The Invention That Makes Banks Obsolete
A Jargon-Free Explanation of Bitcoin's Blockchain
Videos and articles that try to explain bitcoin and the blockchain tend to use cryptic words like hash and public key in their explanations (I find hash in particular to be a challenge because it sounds like a verb but is a noun). But these explanations never stick. Below, I will give you a model of the blockchain that is simple enough to stick, but complex enough to understand a 51% attack and why Bitcoin uses so much energy.
To see why people would want a blockchain, you need to understand the problem it solves: the need for a trusted third party like a bank to keep track of who has given what to whom. When you e-transfer $20 to a friend, there is no banker who withdraws $20, runs to your friend’s account, and then deposits it there. Instead, they just write down that you have $20 less on your ledger and write that your friend has $20 more on his ledger.
But these records are vulnerable. They could get burned in a fire, stolen or mistyped. On top of that, a banker could say that he gave your friend $20 while putting it in his pocket instead! Not good. Humanity’s best attempt to solve these vulnerabilities has been to force banks to be trustworthy by punishing them when they become corrupt or make errors.
The invention of computers didn’t help fix the problem of our need for a tracker to keep track of who has given what to whom. You know how you can just copy-paste a word document 50,000 times? That’s because it’s digital. The same issue plagued past attempts to make digital money - people could always just copy it and spend it again. The only way to solve this was to trust a third party to keep track of transactions. But that’s the problem we want to avoid!
The blockchain fixes this. Let’s pretend that you, me, and five other friends are sitting around a table. We all want to stop using one person to keep track of our transactions, so we do it ourselves. We each get a piece of paper to write down transactions. The limitation is that the paper has space for 10 transactions only. Once you reach 10, you have to put a special wax seal on the page and move on to a new page.
So! whenever someone wants to make a transaction, they shout it out to the rest of the group. Everyone then writes the transaction down on their piece of paper. After 10 transactions, the paper must be sealed. Still following?
The wax seal is unique in an anti-tamper-proof way, and it’s thanks to the machine that makes it. On one end of this machine, you type in two numbers. On the other end comes out a wax seal. Changing the number will change the a) shape, and b) two digits that are pressed into the wax seal. The shape will either be a square, circle, rectangle, octagon, or oval. In other words, five shapes.
The machine also stamps two random numbers onto the seal. It is a transparent seal that has a slightly red hue, and slides on top of the piece of paper. Once it cools and hardens, you can still see the transactions written on the paper, but you can’t change the transactions.
To seal your particular piece of paper, you need a circular seal that has the last two digits of the sum of the transactions on your page. So if you add up all of the money that has moved and it turns out that $3,621 has moved, then you would need a circular wax seal with a 21 stamped on it. But now comes the hard part. When you type in 21 on one end of the wax machine, you get a square wax seal with a 64 on it. Kinda annoying. If you type in 00, you get a octogon with a 03 on it. Not helpful. Just to double check, you type in 21 three more times, and you get a square wax seal with a 64 on it all three times.
What have you learned about the wax machine? It seems like the shape that comes out has no discernable relationship to the number. It seems like the wax number has no discernable relationship to the number you typed in. But it at least seems like typing in the same number produces the same wax seal. So for every number you type in, there’s an output matched to it.
Back to our task of sealing our paper though: you need a circular seal with a 21 on it. But how do you get that from the machine if you can’t work backwards from the wax shape and number using the machine? You’d have to guess all of the numbers. Since you can only type in two digits, the total possible number of guesses are 10 (from zero to nine) * 10, or 100. You’re going to have to keep guessing 100 times until you get the right number.
Fortunately, if you find the right number, you’ll get a prize of $100. Well, it’s not just you - all of the other people at our table are in a mad race to guess the right number and win the $100 prize. You’ve tried 00 and 21, so you try 01 next (no luck), 02 (no luck either) 03 (no) and then … argh, it looks like your neighbour just won. When he types in 97, out pops up a circular wax seal with a big fat 21 on it. He takes the seal and slides it onto the folded piece of paper. Now he can start collecting new transactions! Except nobody else can, because they’re still guessing. In order to start transacting again, he tells them all that the number which worked for him was 97. Everyone else tries it out and lo and behold, it works! Everyone else gets the right seal and affixes it to their page, sealing it.
Everyone else once again gets a new page to start transacting on. And ten more transactions happen. So you add up the total money exchanged, except for one difference: this time, you need to also add the number from the last piece of paper to it - 21. Let’s say that there was $4968 transacted on this second sheet, so 68 + 21 = 82. You’re looking for a circular wax seal with an 82 on it. Once again, you all start a mad race to figure it out. This time, you win! You win the $100. Congratulations.
Let’s just pause here from our little mental simulation and discuss what just happened. See how everyone has a copy of the record of transactions? That makes it distributed. And a record of transactions is called a ledger. So everyone having a copy of the record of transactions makes it a distributed ledger, which Bitcoin is. Secondly, see how everyone needed to guess what the right number was to get the wax machine to poop out a circular seal with the right number on it? That’s where bitcoin’s energy use comes from: a whole bunch of computers just guessing what the solution is to figure out the right answer to math questions. Lastly, each piece of paper is called a block. Since you need the sum from the past block to seal the next one, they form a chain. This may be a bit confusing still, so let’s keep going.
Okay, back to our simulation! Let’s say that someone messes up when writing down transactions - either because they have bad hearing or because they wanted more money than someone else was giving them. What would happen? Well, when it comes to sealing time, his paper would produce a different sum, and therefore he’d need a different sign. So he starts guessing for his unique seal. But because he’s just one person looking for the right number to get his one sum, whereas 6 people are looking for the other sum, the 6 people will find their sum quicker than he’ll find his. And thus the blockchain of the 6 will progress faster and will be longer than his one. The system assumes that the longest blockchain is the correct one, so he needs to trash his last piece of paper and copy someone else’s to start transacting with others again.
Now lets say that someone mispronounces a word, and 4 of the 7 people write down the wrong number. What happens then? Well, we get to the sealing stage, and the 4 are looking for a sum that’s different from the other 3. Because the 4 have more people guessing, they’re going to get to their number faster than the other 3. This is even though the 3 heard correctly. Bitcoin’s blockchain assumes that the longest chain is the correct one. This case above was just an accident, but some could do this on purpose! That’s what is called a “51% attack.”
So now you should know why and how bitcoin:
causes concerns about its carbon footprint
attempts to solve centralized banking
sole weakness: a 51% attack
is said to be decentralized
Hopefully, this mental model clearly explains Bitcoin’s fundamentals - it helped me to understand Bitcoin’s workings and true potential. But it’s not mine. Thank you to Mohit Mamoria’s truly great article for this mental model. He did it 3.5k words, I did it in 2k.