Welcome to Blockchain For Dummies! If you want to find out what blockchains are and the basics of how to use them, this is the book for you. Many people think blockchains are difficult to understand. They might also think that blockchains are just about cryptocurrencies like Bitcoin, but they’re are so much more. Anyone can master the basics of blockchains.

In this book, you find helpful advice for navigating the blockchain world and cryptocurrencies that run them. You also find practical step-by-step tutorials that will build your understanding of how blockchains work and where they add value. You don’t need a background in programming, economics, or world affairs to understand this book, but I do touch on all these subjects because blockchain technology intersects all of them.

About This Book

This book explains the basics of blockchains, smart contracts, and cryptocurrencies. You probably picked up this book because you’ve heard about blockchains, know they’re important, but have no idea what they are, how they work, or why you should care. This book answers all these questions in easy-to-understand terms.

This book is a bit different than just about any other blockchain book on the market. It provides a survey of all the key blockchains in the public market, how they work, what they do, and something useful you can try with them today.

This book also covers the landscape of blockchain technology and points out some of the key things to be aware of for your own blockchain projects. Here, you find out how to install an Ethereum wallet, create and execute a smart contract, make entries into Bitcoin and Factom, and earn cryptocurrencies.

You don’t have to read the book cover to cover. Just flip to the subject that you’re interested in.

Finally, within this book, you may note that some web addresses break across two lines of text. If you’re reading this book in print and want to visit one of these web pages, simply key in the web address exactly as it’s noted in the text, pretending as though the line break doesn’t exist. If you’re reading this as an e-book, you’ve got it easy — just click the web address to be taken directly to the web page.

Foolish Assumptions

I don’t make many assumptions about you and your experience with cryptocurrency, programing, and legal matters but I do assume the following:

• You have a computer, a smartphone, and access to the Internet.
• You know the basics of how to use your computer and the Internet.
• You know how to navigate through menus within programs.
• You’re new to blockchain and you aren’t a skilled programmer. Of course, if you are a skilled programmer, you can still get a lot out of this book — you just may be able to breeze past some of the step-by-step guidelines.

Icons Used in This Book

Throughout this book, I use icons in the margin to draw your attention to certain kinds of information. Here’s what the icons mean:

The Tip icon marks tips and shortcuts that you can use to make blockchains easier to use.

The Remember icon marks the information that’s especially important to know — the stuff you’ll want to commit to memory. To siphon off the most important information in each chapter, just skim through these icons.

The Technical Stuff icon marks information of a highly technical nature that you can skip over without missing the main point of the subject at hand.

The Warning icon tells you to watch out! It marks important information that may save you headaches — or tokens.

Where to Go from Here

You can apply blockchain technology to virtually every business domain. Right now there is explosive growth in financial, healthcare, government, insurance industries, and this is just the beginning. The whole world is changing and the possibilities are endless.

IN THIS PART …

Discover what blockchains are all about and how they can benefit your organization.

Identify the right type of technology and the steps to developing and executing an effective blockchain project.

Make your own smart contracts on Bitcoin, and determine where this technology can fit within your organization.

Beginning at the Beginning: What Blockchains Are

A blockchain is a data structure that makes it possible to create a digital ledger of data and share it among a network of independent parties. There are many different types of blockchains.

• Public blockchains: Public blockchains, such as Bitcoin, are large distributed networks that are run through a native cryptocurrency. A cryptocurrency is a unique bit of data that that can be traded between two parties. Public blockchains are open for anyone to participate at any level and have open-source code that their community maintains.
• Permissioned blockchains: Permissioned blockchains, such as Ripple, control roles that individuals can play within the network. They’re still large and distributed systems that use a native token. Their core code may or may not be open source.
• Private blockchains: Private blockchains also known as distributed ledger technology (DLT) tend to be smaller and do not utilize a token or cryptocurrency. Their membership is closely controlled. These types of blockchains are favored by consortiums that have trusted members and trade confidential information.

All three types of blockchains use cryptography to allow each participant on any given network to manage the ledger in a secure way without the need for a central authority to enforce the rules. The removal of central authority from the database structure is one of the most important and powerful aspects of blockchains.

Blockchains create permanent records and histories of transactions, but nothing is really permanent. The permanence of the record is based on the dependability and health of the network. In the context of blockchains, this means that if a large portion of the blockchain community wanted to change information written to their blockchain, they could. Cryptocurrency is used as a reward to incentivize lots of users to facilitate the healthy function of the network through competition. If the records are changed inappropriately, this is known as a 51 percent attack. Small networks with few independent minors are vulnerable because it doesn’t take much effort to change their information, and powerful miners could do so and gain extra cryptocurrency. Ethereum Class experienced just this type of attack.

When data is recorded in a blockchain, it’s extremely difficult to change or remove it. When someone wants to add a record to a blockchain, also called a transaction or an entry, users in the network who have validation control verify the proposed transaction. This is where things get tricky because every blockchain has a slightly different spin on how this works and who can validate a transaction.

The Structure of Blockchains

Each blockchain is structured slightly differently. However, Bitcoin is a great blockchain to study because it was used as a template for most subsequent blockchains. The data on Bitcoin is structured so that each full node (the computers running the network) contains all the data in the network. This model is compelling from a data persistence point of view. It ensures that the data will stay intact even if a few of the nodes become compromised. However, because every node has a full copy of the history of transactions, since the very beginning, and every transaction in the future, it requires that the entries be as small as possible from a storage capacity point of view.

Comparatively, other distributed networks you may have heard of like Napster and Pirate Bay are an online index of data. Individual files are shared from specific nodes in the network. This allows sharing of large files. However, because the data you may be interested in is not available on all the participants in the network, obtaining the data you’re interested in is problematic. It’s also difficult to know if the data that you’re pulling down is intact and has not be corrupted or contains information you don’t want, such as a virus.

The way that Bitcoin coordinates the organization and input of new data comprises three core elements:

• Block: A list of transactions recorded into a ledger over a given period. The size, period, and triggering event for blocks is different for every blockchain.

  Not all blockchains are recording and securing a record of the movement of their cryptocurrency as their primary objective. But all blockchain do record the movement of their cryptocurrency or token. Think of the transaction as simply being the recording of data. Assigning a value to it (such as happens in a financial transaction) is used to interpret what that data means.

• Chain: A hash that links one block to another, mathematically “chaining” them together. This is one of the most difficult concepts in blockchain to comprehend. It’s also the magic that glues blockchains together and allows them to create mathematical trust.

  The hash in blockchain is created from the data that was in the previous block. The hash is a fingerprint of this data and locks blocks in order and time.

  Although blockchains are a relatively new innovation, hashing is not. Hashing was invented over 30 years ago. This old innovation is being used because it creates a one-way function that cannot be decrypted. A hashing function creates a mathematical algorithm that maps data of any size to a bit string of a fixed size. A bit string is usually 32 characters long, which then represents the data that was hashed. The Secure Hash Algorithm (SHA) is one of some cryptographic hash functions used in blockchains. SHA-256 is a common algorithm that generates an almost-unique, fixed-size 256-bit (32-byte) hash. For practical purposes, think of a hash as a digital fingerprint of data that is used to lock it in place within the blockchain.

• Network: The network is composed of “full nodes.” Think of them as the computer running an algorithm that is securing the network. Each node contains a complete record of all the transactions that were ever recorded in that blockchain.

  The nodes are located all over the world and can be operated by anyone. It’s difficult, expensive, and time-consuming to operate a full node, so people don’t do it for free. They’re incentivized to operate a node because they want to earn cryptocurrency. The underlying blockchain algorithm rewards them for their service. The reward is usually a token or cryptocurrency, like Bitcoin.

The terms Bitcoin and blockchain are often used interchangeably, but they’re not the same. Bitcoin has a blockchain. The Bitcoin blockchain is the underlying protocol that enables the secure transfer of Bitcoin. The term Bitcoin is the name of the cryptocurrency that powers the Bitcoin network. The blockchain is a class of software, and Bitcoin is a specific cryptocurrency.

Blockchain Applications

Blockchain applications are built around the idea that network is the arbitrator. This type of system is an unforgiving and blind environment. Computer code becomes law, and rules are executed as they were written and interpreted by the network. Computers don’t have the same social biases and behaviors as humans do.

The network can’t interpret intent (at least not yet). Insurance contracts arbitrated on a blockchain have been heavily investigated as a use case built around this idea.

Another interesting thing that blockchains enable is impeccable record keeping. They can be used to create a clear timeline of who did what and when. Many industries and regulatory bodies spend countless hours trying to asses this problem. Blockchain-enabled record keeping will relieve some of the burdens that are created when we try to interpret the past.

The Blockchain Life Cycle

Blockchains originated with the creation of Bitcoin. It demonstrated that a group of individuals who had never met could operate online within a system that was desensitized to cheat others that were cooperating on the network.

The original Bitcoin network was built to secure the Bitcoin cryptocurrency. It has around 5,000 full nodes and is globally distributed. It’s primarily used to trade Bitcoin and exchange value, but the community saw the potential of doing a lot more with the network. Because of its size and time-tested security, it’s also being used to secure other smaller blockchains and blockchain applications.

The Ethereum network is a second evolution of the blockchain concept. It takes the traditional blockchain structure and adds several new programming languages that are built inside of it. Like Bitcoin, it has over 10,000 full nodes and is globally distributed. Ethereum is primarily used to trade Ether and create smart contracts. The most popular Ethereum smart contract is the ERC 20. It allows for the generation of interchangeable tokens. These tokens can be used for fundraising purposes. You can discover more about smart contracts in Chapter 5.

There is a third evolution in blockchain technology that is under active development addressing speed and data size constraints. Fixing these issues will enable blockchain technology to be used more realistically with mainstream applications. It will take several years before it is clear what structure will win out.

Popular new developments include sharding, a type of database partitioning that separates large databases into smaller parts called data shards. An Ethereum development effort called fork choice rule splits the Ethereum blockchain into several parallel networks. It may allow Ethereum to scale more efficiently and reduce the congestion on the network, increasing transaction speeds and lowering transaction costs.

Another popular scaling theory is called POS. I cover this subject in more detail in Chapter 8. Broadly, POS is the concept of putting up tokens or cryptocurrency as a bond for processing transactions. If the node is corrupted and does not process the transactions accurately, the node may forfeit their tokens or cryptocurrency.

A third effort to scale blockchain technology utilizes trusted nodes. For example, the Factom network operates with federated nodes and an unlimited number of auditing nodes. These nodes are trusted with ensuring the system. Factom’s elected network is small, just over 60 nodes. To hedge for security risks, Factom anchors itself into other distributed networks to piggyback on the security of more extensive systems. Factom also partitions its network into smaller, faster, more easily managed parts called chains. Factom has faster transaction speeds and lower transaction costs than POW blockchains.

Consensus: The Driving Force of Blockchains

Blockchains are powerful tools because they create honest systems that self-correct without the need of a third party to enforce the rules. They accomplish the enforcement of rules through their consensus algorithm.

In the blockchain world, consensus is the process of developing an agreement among a group of commonly mistrusting shareholders. These are the full nodes on the network. The full nodes are validating transactions that are entered into the network to be recorded as part of the ledger.

Figure 1-2 shows the concept of how blockchains come to agreement.

Each blockchain has its own algorithms for creating agreement within its network on the entries being added. There are many different models for creating consensus because each blockchain is creating different kinds of entries. Some blockchains are trading value, others are storing data, and others are securing systems and contracts.

Bitcoin, for example, is trading the value of its token between members on its network. The tokens have a market value, so the requirements related to performance, scalability, consistency, threat model, and failure model will be higher. Bitcoin operates under the assumption that a malicious attacker may want to corrupt the history of trades in order to steal tokens. Bitcoin prevents this from happening by using a consensus model called “proof of work” that solves the Byzantine general’s problem: “How do you know that the information you are looking at has not been changed internally or externally?” Because changing or manipulating data is almost always possible, the reliability of data is a big problem for computer science.

Most blockchains operate under the premise that they will be attacked by outside forces or by users of the system. The expected threat and the degree of trust that the network has in the nodes that operate the blockchain will determine the type of consensus algorithm that they use to settle their ledger. For example, Bitcoin and Ethereum expect a very high degree of threat and use a strong consensus algorithm called proof of work. There is no trust in the network.

On the other end of the spectrum, blockchains that are used to record financial transactions between known parties can use a lighter and faster consensus. Their need for high-speed transactions is more important. Proof of work is too slow and costly for them to operate because of the comparatively few participants within the network and immediate finality need for each transaction. They also do not need a token or cryptocurrency to incentivize transaction processing. So, they eliminate these things from their system and run faster and cheaper than POW systems.

Blockchains in Use

Thousands of blockchains and blockchain applications are in existence today. The whole world has become obsessed with the ideas of moving money faster, incorporating and governing in a distributed network, and building secure applications and hardware.

You can see many of these public blockchains by going to a cryptocurrency exchange.

Figure 1-3 shows the altcoin exchange for Poloniex (https://poloniex.com), a cryptocurrency trading platform.

Blockchains are moving beyond the trading value market and are being incorporated into all sorts of industries. Blockchains add a new trust layer that now makes working online secure in a way that was not possible beforehand.