What is Blockchain? A simple explanation for Product Managers
This article is for Product Managers who want a non-technical explanation of what blockchain is and how it works. I’ll also explain why cryptocurrencies are called that, and what makes blockchains secure and powerful enough to challenge traditional banks.
I’ll also cover some of the challenges blockchain is facing right now, from scaling the network to improving security before quantum computers become a threat.
Most of the information in this post comes from two great books, The Promise of Bitcoin by Bobby Lee, and The Bitcoin Standard by Saifedean Ammous. I’ll do my best to simplify some of the complex concepts from these books and explain them in plain terms. It’s more of a mental exercise for me than anything else.
Why is it called a cryptocurrency?
The word “crypto” comes from cryptography, the technology used to secure the network. In this case, the network means a group of computers spread across the world and connected through the internet. Cryptography is based on maths, and every transaction is protected using it.
The “currency” part comes from Bitcoin, Ethereum, and other digital coins. A big part of their value comes from belief, if enough people agree something is valuable and are willing to trade for it, then it is valuable. That’s true for Bitcoin, just like it is for gold, pounds, and even art.
Blockchain is like a shared notebook
Think of blockchain like a notebook that everyone can see. Each page has a number and a list of transactions. Once a page is full, you move to the next one. The pages are numbered in order, and once something’s written, you can’t go back and change it. If someone tries to remove or edit a page, the numbers won’t match up, and everyone will notice something’s wrong.
Now let’s assume all your friends have exact copies of the same notebook. Whenever a new entry is added, everyone gets notified and writes it down in their own copy. If someone tries to cheat or skip ahead, the others will ignore it. That’s how the notebooks stay in sync. Everyone works together to make sure the information is correct and consistent.
Blockchain is made up of nodes and blocks
In this analogy, your friends are the “nodes” in the network. The notebook is a digital ledger that we call “blockchain”, and each page is a “block” within the blockchain. The text on each page represents “transactions”. Every block contains one or more transactions, a digital signature and a reference to the previous block, which is how the chain is formed.
For example:
→ Node A (Blockchain/Notebook):
↳ Block 1
↳ Previous block: None
↳ Digital signature: 4738023101c2r3df2m
↳ Transactions:
→ Alice sent money to Bob
→ Bob sent money to Maria
↳ Block 2
↳ Previous block: Block 1
↳ Digital signature: 3045022100b1c3ff9a
↳ Transactions:
→ Charlie sent money to Bob
↳ Block 3
↳ Previous block: Block 2
↳ Digital signature: 7153879011t5f3de8i
↳ Transactions:
→ Charlie sent money to Maria
→ Node B (Blockchain/Notebook):
↳ Block 1
↳ Previous block: None
↳ Digital signature: 4738023101c2r3df2m
↳ Transactions:
→ Alice sent money to Bob
→ Bob sent money to Maria
↳ Block 2
↳ Previous block: Block 1
↳ Digital signature: 3045022100b1c3ff9a
↳ Transactions:
→ Charlie sent money to Bob
↳ Block 3
↳ Previous block: Block 2
↳ Digital signature: 7153879011t5f3de8i
↳ Transactions:
→ Charlie sent money to MariaQuick breakdown:
- Previous block: The hash (or as we called it earlier, the page number) of the previous block in the chain. Block 1 is the first block in a blockchain and doesn’t have a previous hash. It’s called the “genesis block”.
- Digital signature: It’s used to sign your transactions, so the system knows the transaction belongs to you without knowing who you are. For example, instead of entering a 4-digit pin into a card reader, you use a secret password called a “private key”.
- Transactions: A block contains a list of transactions, and each one has its own ID, and logs where the money is coming from (inputs), and where it’s going (outputs).
Blockchain is a system of trust
Blockchain is a decentralised, encrypted system made up of nodes and blocks. People refer to it as a “system of trust”. It’s designed to replace intermediaries with code and remove the need for trust in people or institutions. Instead, trust is built into the system itself.
If only one person, usually an accountant, is keeping records of who paid what, you’d have to trust that person to be honest. But in the notebook example, no one’s in charge. Everyone has a copy, and everyone checks every new page. If someone tries to cheat, the others will spot it and reject it. This system of trust doesn’t rely on any one person, it relies on the rules, the maths, and the system. It’s not about trusting an accountant, it’s about trusting the system to catch mistakes or fraud on its own.
How the blockchain network stays in sync
When a new block is added, only that block is shared across the network, not the entire chain. Each node checks the new block, adds it to their copy, and moves on. This avoids flooding the network with unnecessary data.
For example, if Alice finishes writing page 27 in her notebook, she doesn’t send the whole notebook to Bob and Charlie. She just sends page 27. They each read it, check that the page number follows 26, and that all the transactions look valid. If everything checks out, they copy the page into their own notebook. This way, all the notebooks stay in sync.
Who are the miners and what do they do?
Miners are special nodes responsible for creating new blocks and securing the network. When a miner wants to add a block, it sends the data to the other nodes and makes sure everyone agrees the block is valid.
For example, when you buy something at a shop with your credit card, the cashier uses a machine to read your card number, the expiry date, and your secret 4-digit pin. The cashier then sends that info to the bank, and if the bank gives the green light, the payment goes through.
In blockchain, the bank is the network, and when the cashier sends a transaction, it gets sent to the whole network. All the nodes (or computers) receive it, check that it’s valid, and if it is, they pass it along to the miners. The miners then take the valid transactions and try to save them using a process called “Proof of Work”.
Proof of Work (PoW) algorithm
In our notebook analogy, before anyone can write the next page, they must win a challenge. Let’s say your friends decide that whoever names the song playing on Spotify first gets to write the next page. Everyone starts shouting out names until someone gets it right. The winner writes the page, and then everyone copies what they wrote. As a reward for writing the page first, that person receives a £1 coin.
When it comes to financial systems, speed matters. No one wants to wait ages for a payment to go through. In blockchain, miners don’t just compete to earn rewards, they compete to see who’s the fastest. So the more expensive your hardware is, the better your chances of winning.
So instead of friends guessing songs, nodes have to solve complicated math problems. This requires a lot of computing power and energy. These math problems involve using the digital signature and hash from the previous block to ensure everything matches correctly. If even one transaction has a different hash, the network rejects it and the dishonest node that tried to alter the chain doesn’t get a reward. So if you play fair, you earn money, but if you cheat, you waste time, energy, and money.
Who chooses the miner?
In Proof of Work blockchains like Bitcoin, no one selects the miner. It’s a race. The first one to solve a complex equation gets to add the next block. It’s similar to the Spotify challenge, the first person to guess the song gets to write the next page.
However, over time, the equations get harder and harder to solve, so they need more computing power. That’s why individual miners with small machines can’t really compete anymore. So while technically anyone can mine, in practice it’s mostly done by banks and big orgs with data centres packed with Nvidia servers, which goes against the original vision of decentralisation.
Another algorithm called “Proof of Stake” was created as an alternative to Proof of Work, to help solve this problem. It offers a different way to decide who gets to add the next block to the blockchain.
Proof of Stake (PoS) algorithm
In this version, the nodes that want to add the next block don’t have to run complex mathematical calculations. Instead, they put some of their own money (called a stake) on the line. The system then picks one of them, usually based on their past reliability and performance. If they try to cheat, they lose their money. So if you play fair, you earn money, but if you cheat, you lose it.
Proof of Stake keeps the network decentralised and uses much less energy than proof of work. Because of that, it’s becoming more popular in newer blockchains.
How do transactions work?
Users in a blockchain network aren’t identified by name or email. Instead, each user has a unique public key (like an account number) and a private key (like a password). The public key is visible to everyone and is used as your identity on the network. The private key is kept secret and is used to sign transactions.
When two users want to exchange cryptocurrency, the sender creates a transaction saying “I’m sending this amount to this public key.” They sign it with their private key, which proves it came from them without revealing their identity. The network then checks that the signature is valid and that the sender has enough funds.
Once verified, the transaction is added to a block and recorded on the blockchain. At that point, the funds are considered transferred, and everyone’s copy of the ledger reflects the new balances.
Challenges Blockchain still faces
- Scalability: Blockchains can slow down and get expensive as more people use them. Handling thousands of transactions per second is still not fully solved.
- Centralised mining: Because proof-of-work needs so much computing power that mining can only be done by those who can afford powerful servers and huge energy bills.
- Quantum threat: Quantum computers pose a threat because they could potentially break current encryption methods, but researchers are working on developing quantum-resistant encryption algorithms to protect data against this risk.
- Security vs. speed: Making the system faster can make it less secure or less distributed.
- User experience: Wallets and private keys are still confusing for non-technical users. Managing keys can be tricky and there’s no “forgot my password” link.
- Data storage: As the chain grows, each node needs more storage and processing power. So nodes are controlled by a few big players with data centres full of Nvidia servers.
- No insurance nor guarantees: If you lose your private key, you lose your money, all of it. There’s no central authority, no password reset, no support line, and no insurance.
Note: It has been reported that China has already developed and deployed quantum encryption technologies. China Telecom launched a hybrid quantum-safe encryption system and rolled out a nationwide quantum-secure communication network.
If you’re working on something and this helped you see things a bit differently, or just made the tech a bit easier to understand, then I’m happy. That’s all I was hoping for!
