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What Is a Blockchain? An Analogy to Help With the Fundamentals

What is a blockchain? Well, it’s the backbone of the entire cryptocurrency space, including alternatives to traditional finance, and what’s now called Web 3.0, or Web3.

But that doesn’t answer your question, does it?

At its simplest, a blockchain is simply a continually growing series of blocks, each one connected to the one before it and the one after it, just as chain links are connected.

Rather than the unwieldy “chain of blocks,” early developers coined the term “blockchain.”

If you ever watched your children or grandchildren play with a set of wooden blocks (the ones with a letter of the alphabet on each side), besides stacking them and knocking them over, they probably placed them side by side in a row, or a chain.

The only difference between kids’ blocks and a blockchain is that the wooden blocks are solid. A blockchain isn’t a physical entity (you can’t hold it or pick it up). It exists only as a mathematical construct converted into a bunch of code and a lot of data.

All cryptocurrency blockchains are decentralized, which means that all the data is stored on every computer connected to that blockchain. So there's no point of failure, and very little chance of the blockchain being hacked. For larger chains like Bitcoin and Ethereum, there's zero chance of being hacked.

Crypto blockchains are permissionless, which means that anyone can use them. Purchasing the project's coin or token gives you access to the chain.

There are also permissioned blockchains, which some industries have implemented. Only those with permission to use the blockchain can access it. The most common type is being used for tracking and tracing of materials in various supply chains (for example, cacao).

Plans are afoot by central banks around the world to create what are called central bank digital coins (CBDCs). These will be centralized blockchains run by a central entity (e.g., the Federal Reserve in the U.S.).

A cryptocurrency is a completely digital coin or token that has a value. Bitcoin was the original cryptocurrency. It has existed since January 2009.

Using Bitcoin (BTC) as an example, a cryptocurrency coin or token is fungible. Each BTC is exactly like every other BTC, and each fraction of a BTC is like any other, just as one dime of U.S. currency is worth exactly the same amount as any other dime.

BTC is a store of value (although many dispute this claim since its price rises and falls by thousands of dollars). Of course, with U.S. inflation currently at over 7% a year, the USD isn't a great store of value either.

Bitcoin is also a medium of exchange. If I wanted to, I could buy physical or digital goods with it. It's currently not a practical medium of exchange though, since it takes an hour to confirm any BTC transaction.

What a Blockchain Does

Each cryptocurrency coin or token is a reward for the people who keep a copy of the blockchain on their computer. These people then sell their rewards on the open market.

Each time someone buys some Bitcoin from another person that sale/purchase is a transaction.

It’s just like any transaction you make with cash, or your debit card, or your credit card. With cash, your receipt records the transaction. If you use your debit card, your bank records the transaction and your monthly statement reports it to you. The same with your credit card.

All the Bitcoin transactions that occur in a set period (for Bitcoin, it’s 10 minutes) are bundled together into a block. That block is then chained (attached) to the block created 10 minutes previously.

This block creation and chaining process is called mining. The entire process is far more complicated than what I just outlined, but it may be enough for you to get the gist.

A Real-World Analogy

If you’re not sure you’re getting the gist, here’s an analogy. If you’ve ever driven across Canada’s prairies or the Great Plains in the U.S., you’ve probably seen mile-long trains. Many of those trains are grain trains.

Each car in those trains has been filled with grain stored in a grain elevator in a small town located next to or near a rail line.

A grain elevator next to a railway sidingNotice the tubes coming out of the elevator. These fill each car in the grain train from the top. Source

Blockchain transactions are the equivalent of the grain being loaded into each rail car. When the rail car is full, it’s shunted along and the next one is filled.

Imagine a set of three locomotives heading west from Winnipeg, Manitoba, to the port in Vancouver. When the train arrives at the port, it’s a mile long.

A grain train at a railway crossing.Mile-long grain trains head to Pacific ports every day. Source

It wasn’t that long when it started the journey in Winnipeg. It was likely the three units (each locomotive is called a unit) and perhaps five or ten grain cars.

Travelling all the way to Vancouver with just ten cars would make the grain inside them far too expensive to sell. But there aren’t 100 grain cars or more sitting in Winnipeg’s rail yards.

So the train picks up cars along the way. By the time it gets to the foothills of the Rockies, the train has reached its maximum length.

But if it had to stop in each small town and wait for each empty car there to be loaded, the train could take a week or more to reach the port. And that slow movement would congest the entire rail line, slowing the movement of other goods.

That’s currently the state of some blockchains, like Bitcoin’s. The process of adding transactions to a block is slow—just seven transactions per second. So Bitcoin is an impractical cryptocurrency to use for everyday transactions.

Compare it to Visa, which can process over thousands of transactions per second. Big difference! That speed is why it only takes a few seconds to complete a transaction when you hand over your credit card.

Sidechains Speed Up the Process

For decades, Canada’s rail lines were single track, which took traffic in both directions. To avoid head-on collisions, there were sidings. If an engineer saw a red light ahead, he had to pull onto a siding and wait for the oncoming train to pass.

When the light turned to green, he could proceed, but he wasted a lot of time.

Traffic on the rail lines grew so much that eventually the companies had to spend millions twinning the lines. So now there’s no waiting for an oncoming train to pass, because there is no oncoming train. One line is dedicated to westbound trains, and the other to eastbound traffic.

Similarly, sidechains speed up the processing of blockchain transactions by running alongside them, taking some of the load off the mainnet, the term for the main blockchain.

Offchain Transactions Also Lighten the Load on the Mainnet

On the prairies, there are engineers whose job is to shunt grain cars to railway sidings, where they’re filled with grain. Once they’re filled, they’re ready to head west to the port.

The grain train from Winnipeg stops at the siding, adds the loaded cars to its length, and moves on. This process might take just a few minutes, compared to the hours it would take to fill the grain cars on the main line.

Railway grain cards being loaded on a siding.Grain cars are left on a railway siding, to be filled with grain before heading to port. Source

Similarly, blockchain developers came up with the idea of processing transactions offchain.

To throw another analogy into the mix, think of these offchain transactions like a prepaid Walmart gift card. You take the card to any Walmart store (or shop online) and use it to purchase items, because Walmart agreed previously to accept it.

As long as there is still money on the gift card, you can continue to go to Walmart and pay for goods with it.

Similarly, the two parties in an offchain crypto transaction interact with each other directly in a channel separate from the mainnet. Once they fund this connection, called a channel, with a cryptocurrency, they can continue to transact business until the crypto runs out.

Moving back to the grain train analogy, the channel is like the railway siding, where the cars are filled with grain.

The two parties can continue to use this channel as long as they want, and all their transactions remain offchain (off the blockchain’s mainnet) until they end the channel, which usually occurs when the funds on the channel are all spent.

Once the channel ends, all the transactions they made, and the resulting balance in each party’s account, are recorded on the mainnet as a single transaction.

The siding/offchain analogy isn’t perfect. The siding’s purpose is to get loaded cars onto the main line as quickly as possible.

An offchain channel can continue indefinitely, as long as there are still funds available, and both parties want to continue transacting together.

Wooden Blocks, Grain Trains and Blockchains

Novel and complicated technologies, especially digital ones, usually have no real-world equivalent. So we need analogies to help us understand them.

This has been especially true with blockchain technology.

With the grain train analogy I presented here, you now know the basics of how blockchains work. They’re far more complicated than this though.

Fortunately, the complicated bits aren’t necessary to understand enough to become someone who uses crypto investments to flourish during retirement.

And with this “Blockchain 101 for Retirees,” you now have the added benefit of being able to hold your own with your kids or grandkids when they start talking about blockchains and the investments they’ve made in various cryptocurrencies.

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