Hello,
I am learning about blockchain and cryptocurrencies. This is my conscious effort to understand the space. As I learn more I will keep writing and sharing about it with you.
Understanding the world of Crypto
Mined in 2009, Bitcoin was the first currency built on a blockchain, paving the way for other currencies.
What was the problem Bitcoin sought to solve?
To create a peer-to-peer version of electronic cash. A system wherein one party could pay another without going through a financial institution.
In other words, a system where any two parties can transact directly, without the need for a trusted third party.
For example:
Imagine you are a brand owner promoting your business on Instagram; you are dependent on the platform’s algorithm to broadcast content to your audience. The algorithm is opaque and a slight change in rules can drastically affect your business. Same goes for other platforms, be it- Facebook, Twitter, Google or Amazon. However, if the platform changes its rules, you have no say in the matter.
Another example of platform power is the App Store. Apple charges up to 30% fees for any in app purchases for apps on the App store. This hefty fee is ultimately less money for the makers of the app e.g. King the company behind Candy Crush or Epic games developer of Fortnight. Developers are dependent on platforms. Apple has the power to kick them off their platform in case of a dispute.
Removal of this kind of platform dependency is what crypto seeks.
Taking it a step further, imagine the fees saved on selling/buying a property without a lawyer or a broker.
Or imagine you are a merchant accepting payments via card and not having to pay the bank fees for facilitating the service.
Or a world where you are not reliant on the government changing the rules e.g. Demonetisation, or rising inflation reducing the value of money.
The Bitcoin blockchain’s goal was to create a world where, there is no intermediary (bank, lawyer, broker) or organization (government, platform) who can control your decisions.
How does using blockchain eliminate the need for an intermediary?
Ben Horowitz, co-founder of venture capital firm Andreessen Horowitz, explains-
“Once every decade or two, a new computing platform comes along, you know, mainframes, PCs & smartphones. And the thing that is deceptive about it is, the new platform at the time is generally worse in most ways than the old platform but has some new capabilities. […]
The smartphone also had a camera and a GPS built in, so now you could build, so you didn’t have to just build a spreadsheet [already available in PC], you could build Instagram and Lyft, and you could build new kinds of things.
And with crypto, it’s very similar in that, it is worse in most ways than the old computing platform, that it is slow; it is really complex; it's lacking a lot of features. But, it has one feature that has never existed before, and that’s trust.
And trust is super powerful; it comes from the mathematical and game theoretic properties of the platform, and that means you don’t have to trust the government, Twitter or Facebook or the other people in the network. You just have to trust Math.”
Delivering value via the blockchain
By building a technology- blockchain, built on a universally accepted source of truth- math, the tech has created value by solving a problem faced by society.
What is this technology people are putting their faith in? Why is it worth $3 trillion?
The answer lies in understanding the building blocks of blockchain technology.
What is special about the blockchain that makes people trust this tech more v/s governments or banks?
Blockchain technology powers cryptocurrencies such as Bitcoin and Ethereum.
The currencies exist as a product of the technology. The currencies purpose is to incentivize people to authenticate transactions on the blockchain.
The blockchain technology by itself, has useful practical applications such as storing land records, supply chain tracking, food certification and more.
So how does it work?
The blockchain technology in simple terms is a ledger. It records and stores transactions in a chronological manner. e.g. X paid Rs.1 cr to Y for a plot of land on 1st January 2022. Once an entry is stored, the software ensures that the entry cannot be changed.
Take the example of agricultural land in India, a non-farmer cannot buy designated agricultural land. However, fraudsters have taken advantage of this law. But if the land title is stored on the blockchain it will reflect that the property is agricultural land. Thus, non-farmers will not be able to buy the land and scam people by hiding illicit gains.
How is this different from a government database?
What differentiates this technology and a government database is, that is a distributed ledger. A database which is accessible to all.
The Aadhar database comes to mind which stores information of every Indian. It is riddled with privacy and identity theft issues. A hybrid private public blockchain could enhance security while preserving all benefits.
What benefits could it bring?
Let’s take the example of insurance to understand another application of blockchain technology. You bought a medical insurance policy in India which provides coverage in the US and in India. You entered this record in the blockchain. To verify this information is accurate you pay fees to the authenticators in a cryptocurrency acceptable to both parties. Once accuracy is established it is saved on the blockchain. A few months later you are in the US and had to pay for hospitalization and want to claim insurance. By showing the record on the blockchain the verification of the claim becomes faster as there is trust that the record is accurate as compared to physical policy document which might take weeks to process.
Why do users trust the data entered and stored on blockchain? What makes the data tamper proof?
1. A distributed peer to peer network - Unlike the age-old ledger method where files are stored on a single system, blockchain is designed to be distributed across a large network of computers. This decentralization of information means everyone has a copy of the database, reducing the ability for data manipulation.
2. Hashing- Every block of data has the previous block’s hash. This hash is unique like a fingerprint. Any tampering causes the hash of the block to change resulting in all subsequent blocks to be invalid. Thus, hashing provides a layer of security to the data.
3. Consensus mechanism – Writing the next set of transactions to the blockchain requires a distributed set of unrelated authenticators to agree on them. The distributed, unrelated nature minimizes chance of manipulation between participants.
These properties of the blockchain have allowed Smart Contracts to emerge.
What are smart contracts?
Smart contracts are programs which allow parties to directly transact with each other. Thereby removing the need for an intermediary.
Here is the analogy given by Nick Szabo one of the pioneers in this space,
He compares a smart contract to a vending machine. Individuals insert coins into the machine and—assuming the inserted amount is correct—the machine delivers the goods they requested.
This predictable interaction requires little to no trust amongst the contracting parties: the vending machine has no choice but to deliver the goods upon receiving the money. The technological infrastructure of the machine is a guarantee that the contract will be fulfilled as intended.
In a similar way, smart contracts are computer programs, written with business logic and is self-enforcing, that is if a,b and c conditions are met transfer x to Mr.A. This if-then programming results in automatic execution. Vitally it removes the need for human intervention.
The program is usually stored and executed on the blockchain, dependant on the blockchains properties to make it trustless and secure.
To give a real-world example, a group of people raised $47 million to buy one of thirteen remaining copies of the US constitution. The endeavour was one of the largest distributed fundraising efforts, all powered by smart contracts.
Smart contracts allowed investors to pool in funds in the form of Ethereum. If they won the bid then Ether would be converted into dollars to pay the seller of the constitution, otherwise the Ether would be refunded to the contributors.
Unfortunately, their bid was unsuccessful, and the Ether was refunded.
Smart contracts with their varied uses will continue to power efforts like this and more in the future. Potential uses cases for smart contracts are – insurance, payments, decentralised finance, supply chain, crowdfunding.
Smart contracts are already transforming the world of finance with their applications in the Defi space. That, however, is for another post.
To understand more about smart contracts, look here
To understand more about the technicalities of how blockchains work look at these two videos,
Smart contracts and blockchain have revolutionised the world but aren’t without challenges. These issues have resulted in people losing millions of dollars.
In my next post I will cover the issues and shortcomings of crypto.
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