Blockchain in a Nutshell
Learn about the first fundamental blockchain concepts!
A blockchain is a distributed ledger. Let's take this statement apart.
Core Concepts
Ledger
A "ledger" is a record of balances associated with an identity. Here's an example to illustrate this concept: Alice, Bob, Charlie, and David are schoolmates. They want to keep track of how many Pokémon cards each one has and decide to start a ledger.
1. Alice is the only one with Pokémon cards and has 50 of them. The friends meet and record the situation:
Alice
Bob
Charlie
David
50
0
0
0
2. It's Bob's birthday, and Alice decides to gift him ten cards. Now the balances have changed:
Alice
Bob
Charlie
David
40
10
0
0
3. Bob has lost a bet against Charlie and David and now has to give them two cards each.
Alice
Bob
Charlie
David
40
6
2
2
The ledger enables the friends to always have a perfect and uninterrupted overview.
A blockchain does the same as the example above. It records the balances, but instead of names, a blockchain uses addresses. Here is a Bitcoin address: 1A1zP1eP5QGefi2DMPTfTL5SLmv7DivfNa.
Some readers might have noticed that the approach of Alice, Bob, Charlie, and David is flawed. Their system involves a substantial amount of trust. Who keeps a copy of the ledger? What prevents a participant from changing the history? How can it be guaranteed that a classmate edits the numbers truthfully? In short, their system can't be trusted and is easily exploitable.
In traditional banking systems a ledger is always kept. Similar to the example above, only a few identities are allowed to have a copy of the ledger and have the right to maintain it. A system where only a few authoritarian entities control the record-keeping of the ledger shared by many it is called centralized.
Blocks
Blockchain works differently. Instead of having a long list of balances stored in a ledger, a blockchain splits the data up in smaller chunks, called blocks. These blocks are chained together, resulting in what's called a blockchain.
Consensus
Blocks are immutable. If a user does a transaction, the network does not change the previous block. Instead, the network includes the transaction in a block and then adds it at the end of the chain. The network protocol determines the rules on how and when to add a block. This process can be referred to as a consensus mechanism.
The consensus mechanism is the heart of any blockchain. It determines the security, the degree of decentralization, and the speed of a blockchain. Decentralization refers to the degree to which participants are able to participate in the creation of new blocks, more access, more decentralized.
Bitcoin's consensus mechanism: The participants who add blocks to the Bitcoin blockchain are called miners. A miner has to solve a randomized mathematical task first to be allowed to add a Bitcoin block. When he solves the task before every other miner, he includes the transactions into a block and adds the block at the end of the chain. The network compensates him for his work, called the block reward, which consists of newly created bitcoin and transaction fees.
Transaction Fee
A Bitcoin block has limited space. Only a certain amount of transactions fit into it. Therefore, a user has to pay a fee to be eligible to get his transaction included in a block. The fee amount varies from network to network.
Explorer
Blockchain data is publicly available for everyone. A user can inspect the blockchain using an explorer. One example of an explorer is the following webpage https://btc.com/. There he can find a list of all blocks, all transactions associated with an address, and more. On Binance Smart Chain, it's https://bscscan.com/.
Seed Phrase, Private Key, Public Key & Address
If a user wants to make a transaction on a blockchain, he can't use his regular banking account. First, he has to create a wallet. There are a couple of different kinds of wallets, but the steps to create one are always quite similar:
The user has to research a wallet that is suitable for his preferred cryptocurrency. Some wallets support only one currency, and there are also a few which support multiple.
After having chosen a wallet, the user has to install their software or access their web app.
The wallet now prompts the user to write down a seed phrase on a piece of paper.
The user writes down the seed phrase, and then he is done.
What is a private key? A private key looks similar to a wallet address, e.g., L25K7KdqwFDwPtT1KBoaQjVtHQR1uXBN1baDHboYZmmxPBqac6jj. A private key is the most critical part of a wallet. It is the gateway to using the funds of a user. Therefore, it must not be sent to any other person and handled carelessly.
What is a public key? A wallet generates the public key from the private key, and they are mathematically connected, e.g., 1GB7UgW3kbkbiXEAS2VJXkntchgmvs5696. A user can share the public key risk-free with others. Other users can send money to your public key since it is the wallet address.
What is a seed phrase? A seed phrase is a collection of words, e.g., file oven staff cruel occur team issue gym float bright print champion. Modern wallets generate a seed phrase for you instead of a private key. The benefit is that a seed phrase represents many different private keys. It also must not be shared with anyone, or the user risks losing funds.
Warning: Do not use the public key, private key, or seed phrase provided in this article.
Note: A few wallets are controlled by a centralized entity and don't require the aforementioned steps. Such wallets might be simple and easy to set up; they only need your email and a password, but a user sacrifices complete control over his money. A famous saying goes, "not your key, not your coins".
Smart Contract
A "smart contract" is simply a program that runs on the Ethereum blockchain. It's a collection of code (its functions) and data (its state) that resides at a specific address on the Ethereum blockchain. ~ Ethereum Foundation
Here is a simple example of a contract. Alice has agreed to send Bob one ETH when she gets 10 BNB from him. They decide to write a simple smart contract with the following logic:
When Alice deposits 1 ETH to the contract it waits for Bob's 10 BNB. If he doesn't send them to the contract after one day, the deal gets canceled, and Alice gets her ETH back. However, Bob deposits the BNB. Now the contract sends the BNB to Alice and the ETH to Bob.
Learn more about smart contract:
Common misconceptions
Cryptocurrencies are not in your wallet.
Alice sends Bob 1 ETH. Bob happily receives ETH, but then loses his mobile phone where Bob has his wallet stored. He worries his precious money is lost. Is he right? No, because before creating the wallet, he has noted down the seed phrase. Bob downloads the wallet software on his new mobile phone and then imports his seed phrase. Voilà, he still has access to his funds. Remember: As long as you have the seed phrase, you can always generate the public/private keys associated with your funds, you won't lose your money. You can even have your wallet on multiple computers. This is because the record of your funds is kept on the blockchain, not in your wallet, your wallet gives you access, it doesn't store your funds, much like a key to a safe.
Transactions are not instant.
Depending on the blockchain and the amount of fees you paid, a transaction might only take milliseconds, seconds, or minutes. You have to wait until your transaction gets included in a block.
Different blockchains have different ledgers.
Let's say Bob has 1 BTC on Bitcoin and 1 ETH on Ethereum. Bob can't just send his ETH to his Bitcoin wallet. Blockchains are blind and deaf and don't know what other networks are doing. If he tries the erroneous transaction, then he might lose his ETH. Funds can only be sent between blockchains when using a bridge.
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