Want to get your head around blockchain? Here is an ELI5 for dummies: What is Blockchain. Note this is as ELI5 so you can read this as an ELI5 Cryptocurrency also, although keep in mind that cryptocurrencies vary on how each one works.
So here it goes. Imagine a filing cabinet:
- It has multiple drawers, which you can continue to add over time
- You can have an infinite number of drawers in the filing cabinet
- Inside the drawer are folders that are carefully organised
- The cabinet is maintained while drawers are added to the filing cabinet by various individuals
In this example, the filing cabinet is the blockchain– ever growing, and contains all historical data. Each drawer represents a block and the folders inside each drawer represent the transactions and relevant data.
The individuals in this example are made up of miners, developers, and users (nodes).
The miners work hard to review the information coming into the blockchain.
The users verify the information and make sure that only the right information is added to the blockchain.
The developers make sure the filing cabinet continues to work safely and securely over time, i.e. continue to maintain, secure, or enhance the blockchain.
Before you read on – I want to make it clear that the blockchain is the underlying technologies that cryptocurrencies such as Bitcoin and Litecoin are based on.
Let’s say for example Humpty wants to pay a friend, Dumpty, some Bitcoin. Humpty writes on a piece of paper that ‘Humpty wishes to transfer ownership of 1BTC to a friend named Dumpty’. Humpty also has the option to pay the horseman that will process this transaction, a transaction fee. So all up it may cost Humpty 1 BTC + small Transaction fee (BTC) to make this transaction.
Humpty then creates several copies of this piece of paper. Each one is folded in the exact same way, very carefully, using a certain technique, such that only the miners can unfold and see what is written on this paper.
Every copy is sent to every miner.
Now, each miner will attempt to open the piece of paper and organise it into a drawer. In the process of doing the above, they have ‘mined’ a block and are rewarded for their efforts in Bitcoin.
The first miner to do the above, will earn the transaction fee (.005BTC is allocated to the miner) as well as a reward (set number which changes over time). In this example, imagine that the miner, writes on another piece of paper, that he is now the owner of .005BTC (from transaction fee), as well as some brand new BTC (from reward).
The drawer is then reviewed by all the nodes, all the folders are verified, and the data accuracy is insured. That is, the block is published on the network for the nodes to verify that it meets the rules of the blockchain. They make sure that block is mined successfully, is legitimate, and that the relevant parties involved in the transaction are indeed who they say they are.
The drawer is then added to the filing cabinet, therefore the filing cabinet is now one drawer bigger. The same principle applies to blockchain. When the new block gets added to it the blockchain gets bigger, block-by-block.
When the drawer is verified by the nodes, it is also assessed against the drawers before it that are already in the filing cabinet. That is, the drawer needs to fit certain size and shape criteria. So every drawer being added is linked to the drawer before it. Likewise, every block that is attached to the chain also gets verified.
In conclusion, you have a longer filing cabinet with a new drawer. The drawer contains a new folder with data. If you open the folder and review the contents, it will state that you ‘Humpty is no longer the owner of 1 Bitcoin’, that ‘Dumpty is the owner of the coin’, and that the miner is the owner of the rewarded Bitcoins.
As a side note, the drawer size and shape can determine the limit of transactions or features of the filing cabinet. Similarly the blockchain only allows for certain block sizes (limits the number of transactions per block), as well as allowing for other features to be built on to it (e.g. smart contracts). This is what the developers continue to work on, enhancing the blockchain over time, so its use case becomes more apparent and popular.
Clear as mud? Hopefully that gives you a good context to what is Blockchain. Now read the Beginners Guide to Blockchain to wrap your head around it even more.
If you’re keen on getting started with trading Bitcoin or trading Cryptocurrency, then I suggest you read the Bitcoin Trading 101 guide.