What Actually is Blockchain?
If you're a long time reader, you will have a good idea about the many pros and cons behind cryptocurrency and why it might be the next 'big thing' or why it can fail. But what I haven't explored is the technology powering it.
Blockchain has become a bit of a buzzword that people apply without really knowing what it means, or what it is. Mainly, because it is very difficult to explain. So I will do my best to overcome this.
Why do you need to understand Blockchain?
Rule number one of any investing process is to understand what you're investing in. From head to toe. Understand the product. Understand the business model. Understand the management structure. We will be focussing on the product part of this equation, as we have been for the past few months. But when explaining it to you, I have very much put the cart before the horse and elected to neglect the foundational logic behind blockchain mainly because I struggled to get a grasp of it myself.
It has become clear to me that listing things like transaction time, transaction fees, security, privacy, energy efficiency etc. are all persuasive in selling someone on the blockchain attraction, but if you don't actually know what drives these aspects on a fundamental level, you could miss a minor detail that has very adverse consequences on your portfolio.
Michael Burry is a proponent of this, highlighting the fact that one person's misunderstanding is another person's opportunity to take advantage of a gap between price and value. So consider this the beginning of a 'how to understand the ins and outs of blockchain' from someone who is starting in the same place as you are.
What is blockchain?
According to Euro Money:
"A blockchain is essentially a digital ledger of transactions that is duplicated and distributed across the entire network of computer systems on the blockchain. Each block in the chain contains a number of transactions, and every time a new transaction occurs on the blockchain, a record of that transaction is added to every participant’s ledger. The decentralised database managed by multiple participants is known as Distributed Ledger Technology (DLT).
Blockchain is a type of DLT in which transactions are recorded with an immutable cryptographic signature called a hash."
While comprehensive, I'm sure many of you are no closer to understanding what blockchain is. Let's breakdown the elements:
Blocks
Chain of blocks
Distributed Ledger Technology
Blocks
There are three elements to each block, two of which will be covered here. First there is the data that the block stores. In this instance it is data that is key to that transaction, but there are other applications of blockchain which we will leave for now.
The second element is the hash. The hash of a block is determined by the data inside the block. If the data changes, the hash changes too. The hash of every block is unique to that specific block, so you can consider it some kind of digital fingerprint in that no two are the same.
Chain of blocks
To understand the chain of blocks, you have to understand the third element of each block in the blockchain. This is the hash (digital fingerprint) of the previous block, connecting each block to another block, creating a chain. Here is the first layer of security that a blockchain network provides. If you successfully tamper with one block, you would change the hash of that block, which will render the subsequent block, and all following blocks in the chain invalid, as the previous hash doesn't match the previous block's hash.
To successfully tamper with the data in a block, you would have to tamper with the data in all subsequent blocks.
Distributed Ledger Technology
A ledger in this context is a record of the data in a blockchain. Something that is key to understand is that a blockchain network is completely decentralised, meaning anyone can join it (Whenever you here peer-to-peer network think of this). This is where the distributed ledger becomes useful.
Every user on the network is given a copy of a specific blockchain, and whenever a new block is added to that chain, they all have to come to the consensus that it is a valid addition to the blockchain. This process is called Proof of Work (there are other alternatives that we will cover at a later date).
So in order to tamper with this system, not only do you have to tamper with every block, but you have to control at least 50% of the network and redo the Proof of Work. This apparently is not easy at all.
It is worth noting that this is the earliest iteration of blockchain technology, with this outline being particularly similar to the system Bitcoin initially used. Elements such as Proof-of-Work and the kind of data that is stored in a block and the level of decentralisation are all elements that have evolved overtime. This is very much the simplest and earliest outline of blockchain technology which we will develop in the future.
This video provides a clear overview of the basics outlined in this article.
Takeaways
You need to understand this to gain the biggest possible advantage in investing in the blockchain industry
This is an explanation of the earliest form of blockchain and it is most attributable to Bitcoin
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