recording transactions in many databases that are widespread on many computers, each of which contains identical records. With this decentralized transaction record, it is almost impossible to hack or change unilaterally, without controlling the majority of all databases or computers.
Note these transactions are contained in blocks that are interconnected. If one block is full, the next block will be connected to the previous block. Transaction records that are contained in blocks that have been created, cannot be changed anymore – so the blockchain is often called immutable.
Comparison of Traditional Systems with Blockchain
I’m sure you can find many definitions of blockchain on the internet, so I will try to explain the meaning in my own way. Let’s compare the traditional system with the blockchain system.
1) Traditional System: Trust With Third Parties
Suppose you buy a cup of coffee at your favorite café at the Mall. When you pay, you swipe your credit card at the café card machine. Here a money transfer occurs from your account to the café account earlier. But how do you know that this transfer actually happened? Why does your café believe that your money has been transferred to their account? This is because there are third parties that are trusted by you and your café. In this case, the third party is your bank, or the card network that you use (Visa, MasterCard, or Amreican Express). Your café trusts third parties.
2) Blockchain system
Blockchain is a system that does not use these third parties. In essence, records of transactions that have occurred, are stored by many computers spread over the network itself. So it will be more difficult to hack a system of hundreds or thousands of computers, and it is unlikely that all of those computers will crash at the same time.
So, if you for example pay for your coffee using Bitcoin (a cryptocurrency), Bitcoin for coffee payments is transferred from your Bitcoin address to your Bitcoin cafe address on a peer-to-peer basis. And this transaction will be recorded on all computers spread over the Bitcoin network.
Simple Analogy To Explain How Blockchain Works
The Characteristics of a Blockchain that are Important for Cryptocurrency Investors to Understand
If you have read and understood the concept of blockchain in general above, here is a further explanation about blockchain from the cryptocurrency investor side.
1. Open-source and Transparent
It is important to understand that the blockchain code is transparent. If you are a developer who can read blockchain code, you can verify what code yourself is writing, for example on Bitcoin:
How many Bitcoin supplies were there at the start (Genesis block)
What is the Bitcoin inflation rate (to understand demand and supply)
If you compare it to a country’s common currency (for example US Dollars), which is usually controlled by a central bank (Federal Reserve in the United States), ordinary people like us will never know how much new money will be printed in the future, for example 10 next year; Or what is the bank interest rate in the next year. With cryptocurrency, all of this can be verified in written code.
2. Decentralized / Not Centralized
Cryptocurrency is a scattered system, where no one person or one company controls it. The blockchain code is not located on a central server operated by a company, but is spread across thousands of computers on the blockchain network. You can also have your own node, where your computer / machine contains the blocks and records of the blockchain transactions.
3. Supply and Inflation Level Are Clear (Data Available)
Because the blockchain is transparent, we can know exactly how many cryptocurrency supplies there are and how many will be printed in the future.
Why is Supply Important?
Everything in this world that can be sold and bought has a price. And the price of all things always depends on supply and demand (demand and supply).
Imagine if everyone in the world had an apple tree that could produce an unlimited number of apples, with the same quality. Then the price of apples will be very cheap and maybe even close to 0, because it’s useless you buy something that you can produce yourself whenever you want.
Another analogy: Imagine if the Ferrari car company only produced 10 Ferrari special editions in the world. You decide to buy one of these cars at a high price, because it is very exclusive. But in the next 5 years, it turns out that Ferrari decided to produce 10 thousand units of the car. How do you feel? And what do you think will happen with the price of the special edition car?
The concept is the same as stocks. To understand the price or value of a company, we need to understand the company’s market capitalization, which can be obtained from the number of shares multiplied by the share price. Future earnings and profit margins are also important, but this is a separate topic.
Bitcoin Supply and Inflation Rate
Let’s look at the amount of supply and the inflation rate of Bitcoin as an example. The chart below is based on the Bitcoin code, and can describe exactly how much Bitcoin supply will circulate in the future.
Whatever has happened and confirmed on the blockchain, cannot be undone. So if you have made a mistake in transferring your funds to the wrong address, it means that your funds are lost – unless the owner of the recipient’s account is kind enough to return your funds. But it must be remembered, it is almost impossible to find out who owns a cryptocurrency address.
Of course there are exception cases on the blockchain where something can be undone. Examples occur in Ethereum. At that time, a (or a group) of hackers stole a huge Ether fund from The DAO project (15% of all Ethers in circulation). The inventors and developers of Ethereum did not allow this to happen and canceled the transaction with a hard fork that produced a new version of Ethereum. But the old version of Ethereum is still maintained by several miners. This old version is known as Ethereum Classic.
5. It is almost impossible to be hacked
A good blockchain project will certainly be supported by many miners / miners who help to secure the blockchain network with the power of their machines / computers. Cryptocurrency mining is a very large separate business. Miners are rewarded with the cryptocurrency they mine.
In essence, the miners compete to complete a mathematical calculation. Anyone who successfully completes the calculation accurately and creates a new block for the blockchain, will be rewarded. Therefore these miners dare to invest heavily to buy powerful computer equipment and also pay expensive electricity for their activities.
A note: The mining system above is for a proof-of-work blockchain system, such as Bitcoin. Some types of blockchain (such as Ethereum in the future), use a proof-of-stake – or virtual mining system. This is a separate topic.
To be able to hack a blockchain, you must control more than half (> 50%) of the power of the computer that is involved in securing the blockchain network (known as attack 51%).
You may have heard that a blockchain has been hacked before. These hacks generally occur on an exchange (such as Mt.Gox), and smart contracts that have security weaknesses (such as The DAO); and not on the blockchain itself.