The following article is a contribution to Humans of Blockchain ™
from Jan Young – MBA, Product Manager, Blockchain Enthusiast & Blogger
I was drawn to Blockchain technology first. For me, the coins were secondary. I’d heard about the Bitcoin hype of 2017, but I hate hype. FOMO — Fear of Missing Out, is big in the cryptocurrency world: “What if the next big coin comes out, and I miss it?” I don’t really care about FOMO. I distrust get rich quick schemes.
So, my first question when I started learning about Blockchain was: “How can I get rid of the coins?” BUT, that kind of misses the point in 2 ways.
- Per my previous article, the technologies that make up Blockchain were combined in part to solve the problem of how to use currency over the internet with strangers (AKA Trustless) so the coin WAS the point.
- The coin is part of the design. NEW CONCEPT in this series: Coins compensate and incentivize the miners.
Remember the Miners from the previous article?
MINERS: The owners of the computer nodes that process the blocks of the Blockchain.
Mining costs money — literally. Miners invest in equipment and pay electrical bills for running and cooling equipment. So, they need compensation and incentives for mining. Miners are incentivized by a combination of a reward and transactions fees. (The transaction fees vary based on supply/ demand and are paid when you transact on the blockchain.)
The Miner’s Reward.
If you recall, in the previous article about the Bitcoin protocol, each Miner is racing to solve the nonce. A nonce is the answer to the encryption math problem for the block. The encrypted nonce includes all the transactions for the block as well as the nonce from the previous block, thus linking the transactions on the blockchain, and protecting the transactions from being changed. The Miner who “wins” the race to find the block nonce earns newly minted Bitcoin.
The reward has actually changed over time by design: initially, the miner reward was 50 Bitcoins per block, this reward was halved 4 years later in November 2012 to 25 Bitcoins, and continues to halve every 4 years until the total number of Bitcoins in circulation is 21 million coins. Currently, the reward is 12.5 Bitcoins per block.
Miner’s Reward = New Bitcoin
The Miner’s reward isn’t just an incentive, it is how newly minted Bitcoin is steadily introduced into the cryptocurrency. New Bitcoins are created and added to the total number of Bitcoins when the Miners create a block — that is how they got the name “Miners” because it is like they are “digging for gold” when a computer node solves a nonce and new Bitcoins are created.
By Satoshi Nakamoto’s design, the maximum number of Bitcoins that will be produced is 21 million. Since each block is designed to be created every 10 minutes, there are approximately 144 new blocks each day. More than 98% of the Bitcoin will be mined by 2030, but due to halving, the full 21 million Bitcoins will be mined sometime during 2140.
The Bitcoin protocol was also designed to prevent the type of inflation that we experience in government currencies like the US dollar.
For Example, US dollar inflation:
In 1970, $1 could buy about 3 gallons of gas, but in 2018, $1 can buy about 1/3 of a gallon of gas (at a Los Angeles Costco last week).
Bitcoin over time is intended to be worth MORE, not less because there will only ever be a finite number of Bitcoins.
Since the value of Bitcoin is expected to increase, people tend to buy Bitcoin and HOLD it as an investment. You may see this referred to as HODL. This is not really an important term, just like FOMO is not really an important term. I only mention it because you might run across it as you read other articles.
Sidebar: What is a Protocol?
You may have heard the word “platform” in connection to technology — you’re either using Windows platform or Mac platform. Your phone is either an Android platform or Apple. Platforms require different equipment and software that goes with it. You can’t use an app made for an Apple phone on your Android phone because they are different platforms. These are things that we know just from using our phones and our computers, we didn’t have to study computer science to experience it.
For Blockchain, it doesn’t matter if you’re on a Mac or a PC. It doesn’t matter if you have an Android or an Apple phone. Thus, different blockchains are not usually described as platforms.
A protocol is a framework of rules.
Each type of blockchain has a set of rules that determine how it is structured and how it works, so they are each usually referred to as protocols.
Above, I described some of the rules for Bitcoin — how Bitcoin is created, how it is earned by Miners, how much is earned over time by Miners, and the maximum number of Bitcoins. These rules are part of what makes up the Bitcoin protocol.
As well, most blockchain protocols have an associated cryptocurrency/ coin. This is kind of like how each country has a different currency. You might exchange a US dollar for a Canadian dollar or for a Euro. They each have relative market values based upon the perceived strength of the currency. Bitcoin was the first cryptocurrency created on a blockchain that could be transacted safely over the internet, and it continues to be the strongest of the cryptocurrencies. There are online cryptocurrency exchanges where you can trade one type for another, much like how one might exchange US dollars for Canadian dollars or Euros.
Later Discussions coming in the series: Alternative Coins/ Alt Coins, and other types of coins such as Security Tokens and Utility Tokens
More About Transaction Fees.
Or, why Blockchain isn’t for the masses yet.
When there are lots of transactions (Tx), demand is higher and transaction fees are higher. During the big rush on Bitcoin and other cryptocurrencies in the fall and winter of 2017, transactions got expensive and took longer. Bitcoin, by design, can process up to 7 transactions per second. During the market peak, when there was a demand for more transactions than what could be completed in a block, the transactions willing to pay higher fees were taken first, and thus it sometimes took days for a transaction with a lower fee to be added to the blockchain.
Changing the maximum transactions that can be processed in a Bitcoin block would require a change in the protocol design, leading to a FORK in the Blockchain. I will reserve that concept for a later discussion.
Thus, another limitation on scalability is when demand is high, transaction fees get higher too. And if you want to buy a $5 cup of coffee with Bitcoin, you don’t want to wait until the next day for the transaction to complete and then get charged $30 for the transaction.
These types of issues during the peak market of 2017 made it clear to the Blockchain community that cryptocurrency is not yet ready for mainstream use, not until scalability can be addressed. This is especially true when you consider that some people envision Bitcoin replacing government currencies. Bitcoin’s 7 transactions per second doesn’t begin to compare to Visa processing 24,000 transactions per second.
There are lots of people working on scalability so that blockchain based cryptocurrencies can be used in a more feasible manner. That is in part what led to so many Alternative Cryptocoins as well as scalability projects usually referred to as Layer 2 Technologies. There are so many Alternative coins and scalability projects, I’ll address them in a later article.
Lastly, in answer to: Can I Skip the Crypto?
The case for cryptocurrencies.
While in the US, we feel comfortable with our currency and generally can trust its stability, that isn’t the case in every country. There are countries that periodically have very high inflation and wipe out economic value, most recently we’ve seen that in Venezuela. But other countries are challenged to have basic marketplaces that we take for granted in the US. One of the co-founders of Ethereum, Charles Hoskinson, spoke about that recently in Los Angeles at Start Engine Summit, you can check it out here (inspiring and fascinating 20 minutes). In these types of economies, the case can easily be made today that cryptocurrencies can provide more stability or allow for marketplaces to develop. (More about Cryptocurrency blockchain uses in another article.)
Skipping the Crypto.
Cryptocurrencies and Tokens are primarily associated with Public Blockchains such as Bitcoin: Anyone can participate, just buy a Bitcoin and you can transact on the Bitcoin blockchain. However, there are Permissioned Blockchains such as Private Blockchains and Consortium Blockchains that are not available to the public, you have to be invited or part of a group.
An example is Walmart’s global food tracking initiative using blockchain. The only participants are vendors that work with Walmart. It has allowed Walmart to find the source of salmonella outbreaks in seconds when it used to take weeks. Walmart is now looking to expand the project to include more buyers and more vendors. Blockchain systems like these do not necessarily have Cryptocurrencies or Tokens as part of their design. (more on these later)
In the end, it depends on the purpose and the design of the blockchain. The primary element of a Blockchain is the Decentralized Ledger Technology (DLT) in which the data is kept across a decentralized group of computer nodes. If the participating nodes are permissioned (invited by you) and you do not need to incentivize them to participate, or if all the nodes are private and operated by you, then you do not necessarily need a coin or token as part of your design.
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