Table of Contents:
What is a Blockchain?
What is Mining and Staking?
What is Cryptocurrency?
What is Cryptography?
What is a Token?
What are Smart Contracts?
What are NFTs?
What is a Blockchain? A blockchain is exactly what it sounds like: a chain of blocks, each block containing some transactions (such as a transfer of 2 Bitcoins from me to you) and data. Although there are various implementations, the basic idea is this: every so often, a new block is added to the chain, which allows new transactions to be processed. This allows new information to be added, in the form of new blocks, while keeping a history of past information, in the form of old blocks. All blocks are linked together, and old blocks cannot be changed. In order to understand how new blocks are added and what they do, we should first understand what a hash is.
A hash is a cryptographically-generated sequence of letters and numbers that provides a way to represent a large amount of data in a small, fixed-size way. For instance, if you had a list of 3,000 breeds of dogs, and you used the SHA-256 hash algorithm (this is the algorithm the Bitcoin blockchain uses!) to get a hash the entire list (the list is the input to the hash algorithm), you would get a 64-character sequence of letters and numbers that looks something like “1328a347aa5b1d46d6d1278ad40820d5a74a644c909d928e599901cad51cb093” that represents that list. This is called the “hash” of the list. If you changed even a single letter in that list of dog breeds, the hash would drastically change. As you can see, hashing can be used to detect small changes in the input of the hash function. With a good hash function, it is statistically impossible to find an input (like another list of dog breeds, or anything else) that would give you the same hash as some other input (like the original list of dog breeds). You will soon see why this is important.
Now that we know what a hash is, we can talk about how new blocks are added to the blockchain. New blocks contain a few things, but the most important ones are: all verified transactions since the last block (for example, if Bob sent 5 BTC to Alice, that would be included), a hash of all of these new transactions, and a hash of the previous block. This hash of the previous blocks essentially serves to represent the history, in a small size, of the entire blockchain so far! Here, we can see what makes it impossible to rewrite the history of a blockchain: if someone attempted to change even the tiniest bit of something in the history of the blockchain, it would alter the hash of the previous block into something that we do not expect it to be, which would be detected.
Now, how do new transactions actually get into blocks? Let’s walk through an example. Say we’re on the Bitcoin blockchain, and I want to send you 2 Bitcoin (BTC). I’d send this transaction, which specifies that I want to send you 2 BTC, to a node. A node is a computer running specific software that helps the blockchain operate - there are many nodes, and blockchains need them to run in a decentralized way.
This node will see my transaction and spread it to other nodes, which each use their software to verify my transaction. For instance, they’d make sure I actually have 2 BTC to send to you. Once the transaction is verified, it is sent to a block creator (this could be a miner or staker, depending on the blockchain - miners and stakers are discussed next) so that it can be included in the next block. Once that block is added to the chain, your account will increase its balance by 2 BTC, and mine will lose 2 BTC.
Incentives play a role here as well. Block creators are rewarded with tokens for correctly adding blocks to the chain. For instance, on the Bitcoin blockchain, correctly added blocks reward the block creator with 6.25 BTC. However, only agreed-upon blocks will reward the block creator. So, when a block creator is offered the chance to compile various transactions, like mine where I sent you 2 BTC, into a block, it is in their economic interest to do so correctly. This helps improve the security of the blockchain.
It is also important to note that there are many blockchains out there. Bitcoin has its own blockchain, Ethereum has its own blockchain, Doge has its own blockchain, and so on. Communication between blockchains is not built into most chains, but developers have come up with ways to do so or work around this in some cases. We’ll discuss that in another article.
Video:Article: https://www.investopedia.com/terms/b/blockchain.asp
-
-What is Mining and Staking? Let’s start with staking. Simply put, staking is a way of earning rewards for holding certain cryptocurrencies. Staking is able to earn you yield on your existing crypto because the blockchain you “stake” your tokens on is actually putting your funds to work. Cryptocurrencies that allow staking use a consensus mechanism called “proof of stake”, and staking your crypto allows it to become part of this process.
Actually, let’s quickly go over mining first. Some cryptocurrencies do not allow staking. Bitcoin, for example, doesn’t allow staking because the Bitcoin blockchain uses a different consensus mechanism called “proof of work”. Proof of work is done by using a large amount of computing power to facilitate consensus - the process of putting valid transactions into new blocks on the blockchain - using computing hardware called miners. Here, miners compete to solve math problems as fast as they can. The first miner to guess the correct answer gets to compile the block, which, as we learned earlier, gives them tokens as a reward! The Bitcoin blockchain uses proof of work, so that’s why we call the participants “miners” - they are using high-powered hardware to try to solve these math problems first, non-stop, in order to be able to compile a block and earn BTC as a reward.
Proof-of-stake, rather than using energy-intensive computing hardware to decide who gets to participate in consensus, facilitates consensus based on investment amount. The exact way this works can different depending on the blockchain, but, in essence, users “stake” their tokens for a chance to add new blocks onto the blockchain in exchange for a reward. Staking is simply a fancy word for “locking up your tokens”. The network then chooses who gets to compile blocks based on the size of users’ stakes. As a rough estimate, if a user had 20% of all tokens, you’d expect that user to be selected to compile about 20% of new blocks. Software running under the hood takes care of the actual block creation process to make it quick and easy.
The staked tokens act as an additional incentive: users who have more tokens staked, theoretically, should not want to harm the network (for instance, by attempting to add un-verified transactions into a block). Also, if a staker tries to submit false/un-verified transactions, they can be slashed, which means some of their staked tokens are taken away from them as a penalty.
So, what are the pros and cons of staking? Many long-term crypto holders look at staking as a way of making their assets work for them by generating rewards. Staking also allows you to support a blockchain that you like - by staking your tokens, you are contributing to the security and efficiency of the blockchain. You help make the blockchain more resistant to attacks and strengthen its ability to validate and process transactions. On the other hand, there are some risks to staking. Staking often requires a lockup or “vesting” period where you can’t do anything with your staked crypto for a certain length of time. This can be a drawback as you can not trade tokens during this period, even if the price shifts dramatically. Before staking, you want to understand the rules and requirements associated with the token you are looking to stake.
Video:Article: https://www.sofi.com/learn/content/crypto-staking
-
-What Is Cryptocurrency? Cryptocurrency is a decentralized, digital form of currency. Cryptocurrency is secured at the protocol (blockchain) layer using cryptography and various incentives, which prevents counterfeiting, double-spending, and other attacks on the currency. This protocol (blockchain) layer acts as a distributed ledger enforced by a network of computers that utilize some proof mechanism, such as proof of work or proof of stake, to ensure the continued integrity of the network. These computers are the nodes, miners, and stakers discussed earlier - different blockchains may use different processes, but all require these participants to come to consensus, meaning that they will agree on the correct new blocks.
Why is it important that these computers can come to consensus? Well, because it unlocks the ability to create cryptocurrencies. A cryptocurrency is simply a balance (a number), tied to your account, that the blockchain comes to consensus on. If you have a balance of 100, and you transfer 20 to Bob, the blockchain should come to consensus that this happened and agree that your balance is now 80. If you are unsure what exactly your “account” is on the blockchain, don’t worry; we’ll discuss this later on in the “DeFi Basics” education article.
One big reason that cryptocurrencies are becoming so popular today is their decentralization; they are generally not distributed by any form of central authority, making them theoretically immune to government intervention or manipulation (though, in practice, regulation could certainly hinder adoption). Cryptocurrencies enable the transfer of funds directly between two parties without the need of a third party such as a bank. These transfers happen between two addresses - each with its own public (publicly-viewable) key that specifies the parties and private key (kept secret) that is used to cryptographically sign the transaction. Again, we’ll go over these keys and accounts more in-depth later on.
Video:Article: https://www.nerdwallet.com/article/investing/cryptocurrency-7-things-to-know
-
-What is Cryptography? Cryptography, in crypto, refers to techniques that utilize mathematics, expressed in code, to keep information and communication secure. This is key for the security of blockchains and, therefore, cryptocurrencies. Many different algorithms are used, and we won’t get too deep into the technical details here, but cryptography is what makes things like transaction security and succinct/secure data storage possible. Keep in mind that, when you hear about hacks in the crypto space, you are likely not hearing about flaws in the blockchain’s cryptography, but rather flaws in code implementation done by developers.
Video:Article: https://www.coinbase.com/learn/crypto-basics/what-is-cryptography
-
-What is a Token? We can keep this one brief: a token is just a number, stored in the blockchain, that is linked to an account, giving it its balance. For instance, if my account has 1 ETH (ETH is the Ethereum token) in it, that means the data saying “my account has 1 ETH in it” is stored on the blockchain and has been agreed upon by consensus. Obviously, it can get a bit more complicated than that, but that’s really all a token is. People can create new tokens as well. You simply create a new smart contract (discussed next) that enables balances of that token to be tracked, as well as any other custom logic that you want (one example could be “you are only allowed to transfer this token to an approved account”).
No video or article for this one!
-
-What are Smart Contracts? A smart contract is a customizable, self-executing program that is secured by, and can interact with, the blockchain that it resides on. Smart contracts allow the execution of code and transactions to occur without third parties because the computers helping run the blockchain can execute the program, verify the result, and agree on the result. The contracts are coded, compiled to the correct lower-level code for the blockchain, and stored on the blockchain. Keep in mind that smart contracts, once they’ve been put on the blockchain, cannot be changed!
Although the exact level of customizability depends on the flexibility offered by the blockchain’s smart contract platform, there is a relatively large amount of use cases for smart contracts. One of them, as discussed above, is tracking the balances of a token. Further, every interaction that modifies the state of the smart contract costs gas (discussed later on in “DeFi Education”). For instance, updating the balance of a user in smart contract storage would cost a fee, but simply viewing that balance would not.
You could compare a smart contract to a vending machine in the sense that they are deterministic - the rules are predefined and transparent, and they will always behave according to their code. However, this also makes it much more important to spot bugs before deploying a smart contract, as they are immutable (cannot change) and a whole new version must be deployed if updates are needed. Smart contracts are essential to DeFi applications, NFTs, fungible tokens, blockchain games, and more. Understanding them can be a helpful tool when investing, both for recognizing scams and for recognizing innovation versus simple copy-and-paste. Here is a pros and cons list to summarize:
Pros: Automated execution, Trustless, Deterministic, Secure, Cost efficient, Transparent, Precise
Cons: Unclear regulation, Cannot directly call API's (need oracles), Limits on customization
Video:Article: https://www.investopedia.com/terms/s/smart-contracts.asp
-
-What are NFTs? NFT stands for non-fungible token. Basically, “non-fungible” means that it can not be duplicated, making it a unique 1/1 token. These digital assets can represent many different things: real world objects like tickets or music, digital art, membership to a club, and so on. They can be bought and sold, are usually purchased with cryptocurrency, and anyone can trace their ownership using the history of the blockchain. Although most popular NFT projects reside on Ethereum, it is important to note that other blockchains support NFTs as well.
NFTs have been around since 2014, but have recently been gaining popularity due to the lucrative jumps in value some assets have experienced. In terms of why certain NFTs are so valuable: the scarcity and perceived, artificial value drives prices. Other drivers, depending on the NFT, can be historical relevance, ability to redeem for some real-life object, or social status from showing off the NFT (especially in multiplayer games or social media settings). Additionally, many crypto enthusiasts are using highly-valued NFTs as a store of value, keeping their assets in the digital world instead of turning them into physical currency. A few notes on NFTs from a technical perspective:
(1) On Ethereum, NFTs typically conform to the ERC-721 token standard. This standard, implemented through the NFT’s smart contract, allows uniform interaction with NFTs for use cases like generalized NFT marketplaces. This standard has not been around forever though. If you look at older projects like Crypto Punks, they do not use it. Again, just like with typical tokens, smart contracts track balances of the NFTs. They also track data related to the NFT, such as an image file.
(2) In most cases, the actual file for the NFT is not hosted on the blockchain. Instead, the NFTs, on the blockchain, have a “tokenURI” which provides a link that points to the file. This is done to save space on the blockchain - rather than storing all of the file’s data, we can just store a link to the file.
(3) It IS possible to wash trade NFTs by selling them back and forth to yourself or in a closed group, using different wallet addresses, at higher and higher prices. Many people will use this argument to try to discount the valuations of certain NFT collections, and, in some cases, this may be true. However, it appears to be rare, and you will almost never find it occurring in more “legitimate” projects.
Video:Article: https://www.theverge.com/22310188/nft-explainer-what-is-blockchain-crypto-art-faq
-
-