What's a Blockchain?

[Technically tries crypto] it's really just online accounting

Feb 06, 2023

This is a guest post from Shekar Ramaswamy, author of the Coinsights newsletter. If you’re interested in simple breakdowns of Web3 topics, check it out.

TL;DR

A blockchain is a digital ledger. Blockchains as a concept have been around for a while, but they’ve recently become popular because of the cryptocurrency boom (Bitcoin anyone?).

A blockchain is just another way to store data. As with any other technology, there are trade-offs when using it
Blockchains record transactions, which are asset transfers between parties
The blockchains we hear about are decentralized, which means no single entity controls them
Decentralized blockchains are the technology underlying popular cryptocurrencies like Bitcoin and Ether

In this post we’ll run through how blockchains are created, why blockchains are useful, and which problems they’re best suited to solve. Let’s dive in!

The building blocks: we need to store data somewhere

Like SQL databases, blockchains are a way to store data. SQL databases store data in rows and are great for storing “facts” like how many likes an Instagram post has or the contents of this article.

Unlike SQL, blockchains take a state-machine based approach to storing this data. A state machine models reality in a different way than the spreadsheet-like relational databases that you’re used to.

A state-machine describes ways of moving between states via actions. For a simple example, think about a button. The button has two states: pressed (on), or not pressed (off). When you take the action of pressing the button, the state changes from off to on (and vice versa).

On the blockchain, an action like “button pressed” is called a transaction. And in the context of cryptocurrencies like Bitcoin, the most common type of transaction is moving value from one entity to another. In state 1 (the beginning), Alice has $7 and Bob has $1. Then a transaction happens, where Alice gives Bob $2. Now, in the subsequent state 2, Alice has $5 and Bob has $3.

These transactions are grouped into blocks. Blocks are then chained together, forming a blockchain! And voila, you understand the blockchain.

Blocks depend on the previous state, which is determined by the previous block, and so on. In essence, the blockchain is a sequential list of changes (blocks) made to the initial state.

On a blockchain, the current state is never explicitly represented because only transactions are stored. In other words, there’s no record saying “Bob currently at this moment has $x.” This is different from how SQL databases store data, where the only thing stored is the current state (and perhaps some history). As with all things technology, there are tradeoffs to this approach:

Since blockchains don’t store the state, it takes time to calculate it by running through previous transactions, whereas SQL databases always have access to the current state.

On the other hand, blockchains automatically store history via transactions while SQL databases don’t keep a record of the history at all. Storing history is powerful because it enables blockchains to be transparent: it’s easy to see how we got to the current state on a blockchain. This key property enables a lot of cool use cases, which we’ll cover in the next section.

Why are blockchains useful?

Now that we’ve covered the basics of how blockchains work, we can talk about a key characteristic of the major blockchains today: they’re decentralized. Decentralized means that no single entity controls the blockchain.

To better understand this, consider a centralized system. In this case, a single entity has complete control over the state of the system. An example of this is how our government has final say over economic decisions like how much money is put into circulation. Or how your balance in the Bank of America app is basically entirely controlled by them.

Finally, some people decided that enough was enough and that it shouldn’t be up to a couple of suits to decide how the entire country uses money. In 2009, they decided to create an entirely digital currency (a cryptocurrency) called Bitcoin using a decentralized blockchain.

Fun Fact

The creator of Bitcoin is only known under the pseudonym Satoshi Nakamoto. Nobody has ever figured out who they really are, but they hold $20B worth of Bitcoin!

Satoshi’s decision to use a decentralized blockchain to create Bitcoin was smart because no single entity could control it. This means that nobody can arbitrarily decide to create or destroy Bitcoin. In fact, one of the major appeals of Bitcoin is that it’s inflation resistant (also known as sound money), unlike the US Dollar or Venezuelan Bolívares.

Fast forward to today, and decentralized blockchains are rising in popularity because they enable transparency. It’s impossible for one group to try to change the blockchain without everybody else knowing (this is why storing transactions instead of state is important)!

As a result of this transparency, the use cases of blockchains are growing beyond cryptocurrencies. This is critical to understand: the promise of blockchains as a technology is much more fundamental than just something like Bitcoin. Yes, there are a lot of scams out there – but it’s important to focus on the technology and what makes it special.

Differentiating between blockchains

You’ve probably heard of Bitcoin and Ethereum, but you may not know that there are actually hundreds of blockchains. With so many (and new ones popping up weekly!), it can be difficult to compare them.

There are two major ways to compare blockchains:

On their technical implementation. This includes specifications like how many transactions are processed per minute or how many transactions go in a block.
On the financial performance of the cryptocurrency they power. For instance, most people know about the Bitcoin and Ethereum blockchains because Bitcoin and Ether, their corresponding cryptocurrencies, are considered blue chip assets.

🚨 Confusion alert 🚨
The blockchain that powers Bitcoin (the currency) is also called Bitcoin. People often don't realize that cryptocurrencies and blockchains are two distinct concepts. Other blockchains make a clearer distinction: Ethereum (blockchain) powers Ether (cryptocurrency) and Polygon (blockchain) powers Matic (cryptocurrency).

People tend to use financial performance to analyze different blockchains. Who doesn’t like talking about money 🤑? Let’s break down Bitcoin’s stats:

Price: how much 1 Bitcoin costs
1h% and 24h%: how much the price of Bitcoin has changed over those time periods
Circulating Supply: number of Bitcoins in existence
Market Cap: the total value of the Bitcoin ecosystem. Calculated by multiplying with Price and Circulating Supply
Volume(24h): the value of Bitcoin that has changed hands in the past 24 hours.

Of these stats, a high Market Cap and high Volume are indicators of a popular blockchain. Now you’re armed with a simple yet powerful method for judging blockchains!

Technically Pop Quiz

There is a ton of debate around which problems blockchains best solve. See if you can figure out if a blockchain would be useful for the below use cases (answers at the end).

Housing records for a local county
A chat app like Facebook Messenger
Voting systems

So What’d We Learn?

In summary, blockchains store data using transactions instead of state. Decentralized blockchains are on the rise as a rejection of the traditional financial system, but have expanded in scope to other areas of the economy.

With so many blockchains in existence, it can be difficult to differentiate blockchains just based on their futuristic-sounding names. It’s important to take a look at the cold, hard stats and see for yourself which blockchains are the most valuable.

Pop Quiz Answers:

✅. Housing records are a public good that are transaction based when going from one homeowner to another.
❌ Chat apps don’t need to be decentralized because messages are exchanged between only a few parties.
✅ Voting systems have been accused of fraud. Using a blockchain would allow anybody to verify the number of votes that were cast and who they were for.

If you liked this, check out Shekar’s Coinsights newsletter for more simple breakdowns of Web3 topics.

This post was an experiment. Should Technically cover more crypto and Web3 topics? Or stick to software engineering?

As always, if you have more thoughts, reply to this email directly or shout out to justin@technically.dev if you’re reading this on the web.