Blockchain Demystified

Last update March 12, 2025 (What’s new?)

1.1 Introduction

A blockchain is a system of networked computers storing information that can be shared in an open, trusted way, such that new information can be added but existing information can’t be changed.

The following analogy explains the concepts in simple terms.

1.2 Analogy

Once upon a time there was an island, in the middle of an ocean, as islands often are. The people of this island traded with each other by exchanging promises, such as “if you give me a goat today, I’ll give you 20 coconuts when they’re ripe.” At first, it was easy to remember who was owed fish or a new grindstone or fresh vegetables, but as the population grew larger it became harder to keep track, and sometimes there were disagreements about who promised what. So the people of the island appointed a scribe to keep track. Each time a promise was made, the scribe wrote it down with piece of charcoal on a scroll he kept in his house. Each time a promise was fulfilled, he added a note to the scroll. People could now see a clear record of every trade, all the way back to the beginning of the system.

But all was not perfect in paradise. A few people started complaining that they couldn’t trust the scroll or the scribe. “Hey, I promised you 20 seashells, not 30.” “Look, it says 30, right here on the scroll.” “That’s not what we agreed on. Somebody changed it! You bribed the scribe!” “I did not. You’re trying to change your promise.” Accusations flew, arguments escalated into fights, and one day the scribe disappeared with the scroll. They never saw him again. No one ever found out if he was taking bribes or if people were sneaking into his house and changing entries in the scroll, but they knew they needed a better system.

They couldn’t trust the scroll, since it could be altered, and they couldn’t trust people, because… well… they were people. The island needed an unchangeable record that everyone could verify. Some islanders suggested putting a huge rock in the center of town where every transaction could be chiseled into stone so it couldn’t be altered, but others pointed out that someone could still come in the middle of the night and add an unverified entry to the stone, such as “Bob gave Alice the 16 seashells he promised.”

Then a clever hermit named Satoshi proposed a solution: create multiple copies of an unalterable, public record so that any discrepancies could be resolved by consensus. The islanders agreed that once a day they would meet in the center of the island so that all new promises and fulfillments of existing promises could be recorded on multiple stone tablets by a group of islanders who took the job of “chiselers,”. Everyone could look at every tablet and verify every transaction. If there was a disagreement, for example if one chiseler wrote “Bob owes Alice 50 carrots” but another tablet read “Bob owes Alice 500 carrots,” all the tablets would be reviewed, and the most common entry would be the trusted version. In general, simply knowing that an attempt to falsify a record would likely fail the consensus test was sufficient to keep everyone honest. And a chiseler whose tablet frequently failed to match the others could be kicked out.

The idea worked. It was a bit complicated, chiseling on all the tablets took time and skill, so the chiselers were given a small portion of goods being traded to compensated them for their work, and the tablets had to be managed, but the islanders no longer had to worry about trusting a single scribe or a single scroll, and they lived happily ever after.

I came up with this analogy independent of similar analogies from (Shawn Dexter) and (Adam Cochran).

1.2 Blockchain Basics

A blockchain is an immutable, distributed ledger managed by consensus amongst a decentralized group of peers. As in the analogy, there are multiple copies of the ledger (slates), written in an unalterable way (carved in stone), shared by coequal participants (chiselers), and observable by anyone. Each record in the ledger is called a block, and each block contains transactions, metadata, and a cryptographic hash of the block before it. A hash is like a fingerprint for the block. The hashes link the blocks together to form an unchangeable chain, since any attempt to change a block will change its hash, which will no longer match the value stored in the following block. Each new block is added to the end of the chain, creating an ever-growing, chronologically ordered record. A set of computers each maintain a copy of the entire blockchain by sharing information over a network. Different blockchains have different protocols for what they store and how they share information, add transactions, verify blocks, and so on.

As in the analogy, blockchains were invented because of lack of trust. We can’t fully trust all parties, and we can’t trust people not to game a system for their own gain. For example, when you buy or sell a house, the buyer can’t completely trust the seller to own all rights to the house and land without liens and other encumbrances, and seller can’t completely trust the buyer to transfer the money, and neither party can completely trust the other to fulfill the promises and requirements of real-estate transactions, so an entire industry of title companies has arisen. Title companies are third parties that check the history of the home’s ownership, survey the property, review taxes, pay of mortgages, handle the money transfer via escrow, and so on. Title companies provide a valuable service, but they complicate the process, cost money, and —although their reason for existing is to create trust— they may not be reliable.

A decentralized system removes the central authority. If we could completely trust middlemen (banks, title companies, governments, payment processing services, etc.) we wouldn’t need decentralization. Centralization is simpler and more efficient, whereas decentralization is difficult and requires complex mechanisms such as immutability, data distribution, validation, consensus, etc. to prevent the system from being misused or attacked. Major systems such as Bitcoin and Ethereum are relatively safe, but there have been hundreds of attempts to create alternative blockchains that were poorly designed or poorly executed and fell victim to attackers. And, as is usually the case with cybersecurity, the biggest weaknesses are where the system connects to the real world.

Blockchains can be used for much more than cryptocurrency. Essentially any data can be stored on a blockchain. Blockchains can be used to make secure medical records available to any authorized used without needing a confusing web of data services. (How many MyChart accounts do you have?). Blockchains can be used for digital identity, including secure management of digital passports, driver’s licenses, etc. They can store and manage consent, help with voting, compliance, auditing, anti-counterfeiting, monitoring supply chains, and much more. They’re the foundation for NFTs (non-fungible tokens). That said, blockchains are often overused and overhyped. If there’s no need for decentralization, then a simple, secure database is almost always better.

1.3 Blockchain Terminology

Terminology
Explanation
Ledger
The information that makes up the blockchain, in multiple copies across the blockchain network. Like the islanders’ set of stone tablets.
Block
A chunk of records. E.g., one day’s worth of entries on the island’s stone tablets could be a block. Blocks typically hold transactions, but can essentially hold any data.
Chain
Since a blockchain can’t use stone tablets, it needs a way to make its data unalterable (immutable). When a new block is written, it points to the most recent previous block, creating an ever-growing chain of blocks. The link to the previous block is a cryptographic hash, like a fingerprint of the block, so that it’s essentially impossible to alter a block without obviously breaking the chain.
Decentralized
More than one copy distributed amongst more than one governing party. In our analogy, the original scroll maintained by a single scribe was centralized. The stone tablets managed by multiple scribes was decentralized and distributed. Decentralization avoids the need for central control and safeguards data by having multiple copies.
Permissionless
Blockchains have no central authority, so any party can participate in a blockchain as a worker (node), a user (transactor), or simply a viewer. Nodes participate in the process of creating blocks and maintaining the chain. Typically, the only requirement is sufficient computing power (see Proof of Work) or sufficient cryptocurrency to use as collateral (see Proof of Stake). Users submit requests for data to be stored on the blockchain, often in the form of transactions.
Trustless
Because of consensus, where nodes essentially check each other’s work, there’s no need to trust individual participants, only the blockchain system itself.
Public
Most blockchains are public, meaning anyone can check any transaction on the chain (using software that talks to a node). However, private blockchains can be created by controlling who can run a node.
Transaction
In blockchain terms, a transaction is a single record of activity. In general terms it’s either the creation of a new piece of data on the chain or a later update that references an existing transaction. For cryptocurrencies, a transaction is commonly a transfer of crypto coins from an owner to a new owner, but it can also be the creation of a smart contract or app, or the execution of a contract or app. Transaction requests are usually broadcast to the blockchain network where validators or miners bundle them into a new block on the chain. The person or entity requesting the transaction has a unique cryptographic key that allows them to control the transaction, similar to a key to a safe deposit box. (See cryptocurrency transaction for more.) For a cryptocurrency transfer, the owner can request that the coins in an existing transaction be given to a new owner or split amongst multiple new owner, which results in a new transaction that only the new keyholder(s) can access.
Coin
The currency, or digital asset, that is native to a blockchain. Most blockchains use coins as the underlying mechanism to attract participants by rewarding coins (or fractions of coins) for creating blocks or handling transactions. The chain and the coin often have the same or similar name: the Bitcoin blockchain uses bitcoins (or BTC), the Ethereum blockchain uses Ether (or ETH), Solana uses SOL, etc. Confusingly, cryptocurrencies are colloquially called "coins." Many cryptocurrencies are built on top of other blockchains, so their "coins" are actually tokens in the underlying blockchain.
Token
A digital asset or transactional unit that piggybacks on an existing blockchain. Defining a token format creates new functionality without the need to establish a new blockchain. Token types include:
  • utility or platform – to provide users with access to a product or service, similar to a coupon or voucher
  • security – to represent ownership of tangible assets such as stocks, bonds, or real estate
  • DeFi (decentralized finance) – to provide decentralized features of traditional financial institutions such as lending, saving, insurance, and trading
  • asset – to represent ownership or real or virtual items (e.g., NFTs are asset tokens)
  • governance – to govern a protocol or organization, often used for voting
  • transactional – a medium of exchange for transactions beyond the underlying blockchain transactions
  • reward – to represent points, typically associated with loyalty programs
Immutable
Set in stone. Unchangeable. A key aspect of blockchains is that data can never be erased or changed. In the case of blockchains that hold transactions, there are no "account totals" that have values credited or debited, instead there is a new transaction that points to previous transaction, thus "moving" value from the old owner to one or more new owners. For some blockchains the data is actually moved, for others the owner reference to the block is changed.
Hash
A short, fixed-length value created by feeding a set of data into a formula that derives a (usually) unique result. It’s like a fingerprint, where a small pattern can uniquely represent an entire person. For blockchains, the miners or validators compete to be the first to generate a hash for the block that meets certain criteria defined by the protocol. The winner’s block is then added to the blockchain by all the other miners or validators.
Protocol
The rules of a blockchain. The agreed way to record transactions, reach consensus, validate blocks, etc.
Node
The device, usually a computer, that runs the blockchain protocol to store blocks and talk to other nodes. Nodes on a blockchain network are peers, meaning they’re all equal, with no centralized authority. Nodes are kind of like the houses on the island where the chiselers live and the tablets are kept. There is no approval process for nodes. Anyone who wishes to can simply set up a computer running software that implements the blockchain protocol. A simple blockchain might have a dozen or so nodes, whereas a large, popular blockchain like Bitcoin typically has tens of thousands (see Bitnodes).
Validator
A node that adds blocks to the chain or checks blocks being added to the chain. A validator that adds new blocks to the chain (by computing a valid hash and sending the completed block to other nodes) is like a chiseler in the analogy. Validation may also refer to confirming that a block on the chain is valid (has the right hash, links back to the previous block, etc.). Validation is sometimes called verification, confirmation, or auditing. Validation can also, depending on the type of blockchain, refer to determining that a transaction request is signed by the owner of the referenced transaction, that the source transaction has the needed amount of cryptocurrency, that the debit and credit add up to zero, that a stored credential is authentic, etc.
Miner
A node that adds blocks to certain types of chains (such as Bitcoin). Miners are like chiselers in the analogy. A miner repeats complex calculations as fast as possible in the hopes of coming up with a block hash that meets the rules before any other miner does, then it sends the block to other nodes on the network. The winning miner is typically rewarded with a transaction fee and a newly minted chunk of cryptocurrency (which is why the mining analogy is used, since new coins are created).
Mining
In the island analogy, the job of chiselers is difficult because they’re carving stone. Some blockchains, such as Bitcoin, artificially create difficulty to control how many miners participate and how quickly they can create new blocks. If mining were too easy, bad actors could potentially try to corrupt or overload the system with invalid transactions. On the other hand, if mining is too hard, not enough nodes will participate to keep the blockchain viable. Difficulty is usually controlled by the hash requirement (which essentially controls the average numbers of times a miner has to guess at a number that will result in a valid hash). As the number of miners grows or shrinks, and as computing power increases over time, the hash requirements are adjusted to maintain a desired level of difficulty. In the case of Bitcoin, difficulty is adjusted about once every two weeks to keep the hash rate at roughly 10 minutes, meaning a new block is added every 10 minutes. In cryptocurrency blockchains, such as Bitcoin, mining difficulty results in digital scarcity, which contributes to perceived value in the same way that the scarcity of gold or diamonds contributes to their perceived value.
Validating
Transactions and blocks must be validated. Transactions are validated by ensuring that no transactor "spends" more coin than they have. For example, if Alice has 2 coins and wants to give 1.5 coins to Bob, Alice submits her wallet address so the node can look up her transactions to see if she has at least 1.5 coins. Alice also submits Bob’s wallet address so the node can add a new transaction indicating that Bob has received 1.5 coins and Alice is left with 0.5 coins. Blocks are validated upon being submitted by a node to the network. The other nodes validate the block by checking (a) that its previous block hash matches the hash of the previous block, (b) that all the transaction hashes and signatures are correct (see mining tech details), (c) every transaction correctly uses unspent coins from a previous transaction, and a few other details. This works because transactions are zero-sum: every coin on the chain either comes from an existing transaction, was generated as a reward for work by a node, or was generated by an intrinsic coin creation mechanism of the protocol.
Consensus
Agreement by the majority of participants. In the island analogy, a single scribe can’t be trusted. Instead, a majority of chiselers agreeing on a transaction creates a consensus that can be trusted. (Of course you have to buy into the notion that the consensus mechanism works and that the system is designed to properly mediate consensus.) In blockchains, consensus is reached after a new block is added to the chain and a majority of the other nodes agree that it’s valid.
Proof of work
Proof of work (PoW) is a consensus mechanism used by some blockchains, such as Bitcoin, to make mining difficult and keep participating nodes "honest". In order to win the competition to create a valid block before other miners, a miner has to solve a difficult mathematical problem (guessing the right number to combine with transaction data to meet the hash requirement). As explained in mining, the computational effort governs blockchain creation and deters nefarious manipulation of data by artificially raising the bar (in the form of computing power.) A major downside of proof of work is that the computations require powerful computers that use lots of energy. Another drawback is that only companies or "pools" of miners with enough computing power are able to participate as nodes.
Proof of stake
Proof of stake (PoS) is consensus mechanism used by some blockchains, such as Ethereum. Each node "stakes" some amount of its own cryptocurrency to become a trusted participant, which incentivizes the node to create valid blocks, since otherwise it could lose the cryptocurrency it staked. One node is chosen randomly to add its block to the chain, and as a result is paid a transaction fee (in the underlying cryptocurrency of the system). As with a lottery, the more a node stakes, the higher its odds of being chosen. Consensus can be reached much faster than with proof-of-work blockchains because there is no artificial difficulty, and much less power and energy is used. A drawback is that control may become too centralized, as those with more cryptocurrency to stake have a higher chance of being chosen to validate transactions.
Anonymity
Most blockchains make transactions anonymous by using a number (called an ID or an address) to identify the participants in each transaction. In the island analogy, this would be like each villager having an undisclosed symbol that’s put on the tablet instead of their name. As with the analogy, it should be clear that the transactions are not secret or private (anyone can see everything on the tablets), and that it’s possible to identify participants by looking at the characteristics of the transaction. Many people incorrectly think that the use of addresses makes blockchains such as Bitcoin and Ethereum private or anonymous.
Wallet
A place to store the digital credentials (address and keys) that you need to access your transactions on the blockchain. This is a misleading term, since it implies that currency or transactions are stored in the wallet, but it’s more like storing the key to your house in your wallet. Anyone can see all the transactions on the chain, but if you want to reference an existing transaction, e.g., to transfer some of your cryptocurrency, you need the address of your transaction and your secret key to "unlock" it. To create a new transaction, you need your secret key to "lock" it, and your wallet will receive an address for the new transaction. A wallet is a software application running on a general-purpose computer or specialized hardware device. Wallet apps provide features to let you see the transactions that belong to you, send new transactions to the network to be added to the blockchain, and so on. You don’t need a wallet to use a blockchain, since there are many services that can manage this for you. (In essence, they keep a wallet for you that you can access by logging into their service.)