What is blockchain?

Blockchain 101: Understanding the basics

To help better illustrate how blockchain technology works, we’ll be using some real-life examples. Let’s imagine we are buying an ice cream with a debit card 🚶‍♂️💳🍦.

1) When paying, you will insert your card into the ice cream shops credit card machine.

2) By validating your card with your PIN, you allow the transaction to be processed.

3) Starting there, the merchant’s credit card machine asks the bank if you have the required funds to buy the ice cream.

4) The bank verifies your funds, and if the balance is sufficient, it approves the transaction.

5) Your bank account balance is updated.

6) The merchant gives you the ice cream. You can then enjoy it 🙌!

‍

This entire process was facilitated by the bank, who acts as a trusted third-party. The bank verifies to the merchant that the customers information is true, and because the merchant trusts the bank, the financial transaction can occur. This protects the merchant and allows them to do business with customers who are unknown to them.

In order to provide this highly important service, the bank charges fees to the merchant.

This kind of transactions can take place millions of times per day, with millions of different actors. But there is a pattern that we observe in each of them: the bank is the intermediary who transmits and guarantees that information is correct. It acts as a central authority and source of truth.

The central authority system works well enough for day-to-day activities and transactions. Still, security is complex, and no organization can guarantee it 100%. Thus there is fraud, and security risks which require advanced infrastructure like secure buildings, servers, procedures and more. These costs are passed along to the merchant, resulting in fees and costs to use banking services.

How do we build the trust that makes sure the information is true? How can we guarantee the merchant is selling ice cream and not giving it for free?

Let’s imagine that rather than a central authority (the bank in our prior example) keeping track of every transaction, many different people distributed throughout the world had copies of every transaction. Let’s also imagine that they were compelled to not cheat and manipulate these books, and that all of the transactions did not contain any personally identifiable information (they were pseudo anonymous).

Using a system like this, this is how the payment process would look using the same ice cream example as before:

1) You ask the merchant for his pseudo anonymous account number.

2) You ask the network of people distributed throughout the world to verify your payment.

3) These people have records of all of the money you have sent and received, allowing them to see if you have enough funds available to make the transaction.

4) You do, and the payment is approved; your record is updated to reflect the purchase.

5) The merchant instantly receives the funds in his account and gives you the ice cream 🍦.

It is harder to hack or corrupt this system because you would have to hack or corrupt many actors at the same time.

In this scenario, because there is a consensus reached between a large amount of bookkeepers who all having a (financial) incentive to report trustful (and thus the same) data, the information provided is reliable.

This is often referred to as decentralization.

In this scenario, we made the assumption that the people across the world with copies of the transactions had a very good reason to not manipulate their copies and that the merchant had the ability to verify with them that you had enough funds to purchase the ice cream.

These two assumptions are critical to this system working, and can be fulfilled using blockchain technology. As a whole, the underlying mechanism that ensures that transactions are legitimate is very similar to how your privacy is secured on the internet (HTTPS), using cryptography to protect your privacy while allowing the different people to communicate and verify your data.

On blockchains, the people in our prior example are computes which act as a network of bookkeepers with the data and tools necessary to verify that information has not been falsified. Furthermore, they have financial incentives to act honestly, maintaining the integrity of the network.

This is how a blockchain ensures the legitimacy of distributed systems.

This is a very simplified explanation of how blockchain works. We re-iterate: we want to make things simple so we didn’t dive into technical descriptions of the blockchain.

We hope we succeed to explain you what a blockchain is in a different way.

Let’s grab a ☕️coffee and take some more time, because we are now going to discover the power of this technology without talking about maths 🤯. Big challenge, right?

Why the blockchain is a game changer?

Now that you have a better understanding of how a decentralized system uses blockchain technology to function the same way as the existing financial system, we’d like to spend some time going over some of its other benefits. This will help you understand exactly how it can change the world.

Although we focused on money transfers in the prior example, that is just one application of blockchain technology.

In the following section we’ll get into how blockchain technology can be used to ensure systems are decentralized, secure, immutable and transparent.

We’ll dive into each of the attributes to get a better understanding. And don’t worry : if words like immutability or distribution makes you feel overwhelmed, we’ll change that.

Decentralization

As we have just discovered, blockchain technology can be used to power a decentralized system.

Decentralized systems can be very diverse. Here are some examples of how some other industries would operate if they were decentralized:

- Insurance: you can decentralize the periodic subscription fees as well as the compensation declarations and settlement.

- Mobility: drivers and mobility equipment lenders are connected directly to borrowers and passengers for bookings and payments. They don’t need an intermediate platform, they form an autonomous network.

- Tourism: you can look for a room and book being connected directly to the network of hotels and flat lenders. The same applies for activities and restaurants.

- Loans: get money directly from lenders and refund them automatically.

When you think of how different industries would operate in a decentralized manner, you start to realize how many intermediaries currently dictate how we access services. With blockchain, we empower peer-to-peer networks and innovation. The result is that services become cheaper, more customizable and more private.

How does it empower innovation? When we unbind data ownerships from centralized systems it becomes usable and accessible. This results in a more open market where the best user experiences will become the most used, improving our efficiency and ensuring that legacy companies face constant competition and can’t rely on their data monopolies to stay relevant.

Security

As we alluded to in the first section, centralized systems represent attractive targets for bad actors. Decentralization makes it less valuable to hack systems, because you would have to compromise a large amount of them. To put it simply, that amount of effort is too time consuming to be attractive.

These many layers of verification also removes one of the largest security flaws: humans. Humans can easily make honest mistakes, or act engage in behavior due to financial, personal, political or other influences. And since a centralized system only relies on a single source of truth, if that source is manipulated, it is hard to detect the falsification.

On the blockchain, this paradigm has changed. Data has to be validated by a minimum number of participants in the network whose data needs to match.

If a peer tries to alter or falsify a transaction, the rest of the network will quickly detect that the data is not proper and reject the data entry. This ensures that the data remains trustworthy and secure.

Immutability

Everything stored on a blockchain is guaranteed to remain unchanged. This is called immutability.

The only way data can be changed on a blockchain is through a 51% attack, where more than 50% of the participants in the network have been compromised.

At scale, this is nearly impossible task, so we will not spend too much time on it for now.

Transparency

Another important property of blockchain technology is that the information is transparent. The ledger is public and accessible to all, which is the mechanism that allows the network participants to maintain copies of the data, ensuring data accuracy while also making the data accessible.
In order to use blockchain technology to record financial transactions, one needs a currency that can only be created or exchanged within the blockchain. This ensures that value can flow.

This is called a cryptocurrency.

What's next?

1. 👉 What is a cryptocurrency?