Blockchain Fundamentals

Learn the blockchain basics.

> **Before investing in new technologies, it is important to master the fundamentals.** This section will breakdown the basic terms, the history and features unique to blockchains today.

What is a Blockchain?

First, what is a block? One block contains a timestamp, transaction details and sender/receiver data. Every ‘new’ block is linked to a previous block, creating a chain in the process (Bitcoin’s genesis block was mined on January 3, 2009).

Blockchains are a global ledger of information where everybody agrees on the same ideas. Global blockchains will become the world's system of record. Information is now going from centralized to decentralized, now creating the internet of value. The beauty of digital assets is that anybody can buy them from anywhere.

Blocks are verified at each step. Every new block generated must be verified by each node before being confirmed, making it almost impossible to forge transaction histories. What you need to know is that the chain is a list of records (blocks) that are linked and secured using cryptography. The contents of the online ledger must be agreed upon by the entire network of an individual node, or computer maintaining a copy of the ledger.

So why is this important? Can’t anybody create a chain of transactions? Yes but that’s only one aspect of the blockchain. Remember we live in a digital age with high speed internet and powerful computers. So computer servers can now speak with each other in real time. All the time. This is important because we need consensus.

Why does this matter? Blockchains are creating the internet of value. An opportunity for people to own information. This introductory course will give you everything you need to start investing in blockchains.

Basic Blockchain Terms

Let's begin. Starting with the basics. Understanding these terms will better prepare you for the rest of the course.

  • Ledger: A collection of accounts in which account transactions are recorded. Think of accounting  entries, a series of debits and credits.
  • Block: a unique record of transaction.
  • Crypto: This cool buzzword is short for cryptography. But in the blockchain world it stands for cryptocurrency and viewed as a medium of exchange.
  • Centralization: Where control remains with one authority. An important theme as decentralization is at the core of pure blockchains.
  • Immutable: The inability to change historical data. This is valuable when thousands of computers are agreeing to a single transactions.

Taking baby steps. Some of these words may seem foreign but that's ok. Together we will breakout the use cases and why it matters.

The History of Blockchains

The Genesis Block

The First Block. Our story begins in the middle of the Great Recession.

First, welcome to the new internet. Yes, the new internet. Blockchains are fundamentals for communication architecture. Why does this matter? How does it work? We’ll get into that soon. Right now we need to break down the distributed ledger.

So like every blockchain, this is the ‘genesis’ block or first chapter of learning blockchains.

You see, every blockchain is a ledger of information. Every ‘block’ or transaction lives on the ledger. In chapter 2, we’ll get into the details of how this works. But right now you need to know that transactions are related.

The Genesis Block represents a functioning blockchain. To programmers, it is a message going from Point A to Point B. But in the Blockchain World, it is the beginning of a technological revolution.

Earlier attempts to Internet Money

Before diving in, let's discuss the first versions of internet money. You see, Bitcoin was not the first of its kind. In fact, programmers have been working on different forms of internet money since the 90s.

Now why was Bitcoin successful where others failed? Well for starters, there were some technological challenges before 2008. We will cover the What is the Byzantine fault tolerance? Describe the generals attack story: The problem is that several Byzantine generals and their respective portions of the Byzantine army and have surrounded a city. They must decide in unison whether or not to attack. If some generals attack without the others, their siege will end in tragedy. The generals are usually separated by distance and have to pass messages to communicate. The practical Byzantine fault tolerance algorithm (PBFT) solves for high throughput, scalable, low cost, and is semi-trusted. and other consensus challenges later on.

Pseudonymity also plays an important role here too. Bitcoin's founder, Satoshi Nakamoto, remains unknown but plays a key role in building the cryptoeconomy.

It's important to understand where Internet Money failed in the past. Bitcoin is not the first nor the last of its kind. There will be improvements over time. Better blockchains. This course will help you identify new opportunities in the industry.

What makes Blockchains unique?

The unique characteristic of a blockchain

Blockchains face three technological challenges: decentralization, scalability, and securability. This is known as the Blockchain Trilemma. No cryptocurrency has been able to solve for all three. Next we will discuss each characteristic and why they matter.

What are the advantages of the blockchain? Decentralization and transparency. By eliminating third-parties we reduce the possibility of a single point of failure, such as a large bank or centralized intermediaries.

Cryptocurrencies promise to make it easier to transfer funds directly between two parties, without the need for a trusted third party

Decentralized transfers are secured by the use of public keys and private keys and different forms of incentive systems, such as proof of work or proof of stake.

Because they do not use third-party intermediaries, cryptocurrency transfers between two transacting parties are faster as compared to standard money transfers. Flash loans in decentralized finance are a good example of such decentralized transfers. These loans, which are processed without backing collateral, can be executed within seconds and are used in trading.12

Cryptocurrency investments can generate profits. Cryptocurrency markets have skyrocketed in value over the past decade, at one point reaching almost $2 trillion. As of Dec. 20, 2021, Bitcoin was valued at more than $862 billion in crypto markets.13

The remittance economy is testing one of cryptocurrency's most prominent use cases. Currently, cryptocurrencies such as Bitcoin serve as intermediate currencies to streamline money transfers across borders. Thus, a fiat currency is converted to Bitcoin (or another cryptocurrency), transferred across borders and, subsequently, converted to the destination fiat currency. This method streamlines the money transfer process and makes it cheaper.

What are the disadvantages of the blockchain? Blockchains can be complex, computationally intensive, and expensive to implement. They are also unregulated. With immutability only the majority can reverse or change transactions. Scalability limits to the number of transactions the network can process.

Though they claim to be an anonymous form of transaction, cryptocurrencies are actually pseudonymous.

Cryptocurrencies have become a popular tool with criminals for nefarious activities such as money laundering and illicit purchases.

One of the conceits of cryptocurrencies is that anyone can mine them using a computer with an Internet connection. However, mining popular cryptocurrencies requires considerable energy, sometimes as much energy as entire countries consume.

Though cryptocurrency blockchains are highly secure, other crypto repositories, such as exchanges and wallets, can be hacked. Many cryptocurrency exchanges and wallets have been hacked over the years, sometimes resulting in millions of dollars worth of "coins" stolen.

What are some blockchain misconceptions?  Blockchains are not the answer for everything.

  • 1 myth: Enterprise blockchains are always useful: some use cases have fundamental flaws, some don’t even need to use a blockchain.
  • 2 myth: Blockchains are more efficient: tradeoff between decentralization vs scalability
  • 3 myth: Blockchains are cheap: blockchains are costly to maintain and develop
  • 4 myth: Just build your own blockchain (rather than use an existing infrastructure): existing frameworks have proven success and security.

What are the basics of blockchain Anonymity? Blockchains are not anonymous by default. All open source data is public by default. Most blockchains are pseudonymous and not usually linked to a real identity. "Linking" in terms of anonymity is associating a real world identity with a pseudonym.

What are the levels of anonymity? Anonymity is not absolute in the blockchain. The “degree of anonymity” is defined by how difficult it is to associate your pseudonym with your real world identity. High degree of anonymity = Greater Privacy

What is deanonymization? Deanonymization is to link an entity with its real world identity. A transaction graph analysis can inspect the blockchain history to narrow down identity. Or clustering will identify a group of addresses related to a single entity.

Why does anonymity matter? Well today Traditional mixing/money laundering is  done through hundreds of fake “shell” companies, which don’t do anything and write off expenses to make deposits look real. Mixing on blockchains can do the same thing ‘clean’ money on luxury goods.

How can you setup formal anonymity? An anonymity set is the set of pseudonyms between which an entity cannot be distinguished from her counterparts.

The main goal of mixing:

  • We want our anonymity set to be as large as possible
  • The larger the anonymity set, the harder it is to deanonymize, or relink, pseudonyms to identities to addresses
  • Additional desirable properties include trustless (no counterparty risk) want to ensure that our funds can’t be stolen while mixing and; Plausibly deniable: it shouldn’t be obvious from the transaction history that you’re mixing

Every chain solves problems in its own manner. No two chains are identical. To understand blockchains, you need to understand the landscape of the individuals using each token.

Decentralization

What is Decentralization? A decentralized system is an interconnected information system where no single entity is the sole authority.

Decentralized exchanges don’t rely on a third party service to hold customer’s funds.Trades are peer-to-peer and trustless. In comparison, a centralized network controls the exchange of funds and is not anonymous. A decentralized network is where individual users controls their funds and can be anonymous.

To build a global network we need distributed ledgers. This is a consensus of replicated, shared and synchronized data geographically spread across multiple sites, countries or institutions. No central administrator or data storage.

A shared ledger among counterparties has its benefits. First it provides transparency. Money is a form of information. So record keeping and reconciliations are essential to improve information flow. Instant transactions with accurate auditing can transmit money and information without speed bumps.

Now why do we need a distributed ledger? Well for starters, it is decentralized, meaning no one party controls all of the data. If you’ve used a bank or technology company then you’ll know what I mean by centralization. One party controls all of the data. In fact, you don’t know how anything works behind the scenes.

The advantages of distributed ledgers. If you aren’t familiar with accounting, ledgers may go over your head. But that doesn’t mean you should skip over this section. Have you ever used a bank? Transfer money between accounts? Yes? Good then you're familiar with ledgers. You see, every account has a debit and credit. What you debit, I credit. This happens when you transmit money and information. To reduce operational costs, we can simplify global record keeping and reconciliations. This would be a shared ledger among counterparties. Why do this? Well instant transactions will provide accurate auditing for starters.

Universal blockchains give individuals power in the system. They are no longer constrained to centralized forces. What does this mean? Well for beginners, everyone has equal access.

Blockchain Security

Security is a top priority with internet data, especially when money is involved. And trustless system would be useless without the best security.

Blockchain are designed to fill the gaps in the traditional banking system. This works best for payments, which are a ledger system. Payment transfers typically include a delay from processing payments and verifying third parties.

Nick Szabo, the founder of bit gold, famously said, “Trusted third parties are security holes.”

To solve the security problem, transactions are validated through different functions. The most popular being Proof of Work (PoW) and Proof of Stake (PoS). Proof of Work (PoW): miners solving complex mathematical formulas; energy intensive. Proof of Stake (PoS): largest stakeholders validate new transactions; transaction fees

Blockchains solve the security challenges with complex mathematical formulas to validate transactions. Transparency plays a major role here, at scale. We will discuss security in greater detail later on.

Blockchain Scalability

Scale can be optimized with great technologies. To do this, blockchains need to master clustering and capacity to improve transactions per second.  

Blockchain Clustering are two ways to associate addresses. The merging of transaction outputs occurs when there are multiple inputs to a transaction. Change addresses is when a transaction is split into 0.70 and 0.30 amounts. One of them be a change address. Change addresses are usually newly generated. {{word-count}}

What is Taint analysis? Taint is the percentage of transactions by an address that can be traced back to another address. It can be used to identify if funds came from a bad address. This helped track Ross Ulbricht’s Silk Road bitcoin stash.

How can we identify individuals on-chain? There are a few ways to associate addresses with individuals. First, sending a person Bitcoin to reveal an address. Second, posting your Bitcoin address publicly. Last a third party service providers may disclose it.

Blocksize capacity increase small scalability boost with larger blocks. Centralization risk as minimum server requirements for nodes increases

Segregated witness (SegWit) will provide a small scalability boost since blocks don’t need to store signatures. It speeds up the transaction by removing data.

Sidechains or Layer 2 chains have the potential for large scalability boost.

The Lightning network has a large potential for orders-of-magnitude in scalability boost. It will require significant restructuring of the payment process. Also has centralization risk due to capital prerequisites.

Scaling presents its own challenges when it comes to speed and security. The tradeoffs are noticeable but unsolvable. When investing in blockchains it is important to prioritize for what matters most to you.

In this module, you learned the fundamentals of the Blockchain, from the history to the basic terms. Now you have a strong grasp of why this technology was built. Next we will breakdown blockchain economics.