Module 2: Blockchain Basics

Understand the technology that powers cryptocurrencies and its applications.

Module Overview

This module dives into blockchain, the technology behind cryptocurrencies. It breaks down what blockchains are, how they function, and surveys a few major blockchain networks. You'll discover why blockchain is considered revolutionary and how different blockchains (Bitcoin, Ethereum, Solana, Avalanche, etc.) compare.

3 Lessons
Lesson 2.1

What is a blockchain?

A blockchain is a distributed digital ledger of transactions that is shared across a network of computers. The name "blockchain" comes from its structure: data is stored in "blocks" that are linked together in a chronological "chain," with each block containing a batch of transactions.

What makes blockchain special is that once information is added to the chain, it becomes extremely difficult to change or remove. This is because each block contains a unique code (called a hash) that is generated based on the contents of the block. This hash is also included in the next block, creating a chain where altering any block would require changing all subsequent blocks – a nearly impossible task given the distributed nature of the network.

Another key feature of blockchain is transparency and verification. Everyone participating in the network can have a copy of the entire blockchain, allowing them to verify the ledger's accuracy independently. This creates a system where trust is built into the technology itself, rather than relying on a central authority like a bank or government.

This decentralized design is what makes blockchain revolutionary. Traditional record-keeping systems typically have a central authority that maintains the records and that everyone must trust. With blockchain, no single entity controls the ledger – it's maintained collectively by the network, making it resistant to censorship and single points of failure.

How a Blockchain Works: Simple Steps

  1. 1

    Transaction Request: Someone initiates a transaction (e.g., sending cryptocurrency to another person).

  2. 2

    Broadcast to Network: The transaction is broadcast to a peer-to-peer network of computers (nodes).

  3. 3

    Validation: Network nodes verify the transaction using known algorithms.

  4. 4

    Block Creation: Verified transactions are combined with others to create a new block of data.

  5. 5

    Adding to Chain: The new block is added to the existing blockchain in a way that is permanent and unalterable.

  6. 6

    Transaction Complete: The transaction is now complete and recorded on the blockchain.

Simple Analogy

Imagine a group of friends keeping a shared notebook of debts. When someone borrows money, it's recorded on a new page. Once a page (block) is filled with entries, everyone reviews it to make sure it's accurate. After everyone agrees, the page is "locked" with a special seal that includes information from the previous page, and it's added to the notebook (chain). If someone tried to go back and change an entry on an earlier page, the seal would break, and everyone would know the notebook had been tampered with. This system ensures everyone has the same record of who owes what, without needing a bank to keep track.

Additional Resource

For a more detailed explanation, check out: "Blockchain for Dummies: A Beginner's Guide"

Lesson 2.2

How do different blockchains work?

It's important to understand that there isn't just one blockchain for all cryptocurrencies. Instead, there are many independent blockchain networks, each with its own rules, features, and cryptocurrencies. Bitcoin has its own blockchain, Ethereum has another, and so on.

One of the key differences between blockchains is how they achieve consensus – the process by which all participants in the network agree on which transactions are valid and should be added to the blockchain. This is crucial because, without a central authority, the network needs a reliable way to prevent fraud and ensure everyone has the same version of the ledger.

Major Consensus Mechanisms

Proof of Work (PoW): Used by Bitcoin and originally by Ethereum, this mechanism requires "miners" to solve complex mathematical puzzles to validate transactions and create new blocks. The first miner to solve the puzzle gets to add the next block and receives a reward in the form of newly created cryptocurrency. This process requires significant computational power and energy, making it secure but resource-intensive.

Proof of Stake (PoS): Used by Ethereum (after its 2022 upgrade), Cardano, and many newer blockchains, this mechanism selects validators based on how many coins they "stake" or lock up as collateral. Validators are chosen to create new blocks based partly on how much cryptocurrency they've staked, with higher stakes giving a higher chance of selection. This approach uses far less energy than PoW but introduces different security considerations.

Other Mechanisms: Many blockchains use variations or entirely different approaches, such as Delegated Proof of Stake (DPoS), where token holders vote for a small number of validators, or Proof of Authority (PoA), where blocks are validated by approved accounts. Solana uses a novel approach called Proof of History combined with PoS to achieve high transaction speeds.

These different consensus mechanisms represent trade-offs between security, decentralization, and scalability (transaction speed and cost). No single approach is perfect for all use cases, which is why we see a diverse ecosystem of blockchains optimized for different purposes.

Proof of Work (PoW)

Used by: Bitcoin, Dogecoin, Litecoin

Process: Miners compete to solve complex puzzles

Pros: Highly secure, battle-tested

Cons: Energy-intensive, slower transactions

Analogy: Like a math competition where the first to solve a difficult problem gets to add the next page to the ledger

Proof of Stake (PoS)

Used by: Ethereum (post-2022), Cardano, Avalanche

Process: Validators are selected based on coins they've staked

Pros: Energy-efficient, faster transactions

Cons: Potentially less decentralized

Analogy: Like a system where those who deposit more money in a vault get more chances to be the record-keeper

Real-World Analogy

Think of different consensus mechanisms like different secure voting systems. Proof of Work is like requiring voters to solve a difficult puzzle before casting a vote – it takes effort, which discourages cheating, but it's also time-consuming and resource-intensive. Proof of Stake is more like requiring voters to put up a security deposit that they'll lose if they're caught cheating – it's more efficient but puts more power in the hands of those with more resources. Both systems aim to ensure fair agreement on what goes into the ledger, but they take different approaches with different trade-offs.

Additional Resource

For more information on consensus mechanisms, visit: Wikipedia's explanation of consensus mechanisms

Lesson 2.3

Major blockchain platforms

While all blockchains share some common features, different platforms have been developed to serve various purposes and address different challenges. Let's explore some of the most significant blockchain platforms and what makes each unique.

Bitcoin

As the original blockchain, Bitcoin was designed specifically for a single purpose: to enable peer-to-peer electronic cash transactions without a central authority. Its blockchain is optimized for security and decentralization rather than speed or versatility.

  • Launched: 2009
  • Consensus: Proof of Work
  • Key Feature: The first and most secure blockchain, focused on being digital gold
  • Limitations: Relatively slow (about 7 transactions per second) and limited programmability

Ethereum

Ethereum revolutionized blockchain by introducing smart contracts – self-executing programs that run on the blockchain. This innovation transformed blockchain from a simple ledger into a platform for decentralized applications (dApps), tokens, and more complex financial instruments.

  • Launched: 2015
  • Consensus: Originally Proof of Work, transitioned to Proof of Stake in 2022
  • Key Feature: Smart contracts enabling programmable applications and tokens
  • Limitations: Higher fees during network congestion, still working on scalability

Solana

Solana was designed with speed and efficiency in mind. It uses a novel consensus mechanism that combines Proof of Stake with Proof of History, allowing it to process transactions much faster than older blockchains.

  • Launched: 2020
  • Consensus: Proof of History + Proof of Stake
  • Key Feature: High speed (thousands of transactions per second) and low fees
  • Limitations: Less decentralized, has experienced network outages

Avalanche

Avalanche aims to solve the blockchain trilemma (balancing security, decentralization, and scalability) through a unique architecture of multiple interconnected blockchains called subnets.

  • Launched: 2020
  • Consensus: Avalanche consensus protocol (a form of Proof of Stake)
  • Key Feature: High throughput and customizable subnets for different applications
  • Limitations: Relatively newer, ecosystem still developing

These are just a few examples of major blockchain platforms. Others include Cardano (focused on academic research and sustainability), Polkadot (designed for interoperability between blockchains), and Binance Smart Chain (optimized for trading and financial applications).

Each blockchain makes different trade-offs in the balance between security, decentralization, and scalability – often called the "blockchain trilemma" because it's challenging to optimize for all three simultaneously. The right blockchain for a particular use case depends on which of these factors is most important for that application.

BlockchainConsensusSpeedKey StrengthBest For
BitcoinProof of Work7 TPSSecurityStore of value, simple transfers
EthereumProof of Stake15-30 TPSProgrammabilitySmart contracts, dApps, NFTs
SolanaPoH + PoS65,000 TPSSpeedHigh-frequency trading, gaming
AvalancheAvalanche Consensus4,500 TPSCustomizabilityEnterprise solutions, subnets
Real-World Analogy

Comparing different blockchains is like comparing operating systems such as Windows, macOS, and Linux. They all serve the same fundamental purpose (running software on a computer), but they have different designs, strengths, and communities. Windows might be more widely used and have more software available (like Bitcoin has the most recognition), macOS might offer a smoother experience for certain tasks (like Ethereum for smart contracts), and Linux might offer more customization for technical users (like newer blockchains that allow for more specialized applications). The best choice depends on what you're trying to accomplish.

Additional Resource

For more information on why businesses choose different blockchains, visit: Deloitte's Global Blockchain Survey

Module Summary

In this module, you've learned the fundamental concepts of blockchain technology:

  • What a blockchain is: a distributed digital ledger where data is stored in blocks linked in a chronological chain, secured by cryptography
  • How different blockchains reach consensus: through mechanisms like Proof of Work (mining) and Proof of Stake (staking)
  • Major blockchain platforms and their key characteristics: Bitcoin (secure, original), Ethereum (programmable), Solana (fast), and Avalanche (scalable)

Understanding blockchain technology is crucial because it underpins the trustworthiness and functionality of cryptocurrencies. Different blockchains make different trade-offs in security, speed, and decentralization, making them suitable for different applications.