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What is Blockchain & Cryptocurrency?
Blockchain is essentially a distributed ledger system. But what does this mean?
I’m sure you can find many other blockchain definitions on the internet, so I will try to describe what blockchain is, using my own way.
3rd Party Trust
Let’s say you are buying a cup of coffee at a café. When you pay, you tap/swipe your debit/credit card to the merchant’s machine. Here occurred some money/currency transfer from your account to the merchant’s account. But how do you know this has happened? And how can the merchant be sure that they are getting their money from you? This is because there are some 3rd party entities that says or confirms this move of money, which is for example your bank or the card network (Visa, MasterCard or American Express). The café trusts this 3rd party entity.
But what happens if your bank, or the card networks get hacked; or if their systems crashed completely?
Blockchain is a system without those 3rd party entities. Essentially, the database is kept by many ledgers so it is very difficult to be hacked, or less likely that system crashes occur to all the ledgers.
So, if for example you pay your coffee with Bitcoin (a type of Cryptocurrency), the Bitcoin is transferred peer-to-peer from your Bitcoin address to the cafe's Bitcoin address. And this transaction (Bitcoin movement) is listed in distributed ledgers, spread across the Bitcoin network.
Here is an analogy to help explain what I meant:
A classroom using a 3rd party trust
In a classroom of 47 people, the teacher entrusts money and bookkeeping to Andrew. Andrew keeps a record of everyone who has paid for the planned class excursion trip, who owes whom money from last week’s Easter lunch, and so on. In this class, Andrew acts as the 3rd party trustee. The other 46 students trust Andrew will do the right thing and be honest. Obviously, there are some risks here, for example:
- What if Andrew’s notebook got stolen?
- What if Andrew tries to steal money for himself?
- What if Andrew’s best friends try to manipulate him and the system to get more money?
A classroom using blockchain
If we are to transform the classroom money record system above to a blockchain, the teacher will ask who in the classroom wants to take the job. Let’s say we have 5 people interested. These 5 people will then have to keep the same record of transactions in their notebooks. This way, it will be more difficult to steal 5 different notebooks, or to manipulate 5 different people to steal money.
But what are the benefits for these 5 people to work as the class accountants?
Let’s say in this classroom, everybody loves chocolate, so we will use chocolates as the currency here. These 5 people will be rewarded (or competing to get) some chocolates for their bookkeeping job. In the blockchain and cryptocurrency world, we call these 5 people miners – as they are mining some chocolates.
When there are some complex calculations, for example these 47 students go on a lunch trip together and each student orders different food and is paying a different amount, the 5 miners / accountants compete to finish the calculation first. Whoever completed the calculation first, and have been confirmed by the other 4 that his/her calculation is correct, will get the chocolate. This is why the best miners always have the best system set up, with the most powerful machines.
However, outside the 5 miners, these chocolates can also be traded (bought and sold) by other people in the classroom independently, because it has value (there is supply and demand for this currency in the classroom). And when the class become bigger and will cater more students, we will have more demand for these chocolates, pushing the price up because the supply remains the same, or the supply can only grow at a slower pace as the teacher only gives out 3 chocolate bars per week.
In the real life of cryptocurrency, the chocolate used in the analogy here can be Bitcoin, Ether (the currency used in the Ethereum blockchain), or any other types of cryptocurrencies.