An Introduction to Blockchain and How it Works

Blockchain blocks

It’s difficult to watch any kind of media without seeing a reference to Bitcoin, cryptocurrency, or blockchain. But despite its popularity, Blockchain remains a relatively enigmatic topic that most people don’t quite understand. But with the combined market cap of cryptocurrency reaching $3 trillion, it might pay to learn a bit about it.

So let’s start out with the basics.

What is a blockchain?

Blockchain is the infrastructure that allows the use and transfer of cryptocurrencies. It’s a digital ledger that keeps track of every transaction that happens within its protocol. But what does that mean?

Think of blockchain as Visa or Mastercard. Visa is a payment processing system that tells your bank to send funds to an account when you swipe your card. You’re able to send different kinds of currency over the network. It just depends on what’s in your bank account and where you live.

Blockchain is quite similar in that it processes all “payments” or transactions that happen on the chain. These transactions are then logged publicly so that anyone can look and see what’s going on. While that might seem a little intrusive, it provides a considerable amount of transparency especially when it comes to organizations operating on the chain.

How blockchain works

Nodes

Additionally, a blockchain is hosted on a number of different servers, commonly referred to as “nodes”. These nodes can be anywhere in the world, they just need to be hooked up to the internet to talk with each other. When a transaction happens, the information is sent to one of these nodes.

The node will take the information, verify that it’s possible (make sure there are funds available), and then send it to the other nodes for confirmation. Once a certain number of nodes have verified the process, it will be added onto the blockchain and the transaction will happen. All this, within a matter of seconds or minutes, depending on how busy the blockchain is.

Smart contracts

The basic use of a blockchain is to simply be an online ledger that keeps track of everyone’s cryptocurrency wallet and what’s inside. This is exactly what the Bitcoin blockchain does, and only this. But a few years after the release of Bitcoin, several developers got together and built the Ethereum blockchain.

Ethereum blockchain

The Ethereum blockchain works a little differently than Bitcoin because it utilizes smart contracts. Smart contracts are bits of code that can be run on the blockchain itself. This adds much more functionality to a blockchain because it means applications and programs can be built to interact with the blockchain.

Dapps

This has given rise to decentralized applications or DApps for short. These DApps started out simple like a random dice game that you could bet crypto on. You could select over or under, then the application would randomize a number. The winner would get crypto transferred to their wallet, the loser would have the crypto withdrawn.

But as things have progressed, DApps have gotten significantly more complex and useful. Nowadays, there are tons of different applications that do a wide variety of things. One of the most used DApps is AAVE, and it’s heavily regarded as a “blue-chip” DApp.

AAVE

AAVE is a borrowing and lending protocol that allows cryptocurrency holders to deposit tokens as collateral, and then borrow other tokens against it. Additionally, there are decentralized exchanges (DEXs) that allow users to swap between tokens. So, if you have Bitcoin tokens and you want Ether, you can use the DEX to switch tokens for a fee.

Blockchain process diagram

Layer-1 blockchains

Blockchains like Bitcoin and Ethereum are what are known as layer-1 blockchains. Unfortunately, layer-1 blockchains can’t communicate directly with each other. So, it’s impossible to simply transfer 1 Bitcoin to the Ethereum network, or 1 Ether to the Bitcoin blockchain.

Wrapped tokens

But how is there Bitcoin on the Ethereum network then? Programmers developed a workaround solution, and it’s what is known as a wrapped token. Simply put, a wrapped token is a representation of another token.

So, if someone wanted 1 Bitcoin on the Ethereum network, they would essentially deposit their Bitcoin (BTC) in a specific wallet on the Bitcoin blockchain. Then, they would get a wrapped version of Bitcoin (wBTC) sent to their Ethereum wallet. For all intent and purposes, the wrapped token is BTC and will follow its price accordingly.

Currently, no layer-1 blockchains can directly transact between one another. It’s one of the biggest issues and conundrums in the blockchain world. The workaround has been the process mentioned above, and it’s conducted by a “bridge” established between two different blockchains.

Other layer-1 blockchains

Ethereum was the first blockchain to incorporate the use of smart contracts, making it the go-to blockchain for all DApps and the majority of traffic. Unfortunately, it wasn’t ready for the massive amount of attention it received.

Etherium is expensive

Currently, the Etherium network charges enormous fees to transact on the blockchain. I advise people to avoid Ethereum as simple transfer fees can be $10-$20, and swap fees could be anywhere from $50-$200. So for those looking to dabble, you could spend your crypto very quickly.

Binance, Fantom, Terra, Avalanche, etc.

This has led to the creation of other layer-1 blockchains that are essentially improved copies of Ethereum. These blockchains include Binance Smart Chain (BSC), Fantom, Terra, Avalanche, and several others. These other blockchains each have their own ecosystem and DApps and offer much lower transaction fees. For example, compared to Ethereum, the Fantom blockchain will charge about 10 cents for transfers and under a dollar for swapping tokens.

Newcomers to Blockchain

It’s highly suggested that newcomers start out on one of these other chains (above) as opposed to Ethereum. Low fees and costs will ensure you don’t lose too much money on simple transactions and allow you to get the hang of things before moving on.

While these layer-1 blockchains are smaller than Ethereum, they still have a lot to offer. In fact, there are many “forked” (copied) DApps that were on the Ethereum blockchain that are now available on BSC, Fantom, and Avalanche.

Tokens

Each of the blockchains we’ve mentioned has a certain token type associated with it, meaning that all tokens of that type will work on the blockchain and show up in your wallet. So, while you will see USDT on the Fantom network, it’s actually fUSDT, the Fantom version of the token. In order to transfer it to another blockchain, you will have to use a bridge like Spookyswap.

How do I start using Blockchain?

Now that you understand a little bit of how the blockchain world operates, I’m sure you’re wondering where to start.

Cryptocurrency wallet

Cryptocurrency wallet

The first thing you need is a cryptocurrency wallet. You can check out this article How to Set Up a Cryptocurrency wallet for a quick guide on how to download and set up MetaMask, one of the most popular wallets available.

Cryptocurrency symbol

Purchase cryptocurrency

Next, you’re going to need to trade some of your FIAT currency (USD, Euro, etc) for some cryptocurrency. The easiest and safest way to do this is by using a centralized exchange like Coinbase, Binance, or Gemini. They will allow you to deposit funds in an account and use those funds to purchase a wide variety of cryptocurrencies.

Blockchain symbol

Choose a blockchain

Every centralized exchange is built on or at least connected to the Ethereum blockchain. So as mentioned above, you probably want to avoid it for now, which is easier said than done. Fortunately, most centralized exchanges allow the transfer of certain tokens to different blockchains.

For example, Binance allows you to send certain crypto to the Binance Smart Chain (BSC). However, only BEP-20 token types will work on the blockchain. That usually means you can only send BUSD (Binance USD) or BNB (the cryptocurrency coin that powers the Binance ecosystem) to your BSC wallet. Be sure you are sending the correct type of token to your wallet, otherwise, you will lose it forever.

Start using DApps

Once you have BNB or BUSD in your wallet, you can then use it with any DApp on the BSC chain. As I mentioned above, you can also use a bridge like Spookyswap to take your tokens from BSC to the Fantom blockchain. Since you are off the Ethereum blockchain, you can enjoy low fees and explore the world of blockchain without spending too much cash.

If you enjoy Youtube, Whiteboard Crypto has some amazing explanatory videos on crypto and blockchain.

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