Blockchain: Technology Basics, Cryptocurrencies and Usage

Welcome to the world of blockchain, an innovative technology that has gained attention in recent years because of its great potential.

This article covers the basics of technology and is tailored for beginners who want to grasp key concepts. If you're advanced, opt for a more intricate read, such as my recent exploration of the Dencun update for Ethereum or a deep dive into asset tokenization.

As someone who teaches about blockchain, I've gathered lots of helpful info. This article breaks down the basics of blockchain, covers Bitcoin and Ethereum, explains tokens, and looks at how blockchain is used in different ways.

What is blockchain?

The word Blockchain consists of two parts — block and chain, which means “chain of blocks.” It represents a chain of blocks, where each subsequent block is cryptographically linked to the previous one. Each subsequent block has a link and relies on the previous block. The blockchain is thus an immutable registry that is read-only and write-only. It is not possible to delete or modify data in the blocks.

The immutability of the blockchain is more easily visualized as a chain. If any of the links are removed, the chain will break at this point, and the link where it broke will be the last link. The rest of the chain will no longer be part of it.

When we say that each subsequent block relies on the previous block, we mean that they are linked not only by their sequence number but also by the information they contain. For example, if we change the information in any block, the subsequent blocks will no longer be part of that blockchain — the link will be broken. Thus, it is not possible to change or delete blocks that have already been added.

What information do the blocks contain?

They can be records about who sent funds to each other and how much they transferred. For example, Bob sent 100$ to Alice, and there are also records about other participants: how much and to whom they transferred funds. As a result, we get a ledger where the data on transactions cannot be changed. This protects against changing or deleting data because each block is part of the blockchain.

The blockchain itself is capable of holding any kind of record, so it can be used wherever data needs to be stored and protected from change. Right now, the widest application of blockchain is cryptocurrencies, so consider the example of transferring some value.

Blockchain is a distributed network, so let’s compare it to a centralized model.

Data is usually stored in one place — for example, on a server. Users who access it can read or modify the data in it. This model is called a centralized model — because the data is stored in one place.

When we log in to an email account, all data is stored on the servers of the company that provides access to it. The company that owns the server, and therefore the data, can unilaterally change it: for example, delete a user’s profile. This is the standard and most common model of data storage.

The blockchain model means that it is distributed. All participants in the network are equal, and data is stored on multiple devices at once. This model is decentralized — there is no single storage center, and many participants have data at once.

All participants in the network maintain the same copies of the blockchain. This is what makes it distributed. It also means that when a new block is added to the blockchain, it must be added by all participants so that everyone has the same copy.

This requires rules by which they will synchronize them — a consensus mechanism, which means agreement.

This mechanism allows participants to follow certain rules when adding new blocks. Data cannot be added unless there is agreement between participants on its content.

There are three major consensus mechanisms:

Proof Of Work. It is based on the weight of computing power. The majority of computing power determines the addition of a new block. This is the very first mechanism.

Proof Of Stake. Network participants adding new blocks have to deposit funds. The more funds a participant deposits, the more likely it is to form a new block.

Proof of Authority. Participants who have the authority to decide whether to add new blocks to the blockchain are pre-approved. They are the administrators of the network. This mechanism is typically used in private blockchains that are controlled by a group of individuals or a company.

What types of blockchains are there?

All blockchains are classified into two types: public and private.

Private blockchains are controlled by companies or a limited number of individuals. They are used where centralized control of the blockchain is required (e.g., in the banking sector). They typically use consensus mechanisms such as Proof Of Authority. Their specialty is lower transaction costs and higher throughput. This is because there is no need to coordinate copies of the blockchain among a large number of participants — the network is controlled by a minority.

Public blockchains are completely open. Anyone can store and maintain their own copy of the blockchain and add new blocks. Control is in the hands of users under a consensus mechanism. This means that anyone can create their own applications and integrate them with public blockchains. Anyone can keep a copy of a blockchain like this and maintain it, and anyone can access the information in it, which ensures the transparency of the blockchain. Reliability in public blockchains is ensured by their open consensus mechanisms, which are backed by either computing power or funds.

What is Bitcoin?

The Bitcoin blockchain is basically only used to transfer its cryptocurrency, BTC. Bitcoin was originally designed as a payment system. The consensus mechanism in the Bitcoin network is Proof Of Work, and it is based on computing power. This consensus mechanism implies mining.

How mining works in general terms: First, users add transactions to the network. Next, miners use the computing power of the hardware to solve a complex math challenge to assemble the transactions into a block. They then form the block and are rewarded for doing so. The more computing power a miner has, the more likely they are to form a block and get rewarded for it.

Cryptocurrency in Bitcoin (BTC)

Bitcoin (BTC) is the internal cryptocurrency of the Bitcoin blockchain with the same name. It is native to it (the word “native” means natural, original). It is part of the Bitcoin blockchain.

It is used to make transactions between participants inside the network. In fact, this is all that happens in the Bitcoin blockchain — the transfer of this cryptocurrency between participants. Transaction fees are also paid in BTC. The transaction fees are received by the miner — as a reward for forming the block in which these transactions are included.

Let’s look at the economic model of Bitcoin and start with how its issuance occurs. New bitcoins are created on the Bitcoin blockchain with the formation of each new block. The newly issued bitcoins are rewarded to the miners who formed the block. The logic of the protocol itself has a rule: a new block is formed approximately every 10 minutes, and the total number of bitcoins that can be issued is limited to 21 million, a number that cannot be exceeded. Currently, 6.25 bitcoins are created with each new block or every 10 minutes.

One of the special features of Bitcoin is the decrease in its issuance, which is called halving. Every 210,000 blocks (which is about four years), there is a decrease in the creation of new bitcoins by a factor of 2.

In 2009, 50 bitcoins were created with each block; in 2012, 25 bitcoins were created with each block, which means the number of bitcoins has decreased by two times.

Now, 6.25 bitcoins are created with each new block. The nearest halving will happen in April 2024. The issue of new bitcoins will again decrease and will be two times less — 3.125 BTC. Thus, the creation of new bitcoins is constantly decreasing until its issuance reaches zero. In 2140, the issuance of new bitcoins will stop.

Bitcoin can be divided into smaller pieces — these units are called Satoshi. For example, 100 million Satoshi equals one whole bitcoin, and 10 million Satoshi equals one-tenth of a bitcoin, and so on.

What is Ethereum?

The cryptocurrency of the Ethereum network is the second most capitalized cryptocurrency right after Bitcoin. Ethereum was designed as a blockchain that would support not only the transfer of its internal cryptocurrency but also smart contracts. Smart contracts are programs that are deployed and run on the Ethereum network. They can be used to create applications that run in Ethereum’s decentralized environment.

Ethereum has its own native currency, Ether. It is directly involved in the functioning of the network. Ether is used in the Ethereum blockchain to pay transaction fees. Here, the fee is called gas. It is calculated based on the computing power required for the transaction and the current cost of gas. Ether can be sent between accounts within the Ethereum network, just like Bitcoin within the Bitcoin blockchain.

What are tokens in Ethereum?

Cryptocurrencies are the internal currencies of the blockchains themselves, which are directly involved in the functioning of the network, for example, used to pay fees. Now, let’s understand what tokens are.

Tokens in the Ethereum network are smart contracts. In fact, tokens are programs on the Ethereum network. Since Ethereum is a public blockchain, it means that anyone can place a smart contract in it — their number is unlimited. The number of these tokens can be unlimited because anyone can create their own token. Since tokens are a program, they are controlled only by the logic of the program itself. Tokens do not participate in the functioning of the network, unlike native cryptocurrency.

To make a transaction with tokens, you will need Ether — to pay the fees. Token balances are simply records in these programs, similar to the way a bank keeps a record of a customer’s balance.

How token transfer happens

To transfer tokens, Bob calls the token program and sends a request there to transfer five tokens to Alice. The token program responds to this request and checks if Bob’s balance has enough tokens to do so, and changes the balances of Bob and Alice. That is, the program will decrease Bob’s balance by the number of tokens to be sent and increase Alice’s balance by this value because she is their recipient.

You have to pay a fee for this call to the program in the network because it is a transaction that is paid in Ethereum in the native currency — Ether.

Stable tokens are one of the most popular token implementations. They are linked to some traditional currency 1-to-1, and their market value usually does not change in relation to the currency to which they are linked.

Examples of these tokens are Tether and DAI. They are linked to the dollar 1 to 1. A company that issues Tether promises to hold a reserve of the dollar itself and, in return, issues tokens on the blockchain. Any issuance logic can be embedded in the token, and in such cases, control of their issuance remains with the issuing company. The Tether token is centralized on the issuing company, while DAI works on a different principle.

It is maintained by a decentralized autonomous organization, MakerDAO. The DAI token is also linked to the dollar 1 to 1, but maintaining a stable value comes from the use of smart contracts and collateralized debt positions. Essentially, users can deposit Ether and other cryptocurrencies as collateral and create DAI as a loan against that collateral. The smart contract ensures that the loan-to-value ratio stays below a certain threshold — to keep the price of the DAI stable.

Blockchain use cases

Tokenization of real-world assets: Blockchain acts as a distributed immutable ledger and enables the transfer of rights to real-world assets into the digital space. This offers many advantages in real-world asset deals, such as faster and more efficient transactions, 24/7 availability, security, transparency, increased liquidity, no need for intermediaries, etc.

Central Bank Digital Currencies: Digital forms of Central Bank currencies are implemented using blockchain to concentrate control over the entire money supply at the Central Banks, speed up and cheapen settlement processes, reduce counterparty risks, make cross-border payments cheaper and safer, and ensure 24/7 availability.

Financial sector: Decentralized financial protocols (DeFi), which are implemented as smart contracts, provide absolute transparency of all financial transactions, which are recorded in a continuously updated and immutable ledger — blockchain. There are no centralized regulators, which makes listing or trading easier and faster. These environments give users control over their funds and transactions without the need to trust others: everything happens within the code.

Digital IDs: Blockchain enables trusted and secure identity systems based on unique digital identifiers that cannot be falsified or changed. This provides a high level of protection for users’ personal data and prevents identity fraud.

Healthcare: Blockchain is used to provide transparency and security in the management of medical data and pharmaceutical supply chains. It can effectively track the origin and movement of pharmaceutical products, preventing the supply of counterfeit medicines and ensuring patient safety.

Supply chains: Blockchain provides transparency and reliability of data related to the movement of goods from the production process to the end consumer. This allows for efficient logistics management, tracking of shipments, and authenticity of goods, which reduces counterfeiting risks and increases trust in the supply chain.

Gaming: Blockchain is used to create unique and authentic digital game items for use within game worlds. Players can own and trade virtual items using blockchain, creating new opportunities to develop game economies and participate in game communities.

Certification: Blockchain provides a transparent and secure process for issuing and verifying various documents and certificates. Participants in the system have the ability to quickly and easily authenticate documents, which reduces the risks of falsification and ensures the security of digital transactions.

Conclusion

Blockchain technology is not only the basis for cryptocurrencies but also a powerful tool for transforming various industries. Blockchain applications span a wide range of fields, from finance to healthcare. Due to its decentralized nature and strong data security, blockchain is changing the way we interact and manage data, bringing transparency, security, and efficiency to various aspects of life and business.

Despite the benefits, blockchain technology is still in an active stage of growth, and we can expect an even greater variety of applications and innovations in the future.

Therefore, it is important to follow the progress of this technology and look for new opportunities to utilize it in different areas. Blockchain makes the world more transparent, secure, and accessible to all!