Cryptocurrency Basics: The Many Blockchains
Blockchain, which has been described as a “public database”, is the main technology underlying cryptocurrencies. Yet I still envision it as very long dot matrix printer paper.
From NFTs to Blockchains to “DeFi”, the cryptocurrency space is full of buzzwords, technical concepts, and a whole lot of startups all competing for attention, while navigating a fast-changing regulatory landscape. In order to begin to decipher some of the many concepts in the cryptocurrency space, I wanted to create a series of posts; a Beginner’s Guide to Cryptocurrency, if you will.
We’ll begin with today’s post on a core concepts: Blockchains. I’ll be alternating posts between free and premium. The next post, which will just be for subscribers, will be on demystifying “DeFi” (also known as “decentralized finance”).
What is a Blockchain
Blockchain is the main technology underlying cryptocurrencies. It’s been described as a “public database” that’s shared by multiple computers. The Bitcoin Blockchain is the original one, but there are now several Blockchains in use. For example: you’ve probably heard about Ethereum, the cryptocurrency. Well, Ethereum has its own blockchain, which is distinct from the Bitcoin blockchain.
There are now many different blockchains out there, including: Harmony One, Solana, and the Binance Smart Chain.
The Bitcoin Blockchain
The notion of the blockchain was first described in a whitepaper by the pseudonymous Satoshi Nakamoto. You can think of it as a public record (or “public ledger”) of payments: one where all transactions that have ever occurred are published, for everyone’s viewing. New transactions are chained to the old “blocks” containing past transactions.
I have personally always envisioned it kind of like a long string of that printer paper used by old-school dot matrix printers. For those who missed out, with older printers, the printer paper was all attached (“continuous stationary”), and had holes on the side, and the paper would just keep falling out of the printer in longer and longer strands (until you tore off the sheets):
But the blockchain doesn’t just exist in one single place, on one single computer. It’s replicated across all the different users validating the network. (I envision many stacks of continuous paper!) This is why people described the blockchain as “distributed.”
And the transactions really are publicly available. There are websites like blockchain.com’s explorer which provide exploreres that let you see any transaction on the Bitcoin blockchain, and browse the most recent transactions. If someone knows what your Bitcoin address is, they can drill down on the Blockchain explorer and view all of your Bitcoin transactions over time.
Another proposal Nakamoto offered was a way to ensure that the records of these payments are valid in a “proof of work system.” This is the concept that’s come to be called “Bitcoin mining”. The basic idea was to incentivize people to validate the blockchain, and reduce the benefits of attacking the blockchain. Bitcoin does this through a lottery system.
As new transactions happen in Bitcoin, the system needs users to validate the transactions and ensure nothing’s amiss. About every 10 minutes, a new “block” is added to the Bitcoin blockchain. Bitcoin miners participated in this process by doing two things: verifying 1 megabyte worth of transactions on the network, and trying to correctly guess a 64-digit hexadecimal number associated with the new block. If a miner does both, they receive 6.25 Bitcoins as a reward. Those 6.25 Bitcoins are currently worth about $225,000 with Bitcoin trading around $36,000. Identifying this number is essentially guesswork, and requires a ton of computing power to do.
Miners can mine up to a hard limit of 21 million Bitcoin (there are currently 18.5 million Bitcoin in circulation). One might logically asked, what is the incentive to continue mining Bitcoin once the last one has been minted? It’s unclear. Miners also receive transaction fees, but it’s currently only 6.5% of their revenues, according to the cryptocurrency news site Decrypto.co. The theory is that Bitcoin miners will still be incentivized to validate the network in order to earn these transaction fees.
The Ethereum Blockchain
Speaking of transaction fees! The second oldest cryptocurrency, Ether, was producing record numbers of transaction fees to Ethereum miners during the height of cryptocurrency’s price spike and crash in May 2021 — with Ethereum miners earning $2.35 billion total in transaction fees that month.
First, some terms: Ethereum is the platform (transactions run on the Ethereum blockchain). Ether is the cryptocurrency
Much like on the Bitcoin blockchain, whenever a transaction occurs, it needs to be broadcast / recorded by everyone on the Ethereum blockchain. Like Bitcoin, there are websites like Etherscan.io that allow anyone to view every transaction on the Ethereum blockchain:
Ethereum also rewards its miners, and currently uses the same “proof of work” system as Bitcoin.
But unlike in Bitcoin, lately, the revenues Ethereum miners earn are more about the traffic on the network. As there are more transactions on the Ethereum blockchain, it is more computationally intensive to execute. “Gas” is the word the Ethereum protocol uses to describe just how computationally difficult a transaction is. When Ether gas fees increase, Ethereum mining becomes more rewarding.
Ethereum.org describes gas this way:
gas fees help keep the Ethereum network secure. By requiring a fee for every computation executed on the network, we prevent actors from spamming the network. In order to prevent accidental or hostile infinite loops or other computational wastage in code, each transaction is required to set a limit to how many computational steps of code execution it can use.
This feels a bit abstract until you try it out yourself. Let’s say you have some Ether, and you want to send it to a friend’s cryptocurrency wallet. Sending your Ether requires running a transaction on the Ethereum blockchain, which will require you to pay for the Ether gas it takes to do a transfer. Ether gas prices are at six month lows right now — gasnow.org estimates it would cost less than $1 to send some Ether to your friend’s wallet:
Paying Ether Gas Fees to run transactions on the Ethereum blockchain
Let’s say you wanted to swap some Bitcoin for a different cryptocurrency. You can do so on a DeFi platform like Uniswap or Sushi Swap (I’ll cover the basics of DeFi in the next post in this series). This transaction is more computationally intensive, and will use more Ether gas than a simple transfer: 129,830 gas, for an estimated cost of $5.64 on the high end.
Trying it out on Uniswap shows that the estimate from gasnow.org was a bit off — to swap Ether for another crypto will cost a bit more, $9.26 to run the transaction quickly (in 23 seconds), and $5.24 to run it more slowly:
But back in May, when many people were either trying to swap for coins whose prices were skyrocketing, or dump their positions when crypto began to crash, these fees were far higher. I recall that swapping between crypocurrencies ran in the $40-$50 range at that time, if not higher.
As Cryptobriefing.com wrote at the time:
The gas fees essentially rendered the network unusable for users with smaller holdings, while those trying to save their loans or enter new positions suffered longer wait times due to the surge in activity
There is an added wrinkle to the Ethereum blockchain, however: the community is trying to migrate off the “proof of work” validation method, and onto what’s called “proof of stake”. This is what’s called Ethereum 2.0 — and no one quite knows when it will arrive, though it was initially planned for late 2021.
Under “proof of stake”, not everyone can participate in network validation. In order to ensure that participants have skin in the game (and thus be less likely to attack the network), to become an Etherem 2.0 validator, you must have at least 32 Ether (no small amount! That’s nearly $70,000 at the time of this writing!)
Of course, services have sprung up to try and allow Ether holders to pool together and reach the 32 ETH threshold, allowing them to collectively earn the mining rewards that come with Ethereum validation. Here are a list of services that allow you to “stake” your Ether, and thus earn rewards on it, with less than 32 ETH.
Validators are chosen at random to create blocks and are responsible for checking and confirming blocks they don’t create. A user’s stake is also used as a way to incentivise good validator behavior. For example, a user can lose a portion of their stake for things like going offline (failing to validate) or their entire stake for deliberate collusion.
The Binance Smart Chain
The cryptocurrency exchange Binance has developed its own blockchain called Binance Smart Chain (BSC). This blockchain has used “Proof of Stake” from the jump. Again, just like the Bitcoin and Ethereum blockchains, there are websites that allow you to view all transactions that occur on BSC, such as bscscan.com:
During the high Ether gas fees of early 2021, many people launching cryptocurrency tokens were drawn to use BSC instead of the Ethereum blockchain because of the lower fees.
The low fees also meant a lower barrier to entry, and during the crypto boom in the spring, there were many so-called “shitcoins” (which are cryptocurrencys with no use case or purpose) on the Binance Smart Chain.
You can see just a few examples of shitcoins using the Binance Smart Chain on the website Moonarch.app:
The Binance Smart Chain became so full of scam tokens that in late May, Binance itself tried to distance itself from projects on the network bearing its name, tweeting that “http://Binance.com is not associated with projects based on Binance Smart Chain” and that users should “transact with care”.
Blockchain Blockchain Blockchain
There are many other Blockchains out there. There’s Solana, which is backed by the cryptocurrency exchange FTX, and claims it will be able to far exceed the transactions per second currently supported on the Bitcoin (7 transactions per second) and Ethereum (30 transactions per second) blockchains by using a totally new validation mechanism: “Proof of History”. (Here’s their whitepaper).
Beyond the baseline educational value, why go to the trouble of understanding blockchain basics? Well, which blockchain you’re using becomes an important factor in several instances:
- When you are trying to swap one cryptocurrency for another (which is rather difficult, and requires a way to “bridge” a crypto on one blockchain to another).
- When you’re using a DeFi protocol — Uniswap runs on the Ethereum blockchain; Pancake Swap runs on the Binance Smart Chain; Mochi Swap runs on the Harmony One blockchain.
- Which website you go to view your (or others’) transactions.
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