Blockchain, Cryptocurrency, and Web3 - Part 1
This is the first in a 3-part read that aims to uncover some of the mystery and confusion about technologies that are quickly becoming necessary elements of our daily lives. To read more, go to Part 2 and Part 3.
Blockchain as a concept has existed on the tech landscape for over a decade now. Along the way, a very large number of new words and concepts have emerged that are still associated with blockchains. Some of them are: decentralisation, cryptocurrency, bitcoin (of course!), smart contracts, NFTs, web3, ICO (initial coin offerings), decentralised finance, proof of work, proof of stake, dogecoin, ethereum, stable coin, decentralised exchange, block space, cryptography, and permissionless.
Apart from this ever expanding list of words, are the unsavoury references such as scams, obsession with prices, people losing money, gambling, and Ponzi schemes. There are criticisms too, such as influential experts denouncing cryptocurrencies entirely, some upholding blockchains but denouncing cryptocurrencies, and so on and so forth. Some others say it is technically sound, but does not have any realistic use! There are misconceptions as well, such as that blockchains are entirely about replacing fiat currencies, or that they are only about finance, etc.
What even is this tech? How do you make sense of it?
What is blockchain? How do you understand blockchains?
We deconstruct blockchains using simple language and then weave an imaginative story around what they are. Then we gradually dig deeper, in great detail, into all the different aspects of it, so that at the end you are able to make sense of the entire space, the phenomenon that is in front of us and, also, to understand why blockchains are exciting and hold great promise for the future of the internet and human civilization as a whole. We will steer fully clear of blockchain assets as an investment vehicle and price conversations, ‘numba go up’, ‘wen moon’, etc., at all times.
Bring real world properties to the internet
Blockchains do not compare well to anything on the current internet (before blockchains). What they achieve for users is to bring real physical world properties to the internet.
The real world is full of objects: roads, trees, people, computers, animals, cars, copper, steel, rice, wheat, currency notes and coins, sticks, stones, guns, factories, so on and so forth. An exhaustive list of objects constitutes reality. Over time, certain interactions happen between humans and the objects, among the objects and according to some natural/human rules, and then we arrive at a new reality of objects (some objects have moved, some have transformed into different objects, etc.). As time moves on we keep arriving at new states of reality of objects and agents (humans) as ‘things happen’ to objects based on certain rules or ‘algorithms’.
Let us call the current snapshot of reality the ‘state’ of reality. Then let us say some ‘things happen’ in a small unit of time and we arrive at a new ‘state’ of reality based on the previous reality and ‘things that happened’. This continues ad infinitum, as we keep adding unit times and ‘things happening' to arrive incrementally at new realities each time.
The blockchain acts similarly.
Blockchain, cryptocurrency and web3
The ‘blockchain’ in its entirety, all the blocks that have been added so far (this is for simplicity), makes up the current state of the blockchain. Then we add a new ‘block’ (a set of ‘things happen’ on top of the previous state) to the blockchain. We commit it to the blockchain, and the new block, in addition to all the previous blocks, now represents the current state (or snapshot) of the blockchain.
For example, let us say I have an apple and you have none in the current ‘state’ of reality. In the next instant of time (a block), I give you an apple (transfer of one apple from me to you). In the new ‘state’ after the instant of time, I have no apples and you have one. For this example, transfer of one apple is the transaction that is carried in a block that is then added to the blockchain to reflect a new state of the blockchain.
The addition of the new block is done by agents/parties who secure the blockchain. These are any person/entity in the world who is willing to run the security algorithm. They are rewarded for running the algorithm successfully with the cryptocurrency asset of the blockchain, called cryptocurrency (for bitcoin blockchain the cryptocurrency is Bitcoin, for ethereum blockchain it is Eth, etc.). The algorithm they run is called the consensus algorithm (for bitcoin blockchain the consensus algorithm is called proof-of-work).
Multiple parties have an incentive to modify or corrupt the current state to benefit themselves. For example, I may want to corrupt/change the current state to show that I have 100 apples instead of one. These efforts need to be repelled, and the agents/parties who run the security algorithm do this for the blockchain, securing it from any attacks to change the state.
All that goes INSIDE a block (the assets/objects and the ‘things happen’ instructions) constitute ‘web3’ (NFTs, Decentralised Finance, Decentralised Autonomous Organisations). Web3 is both the assets and smart contracts on a blockchain. Smart contracts are the instructions that define how users (addresses) and different assets (objects) interact among themselves and each other on a blockchain.
**Tldr:**A blockchain is a shared state (data) and execution environment secured by a consensus layer (agents that run consensus algorithms and are rewarded cryptocurrency of blockchain). Web3 is the assets and smart contracts on the blockchain.
We now make a leap of imagination and build on the analogy created above to understand blockchains even better. With a 13-year history, we now know enough to identify blockchains as internet-native digital civilisations.
Blockchains are internet-native civilisations
Human societies/countries did not start off in the current shape of nation states and our tightly woven global structure. They started off way back as human settlements (or city states) that shared a common area (’our settlement’) and protected their settlement with the best means of security (first fire, then bows and arrows, then forts and cannons, etc.) of the time. They carried out economic, cultural, and business activities that were possible for their time (first only hunting/gathering, then cultivation + hunting/ gathering, eventually spices, clothes, metals+cultivation+hunting, etc.). Hence, human civilisation started off as city states that had their own security (say forts, but more powerful over time) and carried out economic activities of increasing sophistication over time.
Blockchains have evolved in a similar fashion. A blockchain is a shared data (state) and execution (instructions) environment protected by a security layer (consensus algorithm + cryptocurrency). Within a blockchain, there are various web3 assets/smart contracts and user accounts (users) that carry out economic and cultural activities of increasing sophistication over time. Blockchains are essentially accelerating the evolution of human civilisation, but in a digital way on the internet.
We are still early in blockchain tech. At this time, blockchains digitally have the maturity of the early city states in the real world. Hence we take this analogy to explain the major blockchains of today, and also the broader emerging trends in the blockchain industry.
We are going to run with the city state analogy through the rest of this article!
The oldest and the largest blockchain in the world is Bitcoin.
The earliest human settlements had a common ground where they settled, and they had a basic security mechanism that protected their common ground and people from attackers (wild animals, anything else) such as fire. The economic activities they pursued were very basic, such as hunting and gathering.
Bitcoin was a monumental achievement in the internet era, largely spearheaded by an anonymous developer who called themselves Satoshi Nakamoto. They invented the blockchain. It put together all the different elements of a blockchain, a (simple) shared data and computation space on the internet, a security layer (secured by a consensus algorithm called proof-of-work and a cryptocurrency, Bitcoin) and support for basic activity on the blockchain. Yet, what it actually does, in blockchain terms, is very simple.
Bitcoin is a single asset blockchain (bitcoin is the blockchain and Bitcoin is the cryptocurrency). The same asset that is created by the consensus algorithm, called proof-of-work, serves as the only store of value. In terms of activity on top of the blockchain, it only supports creation of user addresses and transfer of Bitcoin from any one account A to any other account B, near instantaneously (roughly every 10 minutes).
A blockchain exists in an extremely adversarial environment that is the internet. If there is any vulnerability, it will be exploited. The higher the economic value at stake, the more resources any attacker will use to hack/steal assets from the blockchain. Today, bitcoin blockchain holds $400 billion in value, which at its peak was worth $1.3 trillion. The robustness, durability and security of the bitcoin blockchain is proven at this point. Bitcoin served and continues to serve as a ‘proof-of-concept’ for the blockchain industry as a whole.
While the activities supported by the bitcoin blockchain are extremely simple and basic, it represents a significant step up from the world that existed before bitcoin. Bitcoin blockchain successfully solves the double spending problem. Thereby, Bitcoin (the cryptocurrency) is the first digital native asset. Unlike before, transfers on the blockchain do not involve any humans other than the sender and the receiver (the blockchain is permissionless). There are no human processes needed (regulatory licences, KYC, etc.), or cooperation between different banks that was necessary before Bitcoin. Bitcoin also does not have any geographic restrictions unlike before (international transfers are difficult and time consuming outside blockchains). Also, bitcoin being a completely digital asset, has no shortcomings of physical stores of value (assets), as does gold. Hence, Bitcoin is a huge step improvement from the world before it for transfer of economic value and can transfer tens of billions of dollars of value near instantaneously across the world with no need for any human intervention (other than the sender and receiver).
Bitcoin blockchain is twice as old as the next biggest blockchain (Ethereum) and is the most dominant blockchain in the world today in terms of economic value carried.
Today it is equivalent to an early city state that is dominant, but has as its competitors smaller, more nimble city states that support much more sophisticated economic and cultural activities, but are still no match for its dominance.
Subsequent ‘city states’ have made improvements in different areas, and we will examine these, together with other blockchains, in the next part of this article.