It is almost impossible to find an understandable explanation of these things from the title on the entire Internet!
You go to Google, type “what is blockchain”, “what is Bitcoin”, various texts appear, beautiful animations, video clips…. but, when you look at and read these “explanations”, it’s even less clear to you. They complicate things and go in nerdy tech things.
I thought to myself, “It’s impossible that this is something no one can just simply explain.” So I set a goal to write an explanation that will be understandable to everyone. Even for primary school children.
I am long time in the crypto space, and I had to figure out what it was all about, read hundreds of complicated texts, and talk to people who deal with cryptocurrencies, in order to get the clear picture out of the puzzles. Some things will be simplified, so that they can be understood faster and easier.
Let’s go in order. First the mt important thing:
Blockchain is a technology thanks to which work Bitcoin and all other cryptocurrencies. Roughly speaking, it is a financial book in which it is infinitely reliable to record who has how much money and who has given whom how much money before.
I know, it already sounds complicated. That is why we will immediately draw a picture book that even children can understand.
Imagine that there are these seven people in the whole world:
At the beginning of the existence of this world, let’s say that Antonio has 1000 $usd, and no one else has any. It may not be fair, but it is the easiest to understand.
We will now enter this information in the first block in the chain:
The next thing that happens is that Antonio wants to transfer 300 $usd to Lisa.
We will enter this information in the next block, and connect it to the previous block:
After that, let’s say that Lisa sends 200 $usd to Anna, and Anna then sends 150 $usd to Mark.
We write both of these transactions in the new two blocks, and each is related to the previous one:
Now we are slowly seeing that a chain of all transactions has emerged. Each of these transactions is one block.
So, all these transactions together make a blockchain.
Now you see that the blockchain is simply a list in chain of all transactions that have ever taken place within a single currency.
Each cryptocurrency has its own blockchain. Bitcoin, for example, has its own. That is actually one big file in which all this is written. At the time of writing, the Bitcoin blockchain has 410 GB, and it records all transactions between people ever.
If you have a “friend from work who bought some bitcoins”, the moment when he bought them is forever recorded in this file – called blockchain.
Simple, isn’t it? Then what is so revolutionary about it?
What is revolutionary is that
No one can ever delete or modify any of these transactions again
This is the main reason why the blockchain has become a hot topic – because all personal data about assets can be recorded in it. In the future, in such a chain, it will be written who is the owner of which house, apartment, car, insurance, and so on.
But how? How is this “chain” infinitely safe?
Why can’t some hacker enter this blockchain database now and just pretend that Chris has 10k $usd?
Two things are the reason.
First, the secret is in these “links” that connect the two transactions in the picture. Their purpose is exactly to prevent data from ever changing again once entered. It has to do with that “mining”, I’ll talk about that little later.
Second reason why transactions cannot be changed lies in the answer to the question:
“Where is this blockchain file actually stored? On which computer, on which disk, who owns it?”. Exactly this is the basic principle of blockchain technology:
In the pictures above, this list of transactions is in the center. That is what we are used to in the banking system. The bank keeps all the data on our money, right?
So, there is, say, Deutsche Bank, and in one of their central registers it says who has how much money in the account and what the transactions were. It was written on a disk in a computer at Deutsche Bank. And that disk was certainly backed up in several places, in several bank buildings, just in case.
Now, imagine when the CEO of Deutsche Bank would appear on television and say:
“We have a great idea. From tomorrow, Deutsche Bank will no longer keep data on your money, but we will give it to various ordinary citizens, volunteers, to keep this data on their computer at home. The money information in your account will be kept exclusively by these various strangers! “
It seems like the worst idea ever. Doom in the announcement.
Well, blockchain works just like that. And people all over the planet have invested millions of their money in Bitcoin that works that way. Here’s why:
So, this central register does not exist. Instead, some of the people in this world have voluntarily decided to participate, and the complete blockchain file is on their computer. They are called nodes.
Each of them keeps a fresh copy of the file of this transaction log on its disk. Every time a new transaction occurs, it is instantly updated with each of these users, nodes. There is no “central authority”.
How do we ensure that all copies of the registry are identical at all times? And how do these transactions happen in the first place?
Miners – miners
Each of us probably has “that friend who bought computers to mine bitcoins.” Now you will finally understand what this is all about. Miners (
gold bitcoin diggers) serve to confirm and validate transactions.
The term miner is used because the process of getting a bitcoin is sharing the same principle as trying to find golden nugget in a gold mine because not every rock that you dig is gold. Soon it will be more clear what I mean.
Each node can apply to be a “miner” (but it does not have to). In this world of ours, let’s say that it is Chris and Julia:
How the transaction is done
Antonio wants to send James 100 $usd, and initiates a transaction.
Antionio’s computer sends a message to all the miners in the network:
“Antonio wants to transfer 100 $usd to James.”
At that time, it is an invalid transaction, and it is not yet registered.
The computers of all the miners in the world have now received information about the intention to carry out this transaction. They first check if Antonio has enough funds by going through a whole blockchain (database), see all the transactions Antonio has ever had, and calculate if he has that much money available.
As you can see, in this world there is no my “account balance”, but it is always recalculated, based on all the transactions I have ever had. This is great because it makes the blockchain extra secure. In order for someone to forcibly change my “available balance”, he/she would have to change all transactions from the past, which is absolutely impossible, you will see later why.
So, the miners checked, Antonio has the funds at his disposal, and that is the first step, which does not require any special computer. What follows after this is the problem which requiers specific solution.
At that moment, the competition starts: which “miner” will be the first to find the specific solution to specific problem, and be able to embed this transaction in the blockchain and add it as the next block in the chain. What does that actually mean?
In order to write a new transaction, and add a new link in the chain, miner needs to find one number. It is a number that “fits” into the chain link. Let’s zoom in on the last two blocks in the chain: verified and new (which is not verified – yet).
The old and new transaction now together form one structure, the cryptographic code, and that code only needs one more piece to be valid. That piece is one number (it’s called “nonce”, if anyone is interested). Only when that number is found, a new transaction can be approved and “assembled” into a chain.
There is no way to calculate this number. The only way to find this number is for the computer to guess, generate random numbers and test whether they “match”.
You need to try a lot of numbers before finding the right one. When I say a lot, how does 700,000,000,000,000 attempts sound to you? So the only way to find this number is to have many thousands of computers around the world working on it at the same time – until someone guesses.
On average, it takes about 10 minutes. You are waiting that much for bitcoin transaction, just because of this. In case that it starts taking more or less than 10 minutes, algorithm is readjusting the complexity of solution every 2 weeks automatically.
The first miner in the world to guess this number immediately sends a message to all other nodes: “I found the right number, it goes like this”. At that moment, all other miners stop searching, because they can use that number to add a new transaction to their copy of the blockchain, and begin working on the next solution for the next block. This way, the register is always synchronized and same for everyone.
The first miner in the world who manages to validate a transaction is rewarded – in crypto money. He gets bitcoins. So this is something like a lottery. That’s why people buy expensive computers – they increase their chances of being the first in the world to validate a transaction, and make more money that way. The more computers you have, the greater the amount of guesses they provide, so greater the chance of guessing the correct number, and therefore greater the earnings.
Of course, these powerful computers consume a huge amount of electricity, so the miner has to pay a solid electricity bill. Currently, all bitcoin miners in the world consume electricity like Argentina.
Where did the miner get the money as a reward? Who pays for it?
Miner received money from two sources.
First, the sender pays. It’s not free to send bitcoins.
On the 150 $usd (worth of bitcoins) that Antonio sends to James, Antonio will pay another dollar or two (in bitcoins) as a reward for the miner who first hit the right number, and thus enabled the transaction to take place. So, it’s something like a commission for sending money in the bank, only there is no bank here, but your commission was given to the lucky miner.
The second part of the miner’s reward is a certain amount of bitcoin that is automatically generated from nothing, the moment the miner discovers the number. It’s a reward for helping with the transaction.
The bitcoin system itself has been designed from the first day so that new bitcoins are created exclusively in this way – by mining. All bitcoins in circulation actually came into existence like this.
The reason for this is simple – why would anyone mine in the beginning when there are no transactions, and thus no transaction fees?
The creator of Bitcoin, Satoshi Nakamoto set all the rules of the algorithm and started the system in January 2009. Then he made the first block in the chain. Everything after that was mined. In the beginning, only he mined, so today Satoshi has about 50 billion dollars in bitcoins. By the way, no one knows who Satoshi is, he never revealed his identity. But that is irrelevant – the system itself is designed so that Satoshi is not the “owner” of the blockchain and can not influence anything today.
Now you understand why it’s called “mining” – miners (computers) are actually digging (guessing the right number) and searching for (digital) “gold” once they find which is the right number.
New bitcoins are created by mining. Your friend who mines is a “small money printing house”
Considering that each of our neighbors can mine and thus make money for themselves from nothing, someone would say that this is a catastrophic recipe for inflation, but it is not. Bitcoin is actually a deflationary currency, and here’s why.
First, Satoshi designed the system so that this award for miners is always known in advance, and it is halved every 4 years. I’ll tell you later how much that reward is, because it’s going to only confuse you now.
Second, he limited the algorithm in the beginning so that the total number of bitcoins that could ever be created is 21 million. To date, already over 90% of this projected amount of bitcoin has been generated, about 19 million. The more bitcoins there are, the smaller the reward, so inflation is further prevented. When the miners mine all 21 million bitcoins, this reward will be zero, and the miners will earn only from transactions.
And the third, most important thing that prevents inflation, is the popularity of bitcoin itself. Its value is growing, because for 10 bitcoins 10 years ago you could not even buy Coca-Cola drink, and today you can buy luxury villa at the beach.
Why is the data in the blockchain immutable?
Let’s say that two years ago, Chris sent Mark 500 $usd. That information is in some ancient block in blockchain. And now someone wants to change that, to write that he sent him 100 $usd.
The thing is that the number that the miners found to conclude the transaction in the chain fits only if it reads as follows: “Chris -> Mark 500 $usd”. If anything in the content of the transaction changes, it can no longer be part of the (current) chain. Computers around the world, which keep their copy of the blockchain, would refuse something like this.
Millions of people around the world are “miners”, and they will forever benefit from what they do. In return, the entire bitcoin system gets infinite security, because this huge number of miners guarantees that the information will be protected forever. That is the power of decentralization.
So, it is impossible to change the information in the blockchain, ever.
The data in the blockchain is public
Blockchain is publicly available, on many websites. Here it is. Every person in the world can see the contents of the entire blockchain at any time, all the transactions that have ever happened.
This is terrible, everyone can see how much money I have and to whom I sent it??
Not really 🙂 For simplicity, so far we have said that the blockchain contains information such as:
Antonio sent Lisa 300 $usd
Lisa sent Anna 200 $usd
In reality, that goes something like this:
User 846297763487 is sending user 625879132071 300 $usd
User 625879132071 is sending user 913965464304 200 $usd
Now, this is the perfect time to reveal something shocking: There are no coins in the blockchain! Yup, no coins. Remember, blockchain is just a database, and what it contains are outputs like in previous example.
So in block would be written:
846297763487 —> 625879132071 0,01
625879132071 —> 913965464304 0,007
These numbers at the end we call bitcoins, but computer program sees them as unspent outputs, and after checking if there is enough, new output is waiting to enter into next block.
People are actually hidden behind colored numbers, which are called addresses. Public can only see that some number paid money to another number.
It’s the same as with email addresses. If my email address is email@example.com, you can not know absolutely nothing about me.
How are these addresses related to us?
When you are first time entering the system, you are receiving for free one long number called a private key, which is randomly picked and serves you like a password that only you know. In the beginning it was recommended to write it down on paper.
If anyone ever finds out your private key, they can steal all your money, by simply sending it to themselves. If you lose that private key, you can’t access your money, and no one can help you.
With blockchain, mistakes are unreversible, there is no support to help you.
Then from this private key is derived a public key. This is like your bank account number which we used for identification in examples above.
I can already hear you saying: “Ok this is great, but if sender knows that public key belongs to me, they can see all my transactions, which is impacting my privacy!”
Well… no. When you want to send or receive money, your computer generates another number called an address, based on your public key. Likewise, the recipient’s computer generates a different address based on his private key.
Each time you are using your “bitcoin account,” new address is generated over and over again. It is like having unlimited emails connected to your real email.
Your address and the recipient’s address are then sent to the miners for verification, plus of course the amount sent. We have just explained the whole process in detail above. When the process is complete, these addresses are written to the blockchain.
The public sees the addresses, but no one can use your address to find out your public or private key, and of course, there is no chance of them finding out who you are.
Little disclaimer here: There is always some possibility for this, for example the odds of guessing a bank PIN is 1/10,000; and odds of guessing a bitcoin private key is 1/10,000,000,000,000,000,000,000,000,000,000,000,000
So, in order to send money, you need to know the address of the recipient and your address. This is then published and sent for “mining”.
Some people sometimes put their bitcoin address publicly, say on their website to receive donations. In that case, logically, everyone knows your identity, and can see how much money you got from donations. It’s written in the blockchain.
What is a “digital wallet”?
The option of holding the private key on a piece of paper or USB does not seem very reliable.
There are specialized sites, or better applications that are made for this. The most famous in the world is CoinBase.
When you open an account on CoinBase, they create this private key for you, which even you can’t see, for security reasons. You get an address, which you can then use to send and receive bitcoin, also from the CoinBase.
So, the CoinBase application takes your address and the recipient’s address, the amount you are sending, and sends it to miners around the world for processing, as I explained above. That’s how money is transferred in practice.
In addition to such online solutions, there are also hardware wallets. It is literally a device that is inserted into a computer via USB. It contains your private key, on the basis of which addresses are generated that go to the public, for transactions.
Some may not believe that CoinBase is safe enough to “someone there to hold their key “, but they rather chose to keep it at home, on one such device where they need manually to approve each transaction.
The solution is to write down the seed phrases which unlocks the private key connected to that device, on a piece of paper, and then bury it in the garden behind the house, for example. It may sound ridiculous, but most bitcoin owners have paper backups of their private key.
How to buy the first bitcoins?
The first step is to open an account on the CoinBase website. This is your digital wallet.
When you open an account, it will give you an address where you can send and receive bitcoins to that CoinBase wallet. This is analogous to opening a bank account.
Now. There is also a possibility to buy bitcoins on CoinBase, by entering the card number and buying like everything else you would buy.
Maybe cards from your country are not supported, in which case you need to use website in your country to buy bitcoins. In that case you need to give them bitcoin address where you want them to send bitcoins you bought.
It is important that you understand that you still need a CoinBase account, to have a wallet to which that other website will send you bitcoins. So the exchange is one thing, and the wallet is another.
You can use Coinbase as wallet where you will just store your cryptocurrencies on. Logical, right? Well I wrote this wrongly on purpose. Coinbase can not store your Bitcoins, only blockchain can, remember? Your bitcoins are on the blockchain, and (Coinbase) wallet is just a tool by which you are accessing your Bitcoins.
If you know someone who already has Bitcoins and wants to sell them to you for $usd, then it is easiest for you to give him money AFTER he transfers Bitcoins to your account on CoinBase, in which case you do not have any commission. You meet at a coffee shop, give your address from CoinBase, and seller initiates the transaction. After about ten minutes, when you see that the transaction has been verified, you give him the money and that’s it.
Finally, there are a ATMs here and there for buying Bitcoin, you can find them on Google, but they have high commisions.
By the way, you will often hear the phrase “fiat currency” in the bitcoin/crypto world. Fiat is a common name for all currencies that are not cryptocurrencies, and whe value has not been guaranteed in gold for a long time, but only by trust in a banking system and the state: usd, euros, yuan and so on. That is all “fiat”.
What is simplified in this text?
I said at the beginning that I will present some things in a simplified way to make it easier to understand. Now that we’ve been through it all, I can add some more facts.
First, in the pictures above, the blockchain is shown like there is only one transaction in each block. In reality, there are about 2,000 transactions from all over the world in one block, which have accumulated in the last ten minutes (or longer if blocks are full and transactions are waiting in “memory pool”). So, the miners find one number that will enable all transactions in block to go through at once, not just one. Everything else is as I described. The next block of transactions is related to the previous one, it is immutable, etc. etc. Of course if you would want to know absolutely everything in detail about what I wrote here, you would need few years to learn about math, cryptography and computer science.
How Much Money Can You Make? Is it worth investing in these powerful computers?
To understand the answer to this question, it is important that you read the whole text carefully by now. If you skipped everything and came to this part because you are just interested in “is there any easy money”, go back and read, because it will not be very clear to you.
So, we said above what a miner is. Anyone can become a miner by buying a special computer with extremely powerful processors, which are optimized only for searching for that random number. Here are some of the computers, the table says how much power they have and how much they cost.
So, you buy some of these computers, say Antminer S19, plug it in at home, and you are entering the “lottery”. Now this computer of yours every ten minutes has a chance to be the one to find the number and solve the transaction for the current block.
It is the same as every ten minutes global lottery draw of some sort is happening in which you can win.
What is the reward if my computer, out of everyone in the world, finds a solution for the current block?
The current reward is 6.25 bitcoins. That’s $180,000 at today’s exchange rate.
So, if your computer “stabs” the solution, you earn $180,000 at that moment, in bitcoins ofc. That reward will be swiftly transferred to your bitcoin wallet. Every miner has that “address” described earlier, as do the people who do the transactions.
180,000 dollars I get if my computer “stabs” a solution ??? Well that’s great, I’m going to mine now!
Slow down. It’s not as easy as you think.
We haven’t mentioned one important thing yet: what are the chances that your computer will be a “lucky winner”?
So, let’s say you bought that Antminer S19 from the picture above, it costs $15,000. And you let him work non-stop, day and night.
On this site SoloChance.com, you can calculate what your chances are. Type 95 Terahash per second, that’s the power of this computer of yours:
The chance of me to hit a block is more than one in a million! It says it will take me 44 years, on average. During that time, I have to pay a huge electricity bill.
How then does this pay off for anyone to work????
The trick is that for a long time now, no one sane has been mining bitcoins on their own. It is crazy to expect that something will happen, as you can see. Not to mention how every year there is a stronger cheaper machine coming out.
Instead, with this computer of yours, you join a group of mining computers that work together – the so called mining pool.
How does a mining pool work?
I will explain this with a well-known example:
Let’s say that the LOTTO draw is next week, and the main prize is two million $usd.
The chance that our ticket will win is small. But, let’s say that 1000 of us unite and agree: Each of us will pay one different ticket. If any of us gets the two million $, he will divide the reward into 1000 parts, for all of us equally. Everyone will receive $2,000.
That means that I now have a 1000 times higher chance of winning. Apparently, it is no longer two million $, but $2000, but at least now I for sure have some real chances. If this LOTTO draw was every ten minutes, then all this makes a lot of sense.
Mining pools work the same way.
You join a group, a pool with, say, 1000 computers. If the pool of which you are a member solves the current block, the 6.25 bitcoin prize goes to the entire pool, and then that prize is distributed to the users, according to their contribution.
Some have a stronger computer, some a weaker one, and some have more computers. It is like digging for gold, someone dig with a shovel, someone with excavator. If someone with excavator digs 1000x more than someone with shovel, the guy with excavator will get 1000x higher reward of everything they find together.
Even if you with shovel-level computer find a solution for next bitcoin block and you win 6,25 bitcoins, you are sharing that with everyone else in a mining pool and ending up with 0,0001 bitcoins. On the other hand, even if you never find anything, you are still paid according to your contribution.
In any case, within one pool, it is calculated exactly who contributed how much, ie. who had how many attempts.
There are bigger and smaller minig pools that you can join. Logically, bigger pools have more chances to win, but the profit is also divided into more parts. Here is a list of the biggest pools.
Here you can see a list of all bitcoin blocks that have been resolved starting from this moment and backwards, every ten minutes. As you can see, each block is solved by a pool.
Here, that’s the whole story of mining.
Blockchain will change the whole world
After the success of bitcoin, people began to think about what else blockchain technology could be used for. They quickly realized that this is much bigger than money.
Any property, ownership of an apartment, house, land, car, information on the origin of real estate, cars, medical data… All this is ideal for blockchain and some countries are already working on integrating it.
I wrote an article about killer app for blockchain which I recommend you to read.
Any areas where there is a high risk of fraud, embezzlement, bribery and corruption. Here are quality of blockchains such as cryptography and immutability helping a lot.
Corruption, as we know, often serves to cover up some information – to change it, to forget it, to put it under the rug, to erase it forever. If society switches to the blockchain, it is believed that it will drastically reduce corruption in the countries where it is expressed today. Any origin of money, apartment, car, will become information that cannot be covered up, ever. No matter how much money and power someone has, they can’t change the mathematically unchangeable entries in the blockchain, ever.
This is, under 1 condition – if it is decentralized enough. High level of decentralization is important because then blockchain is censorship resistant which makes it hard and expensive for someone to decide what will come in the new block. If 1000 computers are mining a blockchain, you need to get 1001 computer to “outmine” them (mine faster than everyone else together).
Blockchain car data? We will no longer look at the ads for used cars that say “Audi A4, like new, crossed only 150,000”. One look at the publicly available blockchain will show that the car covered half a million miles, and that two years ago it had an accident in the Italian Alps in which the entire front was destroyed.
Furthermore, the use of blockchain in all areas in which there are any intermediaries today, because they will become unnecessary due to trustless nature of blockchain. Not all of them will lose their jobs, but the way they work will change a lot.
This is a separate area, and another such long text could be written about it, or the whole book, but I will try to summarize here as briefly as possible:
After the success of bitcoin, people created various other cryptocurrencies that work on the same or similar principle. The essence is that it is based on blockchain, and the rules of the system differ. The largest number of users after Bitcoin is Ethereum, followed by Ripple and so on. You can see the full list on the CoinMarketCap website.
There are thousands of these currencies, and they are collectively called alternative cryptocurrencies – altcoins. Click on the previous link to find out why vast of majority of cryptocurrencies today are not altcoins, but that is the inherited name from the past.
Once you bought bitcoins, you can use them to exchange them to altcoin, on online exchanges such as Binance. In recent years CoinBase is also proactively listing better altcoins on their exchange. You can also convert altcoins back to bitcoin, or even to cryptocurrency which value is always $1, so-called stablecoin.
People who deal with these things primarily read the news, and see which new alternative cryptocurrencies have the potential to grow soon. You can go to Google, find out who the founders of the currency are, what the story is, what their site and marketing are like, whether they have a chance to grow 10 times or more in the near future.
In the beginning, when the currency is being generated and sold to first buyers, this event is called Initial Coin Offering (ICO) which is attractive opportunity to buy because there is no one who bought them cheaper before, except maybe few Venture Capital fonds.
The strategy most commonly used is to buy a few of these altcoins that we estimate have big potential on which I wrote separate article. If we discover and buy one of hidden gems for 1000 $usd, in a year that can be worth 100,000 $usd because everyone discovered it way after us. The whole point is to make a good assessment based on same things that Venture Capitals were doing when they invested in Google and Netflix before everyone else know they exist, only now this opportunity is available to everyone.
Another type of people trades cryptocurrencies on the so-called “pump and dump” principle where you are just chasing the hype before it ends:
These people are waiting a story about a currency to take traction – narrative to develop, and when it starts to pump, they buy. Then they sell just before it starts to fall. This is, of course, very risky because you are relying that greater (later) fool will arrive and buy it from you with same expectations.
Of course, there are people who simply buy only bitcoin and do not touch it, waiting for its
value price to increase indefinitely because they think that is the greatest thing ever which everyone will want in the future.
At the end of the day, the value of these currencies largely depends on their marketing and PR. How much hype developed around that currency.
Congrats, now you are not crypto noob!
As the matter of fact, I would say that you understand crypto space better than half people who are into crypto.
This topic is huge, as you can see. There are still a lot of things to be said here, but I think all the basics are covered. Now you can read or watch anything on the subject of blockchain and cryptocurrency – you have a good foundation.
I hope it will be useful to you – to finally understand together how this miracle works.
Happy journey further into the crypto rabbit hole!