What are Blockchains – and why they matter.

In order to buy and sell cryptocurrencies, you don’t actually need to know or understand about Blockchains!

 However, understanding will give you an edge in terms of your investments, and start saving you money on fees today! Stick around to find out what Blockchains are all about and why they affect you and your money.

What is a Blockchain?

A Blockchain is simply a way of storing digital information. It is a large computer file where the digital data is grouped into blocks. Each block contains a link to the previous block – hence forming a chain.

 As new records are made, new blocks are added to the end of the Blockchain. Once a block has been added it cannot be changed. Each chain is a long sequence of blocks that contain data records, like beads on a never-ending necklace.

Any kind of information can be stored on a Blockchain, but with Crypto, these tend to be financial records. 

Why are Blockchains important for Crypto?

When you are dealing with lots of digital money, it is very important to have secure records that are trustworthy and therefore protected from being altered or hacked. That makes Blockchains ideal.

Many Cryptocurrencies go even further to keep their records secure. Rather than relying on one computer file, they spread identical copies of their Blockchain across a network of computers spread around the world. These are called Decentralized Blockchains. This increases the security of the network protection. If one computer on the network fails for some reason, like a power-cut or an internet attack, the rest of the network computers can carry on without it.

 In order to add a new block to the Blockchain, known as mining, it must first be checked and agreed upon by all the computers on the network. This maintains the integrity of the blockchain.

e.g. If someone tried to change one of the copies of the Blockchain to steal money, the rest of the network would see that this copy doesn’t match with theirs and it would be deleted. ( See Consensus)

The only way to hack the decentralized blockchain would be to change more than 50% of the copies held on the network at exactly the same time. ( see 51% attack) This would be extremely difficult and very expensive to achieve.

The level of security and safety this system offers is one reason why Blockchains are so important for crypto.

So what is Blockchain Mining?

Blockchain Mining is the process of earning rewards for making up the blocks and adding them to a blockchain. 
The cost involved in the mining is directly reflected in the fees (known as Gas Fee’s) associated with that blockchain. The higher the cost to be able to add a block, the higher the fees charged.

There are currently two main systems used for blockchain mining called Proof of Work and Proof of Stake.

Proof of Work Mining

Bitcoin is a well-known example of a Proof of Work blockchain.
Bitcoin Miners get paid in Bitcoins for adding their blocks of records to the blockchain.

With Proof of Work Mining, the computers on that Blockchain’s network compete with each other and the winner gets to have their block added to the blockchain. They then get paid for adding a block.

They actually compete by using their computers to solve highly complex maths puzzles. The first computer to solve the puzzle wins. That computer can prove that it has done the work of solving the problem. They can then add their block of records to the blockchain next and are paid for doing so with crypto coins.

Proof of Work blockchains have been highly criticized recently for the massive amounts of energy and computing power used to solve the complicated, yet completely irrelevant, maths puzzles! The power requirements are not only expensive but as they are for pointless calculations it is considered bad for the environment.

The process of creating Bitcoin to spend or trade consumes around 91 terawatt-hours of electricity annually, more than is used by Finland, a nation of about 5.5 million.

Source: EIACambridge Bitcoin Electricity Consumption Index 2019

Finding more eco-friendly alternatives to the Proof of Work blockchain has therefore become really important for the future of crypto.

Enter Proof of Stake Blockchains!

Proof of Stake (POS) Mining

Proof of Stake blockchains involve a decentralized network of computers called Validators who record and verify records in blocks on the Blockchain.

Once accredited the validators are chosen randomly, by the system, based on how many of that blockchains crypto coins they have saved.

Validators with the most coins saved are more likely to be chosen. If chosen they can then create and add a block to the Blockchain and therefore earn money.
If they are not chosen, they simply have to validate the proposed blocks until they are chosen.

POS Staking Pools

 To increase their chances of being chosen, many validators set up their own Staking Pools. These allow other people (such as us!) to add their own coins (staking) into the validators savings.

 The Stakers in the group have no direct involvement in the validation of blocks but do receive a percentage of the reward the validator gets from adding to the blockchain.

 This is significant for individual investors like us!  It gives us the opportunity to stake our crypto coins in Staking Pools in order to earn a percentage of the Rewards.

This is one of the main ways to earn a passive income from owning crypto coins.

Why are Proof of Stake Blockchains more popular than Proof of Work?

Proof of Stake blockchains don’t need to expend vast amounts of energy and computing power trying to calculate a pointless math problem. They only utilize the smaller power required to actually create the blocks and validate them, so they are considered vastly more energy-efficient and eco-friendly.

Why is understanding Blockchains helpful to know?

  • Security
    • Different blockchains have different methods of being secure. Not all blockchains are decentralised.
  • Determining who adds a block to the chain
    • The differing methods have vastly different costs that are reflected in the fees charged
  • Staking Pools
    • This a potent way to earn some passive income

Further Reading

Staking and Staking Pools – What you should know and how you can benefit from them.

Gas Fee’s – What they are and how to reduce them when trading.

Alternative Mining Methods – New methods (not just POW and POS) for adding a block to the blockchain.

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