How does blockchain and crypto work?
Well well well. If it isn’t the latest buzz!
Today, we have an article written by a guest - Shubham Sharma. He’s someone who’s spent a lot of time with blockchain and crypto, so who better than him to tell you about how it works?
Let’s begin! Over to Shubham!
Today, we’re going to discuss the very basics of blockchain and crypto.
Let’s start with a small example:
Suppose you send a picture containing your card number and CVV number to your wife in another country. You click a photograph of your debit card and send it. Bam! The picture reaches your wife in seconds, and she’s able to use the card.
But what if a hacker reads your data mid-way and finds out your card no. and CVV?? You will instantly lose all your money! ☹️
Now consider the same example, with a small twist! What if I cut your picture into 10000000000…0000 pieces, and then send each part in a box at a time through different channels after which your wife reassembles all the parts of all the boxes like a puzzle, and reads out the information. Now you may argue, what if a hacker hacks the channel and reads it here too? Well, it’s practically not possible to hack 1000000000000…0000 channels! Even if the hacker hacks a few, he will never be able to process all the information of the whole picture. Hence this process becomes 100% hack-proof.
This is the same concept on which blockchain technology works - Breaking the data into fragments and transferring it through different channels/blocks, and then reassembling it at the end-user’s location. Consider these blocks as real boxes which store your data (picture fragments in this case).
Now, you might say “Whoa Shubham! That’s awesome! Everything is automatic and can be coded!” But! This transaction i.e. from you to your wife cannot be completed if it's not validated. And that is where comes human intervention.
Blocks are secured by hash codes/encryptions which is analogous to a puzzle that has to be solved. It is technically a mathematical equation, whose answer you need to find by running computer programs (unless you want to solve math equations manually, which may take weeks 😛). Once this answer is found, that particular block of the transaction gets validated. So all such blocks have to be validated through a web of computers all across the world, and only after all of that is done, your transaction is complete. This is what the blockchain world calls Mining.
Now, why would someone get your transactions validated? Because they get paid to do this. These people are called what you commonly hear as miners and they are spread all across the world. The first miner who solves the equation gets rewarded with a token (which we know as “coin”). Anyone with a powerful PC can become a Miner.
Now let’s assume that Ankur started a Blockchain technology product that helps in the transfer of data and named it Jackfruit Blockchain. Here, he will create his own currency called Jackfruit tokens and the miners who help in validating the transactions, will get paid in this Jackfruit cryptocurrency.
This is how Bitcoins are rewarded to miners on the blockchain, and Ether is rewarded to miners on the Ethereum blockchain. They help users of the blockchain to validate transactions, and therefore are rewarded with tokens.
If you have understood this much, then pat yourself on the back, because you’re now ahead of 99% of Indians!
Now let’s dig a little deeper.
You must be thinking - How will the miners use these tokens to buy products that they need? Well, they would sell it to get its dollar equivalent (assuming the miner is American - though usually most bitcoin miners are from Russia ;) ).
Now, where does the dollar equivalent come from?
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Thanks. Now, moving forward to understand pricing.
So Ankur, who is the founder of Jackfruit blockchain gives that to the miner. And how does he decide the price of each token? Well, initially, the price of each token depends on the amount of Liquidity provided against the total supply of Jackfruit tokens. We’ll discuss about liquidity in the next blog, but for now, to simplify it, you can assume that the price depends on the demand and supply. If there is a high demand, more people will want these Jackfruit tokens, which means the token will fetch a higher price. If nobody wants it, means that there is no demand, so the price of these tokens will be less.
So now let's understand how and why a cryptocurrency's price like Jackfruit coin changes.
Let’s assume that Ankur says that he is open to non-miners as well holding the tokens, as Ankur believes that he has a promising blockchain technology.
Ankur presents his goals and mission of his technology to common people like us through a document called “whitepaper”. A whitepaper is nothing but a document that contains all the information regarding the blockchain technology, the problem which Ankur is solving (in this case, transfer of data) with Jackfruit blockchain and the whole roadmap of his tech products. So if people find this promising, they come and invest. As they invest, the demand and Liquidity increases, hence the price rises.
Similarly, suppose Ankur fails to deliver his promises. In that case, people might sell the tokens because they feel that this technology is not going to be of any use, hence reducing the Liquidity, resulting in falling of Jackfruit token price.
That’s it. I think this much is enough for a basic on blockchain and crypto, and I hope this short blog did a decent job at explaining it from a layman’s perspective. We will be covering a lot of topics in the upcoming blogs, such as Liquidity, DeFi, different kinds of coins etc. So do subscribe to this newsletter (if you’re not already a subscriber) to receive weekly emails on Personal Finance, money management and crypto!