The Quick Guide to Blockchain, Bitcoin and other Digital Currencies
/Don’t know your blockchain from your Bitcoin, Ether from your Ethereum? Here’s a quick digital currency guide for non-techies. I've glossed over a lot of the technical detail, this is designed to give you a basic understanding of what's going on.
What’s the blockchain?
Think of the blockchain as a giant book that records information. The first person writes a page of information in the book and passes the book onto the next person. The next person takes a copy of the whole book, writes a new page of information, passes it onto the next person, and so on, and so on. This means lots of copies of the book exist and no one can change information in the book without it conflicting with all the other versions of the book. The blockchain works the same way. Each page in the book is called a block and each page is linked together to form a blockchain.
You will often hear people say ‘the’ blockchain, as if there is one official blockchain. That isn’t the case. Anyone can start a blockchain to store any information they want. Literally anything. Forgetful with birthdays? Start a birthday blockchain to record birthdays and never forget a birthday again. Want to trace where your coffee comes from? Easy, start a coffee bean blockchain to record each of the following transactions:
A coffee bean farmer records the volume of coffee beans harvested.
A coffee bean distributor buys beans off the farmer.
A coffee roaster buys beans off the distributor.
A coffee roaster then sells some roasted beans to your local cafe.
As a consumer, you can now use the coffee bean blockchain to trace back where your cup of coffee came from. Every bean from farm to cup is accounted for and no one can cheat by mixing in some cheap beans in with your fancy coffee.
But how do people know how to record information in each block? There are rules for how information should be stored, like a set of instructions written at the start of the book. These instructions are in the form of a software program called a protocol. This way everyone using the blockchain is working off the same set of instructions/protocol.
That’s it. You now know what a blockchain is.
Ok, so what is Bitcoin?
Bitcoin is different to traditional currencies in that it isn’t controlled by any government. The rules that control Bitcoin are written as a protocol, anyone can buy and sell Bitcoins, and transactions are recorded in the Bitcoin blockchain. If Alice wants to send Bob some Bitcoin, a transaction is recorded in the Bitcoin blockchain that looks something like this:
12 June 2017 12:36 (Time of transaction)
123456789 (Alice’s Bitcoin address)
1BTC (Amount to be transferred)
987654321 (Bob’s Bitcoin address)
Well that sounds easy, but where do Bitcoins come from?
Traditional currencies are issued by a government’s central bank. It’s their job to print new money. But there’s no central bank for Bitcoin, so how do new coins get created? They’re issued to people called ‘miners’. The term comes from the idea that these people are ‘mining’ Bitcoin, but you can think of them as ‘writers’. It’s their job to write a new block in the blockchain to record Bitcoin transactions, and for their effort they get given some new coins. They also receive small transaction fees for the transactions they have recorded to the block. Although this transaction fee is actually voluntary, good luck getting a miner to record your transaction in their block without including a transaction fee.
Now before you get the idea that you might become a Bitcoin miner, know this: it’s hard! A new block is created every ten minutes, and for each block there are thousands of miners all competing to record that block of transaction. Teams of coders work together to give them a chance of writing the next block. It’s this collective and distributed work that helps keep the chain honest. Every miner that is competing to create the next block gets a copy of every transaction to be recorded in that block. That way if a dishonest miner tries to manipulate any transaction in the block, the other miners all say ‘oh no you don’t!’. The miner who solves the computational problem to create the block gets the reward. Currently, miners recieve 4 Bitcoins for every block, and at today’s Bitcoin prices that’s around US$10,000.
This won’t go forever; the amount of Bitcoin that miners get for their work decreases slowly over time and there is a maximum of 21 billion Bitcoins to be mined. There are currently around 16.4bn Bitcoins in circulation and the last coin is expected to be mined around the year 2040. After that, it’s expected that computers will be fast and cheap enough that miners will make enough money just from the transaction fees to make it worth their while.
How can you buy Bitcoin?
The easiest way to buy Bitcoin is through an exchange, and there are a lot of them. If you’re planning on holding Bitcoin for a long period of time, it’s safer to transfer your balance off the exchange onto a Bitcoin software wallet, or even better a hardware wallet. A software wallet is like transferring money from a share trading account into a bank account, while a hardware wallet is like withdrawing cash and carry it around with you. Before you buy Bitcoin or any cryptocurrency, I suggest you read up on the various exchanges and wallet types. Unlike a bank, there isn’t much in the way of customer support. If you lose your bitcoin address, then you lose your Bitcoin.
Can you transfer a fraction of a Bitcoin?
Yes. Think of a Bitcoin as being a dollar and a ‘satoshi’ (named after the mysterious creator of bitcoin) as being a cent. There is a big difference though. While there are 100 cents in a dollar, there are 100 million(!!!) satoshi in a Bitcoin. That’s like 0.000000001 Bitcoin.
How many digital currencies are there?
Bitcoin is just one of hundreds of currencies. Just like anyone can start their own blockchain, anyone can create their own digital currency. Most of them are very similar to Bitcoin, others work quite differently. But each have been designed to meet a specific need, and the instructions of how to use each currency are written in their own protocol.
So next I’ll give you three examples of other currencies. This is not a complete list, but hopefully you’ll get an idea of the differences and what’s possible with digital currencies. The purpose of this guide is just to give you a basic understanding of how it all works. If you want to start buying, selling and using any digital currency, then I suggest you start doing your own research into which exchange, which wallets, and which currency is best for you.
1. Apps, it’s all about apps baby! Ethereum and the other new platforms
So remember that all the blockchain really does is store information. This information can be whatever you want it to be, and at the same time it allows for the transfer of digital currency. Well imagine you’re an app builder and you want to build a ride sharing app like Uber or Lyft. Typically, what you do is build an app with a database to record all the rides that people take on your app, and then plug in a payments engine to take payments from riders and pay money to drivers. Now I know what you’re thinking; you’re thinking “wait...couldn’t you just record all of this in a blockchain? No need to pay for an expensive database, no need to use a separate payment engine.” And you would be 100% correct.
This is the basis for the Ethereum platform. It’s a more sophisticated protocol than Bitcoin’s and allows for greater flexibility. It has it’s own type of currency called an Ether, which works in a similar way to Bitcoin. Ethereum is fast becoming the darling of the tech world and is attracting developers and investors alike. The value of Ether has risen from US$8 at the start of this year to staggering US$350 as of early June 2017; that’s a >4,000% increase! Woah.
So back to your ride sharing app. Users of your app can pay and get paid in Ether. Cool, huh? What’s cooler is that they don’t have to use Ether; you can create your own currency on the Ethereum network. These currencies are known as ‘tokens’. For example, for your ride sharing app, you could create a token called a CabCoin. Congratulations, you’re now the proud owner of your own currency. Which means you can start selling your currency to people. And that leads us to our next jargon acronym, an Initial Coin Offering, or ICO.
ICOs have created a bit of a buzz this year. You probably know how most startups get funding. They find an investor, either an angel investor or a venture capitalist, to invest in their business and use that money to develop their product and grow their user base. You probably also know how Kickstarter works. Companies seek funding for their business by selling the product to the public before it’s launched. Well an ICO is kind of a cross between the two. Startups on Ethereum can bypass VCs and go straight to the public to get investment. But instead of selling part of their business, they’re selling some of the tokens they’ve created. Let’s say you work out you need $10m to get your ride sharing app up and running. You can create 100m CabCoins and sell some of these before your launch to raise money, say sell 10m of your CabCoins to the public for $1 each. If people decide that your Ride Sharing app is going to be a massive hit and therefore the value of CabCoins will rise over time, they can buy some CabCoins during the ICO.
So far this year app developers on Ethereum have raised over $350m in ICOs. You can read more about them on this Techcrunch article.
2. Faster and cheaper transactions, Ripple’s low cost solution to foreign transactions
Currently, big banks pay high fees to move money around the world. These transactions are part of running a big international bank. The system that moves this money around is old, slow, and can involve lots of intermediaries. Ripple is designed as a faster and cheaper alternative to the current system, and has its own currency called Ripples (XBT). In theory Ripple will allow banks to clear international transactions in seconds rather than days and at a much lower cost. It has gathered the interest of quite a few banks across the world and many of these are running pilot schemes.
Ripple has one big difference to Bitcoin in that it doesn’t have a blockchain of transactions with miners recording each block. Instead it has a thing called a distributed ledger. It’s designed this way to put more of the work behind recording transactions into the hands of the banks participating in the platform, rather than third party miners.
3. Private transactions, secrecy and drugs
All transactions in the Bitcoin blockchain are publicly viewable. No one can see your real name, but they can see your Bitcoin address and this makes transactions somewhat traceable. Some people don’t want their transactions being stored in plain view of the public. They find it creepy. Others believe Bitcoin’s publicly available transactions records make their Bitcoin susceptible to hackers wanting to steal their money. And other people REALLY don’t want people seeing their transactions because what they’re doing is frowned upon by law enforcement agencies, e.g. selling illegal drugs online. So a breed of cryptocurrencies has come along to solve this problem. These currencies specialise in keeping transactions private, away from the eyes of hackers and law enforcement officials. Examples are ZCash, ZCoin and Monero.
Summary
So I hope that gives you an idea of what the blockchain is, a basic understanding of what Bitcoin is, and some other currency types. I’ve tried to make this as easy to understand as I can, but if there is an area you’re still unsure about then contact me and I’ll try to update this guide with a better explanation.