Bitcoin and Ethereum simplified for a five-year-old

Etherum

Today, I am going down the rabbit hole on Bitcoin and Ethereum. When I am excited about a new space, I try to follow Feynman’s technique for learning anything:

Sahil Bloom Tweet

Richard Feynman is perhaps the most inspirational teacher I never had. His biography Surely You’re Joking, Mr. Feynman!”: Adventures of a Curious Character is my 2021 favourite book.

In a nutshell, Richard Feynman observed how people mask a lack of understanding with complexity and jargon. In turn, if you can explain anything to a kid, you must have an excellent knowledge of that topic. So always strive to strip down needless complexity.

This and the following few essays are my attempt to simplify what I have learned about Web3 so far, starting with Bitcoin and Ethereum.

Also Read: Why is there no crypto ETF yet in Singapore?

Bitcoin

Nothing illustrates a complex concept better than an analogy. So here you go, my favourite one.

In prison, there are no currencies. No one has access to money of any kind. But a prison, although small, is still a society. And society needs to trade goods and services.

Maybe someone is a barber. This person will cut people’s hair but wants something in return. Something that he can use to later go to his cellmate and give him in return for the book that he wants from him.

The cellmate also needs something in return for the book to use for getting himself another book.

How do you do this without money?

Well, they use cigarettes as a currency. A haircut is worth 20 packs. A chance to play basketball is worth 10 packs. A book is worth five packs and so on. There is a problem. There are not enough cigarettes inside the prison in each person’s hands to be able to do all the transactions.

But everyone knows that once a week a new supply comes in. So instead of getting the packs from each other, they start “owing” each other some packs of cigarettes.

Joey gets a haircut and he owes the barber 20 packs. The barber gets a book and owes John 5 packs. Once the new shipment comes in, everyone will settle their debts.

But how do we keep track of all this?

Well, everyone will have to carry a notebook with them. Whenever two people make a transaction, they both write it down in their books. Luke writes “I owe Johnny two packs” and Johnny writes “Luke owes me two packs”. This way we know who owes what to whom.

But we all write everything in the same format. One transaction after another. So it becomes a long chain of transactions. If I know how many cigarettes I had at any point and go through the transactions after it, I can figure out how many cigarettes I will have.

Last problem: how do we know what people wrote in their books are correct and no one is faking transactions? I can go steal someone’s book and write a fake transaction in it.

Also Read: Merkle Science nets US$5.75M Series A to help detect, investigate, prevent illegal crypto activities

Well, to overcome this we assign the wisest most trustworthy person in the prison as a witness. Whenever two people are making a transaction, he has to witness it and sign both books with his own signature. This way, we know that each transaction is witnessed by our trusted person and actually happened.

Cigarettes are bitcoin. Notebooks are ledgers. The agreed-upon text format in the notebooks is blockchain. The wise persons are bitcoin miners.

Most people, who are not crypto fanatics, have some vague idea of what Bitcoin is. But a few people realise how in just 12 years, the cryptocurrency has become the best investment of all time as it has reached ~3,000,000x appreciation.

You can think of Bitcoin as a decentralised currency. Meaning it was not issued by a central bank like any other medium of exchange. Instead, it was issued by a computer program.

“The world ultimately will have a single currency, the internet will have a single currency. I personally believe that it will be Bitcoin.”- Jack Dorsey, Founder of Twitter and Square

Not too long ago, China, the world’s second-largest economy and the most populous country declared all cryptocurrencies illegal. Yet, today’s price of one Bitcoin is ~US$61,095 (as of October 17, 2021). Proving that it’s hard to devalue it by governments.

Also Read: You don’t care about crypto but here are some things you need to know about DeFi

In simpler terms, it’s akin to gold. It leverages the scarce nature of gold, but it adds an element of digital transferability.

Every currency or store of value shares similar attributes. It must be scarce, portable, fungible, divisible, durable, and broadly accepted to be considered useful.

Bitcoin scores high on all that:

  • Scarcity – the supply of Bitcoin is only 21 million coins.

“There will only ever be 21 million Bitcoins. That property of saying there’s only going to be 21 million is guaranteed by the blockchain. It is not guaranteed by the creators of Bitcoin. It’s not guaranteed by the developers of Bitcoin, by Satoshi Nakamoto. It’s guaranteed by the very network architecture. That never existed before.”- Chris Dixon – The Potential of Blockchain Technology

  • Portability – Bitcoin is a lot more portable than gold. It can be transferred digitally around the globe in seconds. Therefore, it’s cheaper to store and transfer. Not to mention, it’s instantly verifiable, whereas gold can require a slow and manual process.
Image

Source: Michael B. Rihani

  • Fungibility – similar to any other currency, any two Bitcoins are interchangeable.
  • Durability – a lot more durable than paper money and do not degrade over time.
  • Broad acceptability – while it has not reached the acceptability of gold and US$ levels, Bitcoin has made impressive progress. That’s especially true in markets that are less stable politically.

Crypto adoption is dominated by emerging, frontier, and politically unstable markets.

“[Bitcoin] may not seem as compelling to some individuals who believe they live in stable monetary and financial settings, or under a government that respects property rights and the rule of law – but it becomes starkly relevant in their absence.” — Nic Carter, Bitcoin Net Zero

No one knows what the future will bring. Bitcoin is up against gold and traditional mediums of exchange. Regular currencies have centuries of proven track records.

Also Read: Crypto trading: How to be sure you are doing it safely?

Yet, looking at the loyalty of its community alongside the underlying innovation, it’s undeniable that Bitcoin offers an improvement over gold and fiat.

Ethereum

Imagine Bitcoin as a valuable and defensible citadel that has proven to be a great place to store your gold in. Everyone races to store their gold in that impregnable castle because no one has ever successfully attacked it.

Ethereum is the city around that citadel. In fact, you can think of it as a network of cities that trade with each other using Ether (ETH). Then gas fees are paid to miners to ensure each transaction takes place as per the desired outcome.

Ethereum is the streets, land, buildings, pipes, electricity infrastructure, and everything else you need to have in order to build on. So now you can go to Ethereum and build your real estate or whatever else that’s important to you.

Ethereum is the second most valuable cryptocurrency in the world. Today, the market cap of Ethereum is about US$420 billion.

Whereas bitcoin is a combination of currency, a store of value, and a medium of exchange, Ethereum is a lot more. You can think of it as a vast distributed computer that exists around the world. Entirely decentralised.

It is one virtual machine that runs across many computers at the same time. As a result, some people argue that Ethereum is one of the most important inventions of the past decade despite current limitations.

Ethereum is so many things at once, all of which feed off of each other. Ethereum, the blockchain, is a world computer, the backbone of a decentralised internet (web3), and the settlement layer for web3. Its cryptocurrency, Ether (ETH), is a bunch of things, too:

  • Internet money.
  • Ownership of the Ethereum network.
  • The most commonly-used token in the Great Online Game.
  • Yield-generating.
  • A Store of Value (SoV).
  • A bet on more on-chain activity, or the web3 future.

Also Read: DeFi is pushing finance towards its e-commerce moment

Developers can build applications on top of Ethereum using smart contracts. It is similar to how Excel works. In an Excel sheet, we can add a variety of formulas that are linked with one another.

Smart contracts work similarly. Each contract can be linked to another one. In the process, creating opportunities to solve complex problems.

A popular analogy for smart contracts is vending machines. You insert money into a vending machine, and it delivers something back to you. In the same way, if you pay a fee to the smart contract, the smart contract will execute an action. The fees are paid in Ether (ETH), often referred to as “gas” fees.

Another simple example is designing a smart contract to reward your family on their birthdays. Imagine developing a tool that pays each member of your family US$100 on their birthdays.

Then, add the birth dates for each family member, assign the reward (e.g., US$100/person), and the contract will handle the rest. Thus, annually on their birthdays, everyone in your family will receive US$100 without your intervention.

Currently, there are around 117M ETH. Like with everything else, the price is governed by supply and demand. More transactions and usage equals higher demand and thus higher costs. In simpler terms, that’s how a transaction on Ethereum looks like:

  1. You send your friend John 1 ETH
  2. You pay gas fees for that transaction. Let’s say .01 ETH
  3. Your account balance goes down by 1.01 ETH. Your friend John’s account balance goes up by 1 ETH.
  4. A distributed network of random miners on Ethereum gets compensated with 0.1 ETH to solve increasingly difficult cryptographic problems and thus facilitate the transaction.

“Owning ETH is like owning shares on the internet. Demand for ETH will go up with increased Web3 adoption, while upcoming changes will decrease the supply of ETH and let more value accrue to holders. It’s like a tech stock, a bond, a ticket to Web3, and money, rolled into one”, says Packy McCormick.

Lately, Ethereum has been in the epicentre of a lot of exciting innovations. Concepts like DeFi, DAOs, NFTs, Social Tokens have become all the hype around the world. Ethereum and other similar platforms are enabling people to cooperate like never before.

Also Read: You don’t care about crypto but here are some things you need to know about DeFi

The open, trustless, and permissionless internet finally has strong use cases. Cryptocurrencies like Ethereum and Bitcoin have shown us the potential behind Web3, and we are just getting started.

Unfortunately, current solutions are still slow and expensive. That was an intentional design; both Bitcoin and Ethereum are meant to be slow because of security reasons. Yet, the activity in Web3 is attracting the smartest people from all walks of life.

Strong financial incentives and incredible talent are usually a recipe for overcoming any obstacle. So I am sure that we will be able to have secure yet fast and affordable solutions in the near future. That’s why I am pretty excited about what’s coming next.

Editor’s note: e27 aims to foster thought leadership by publishing views from the community. Share your opinion by submitting an article, video, podcast, or infographic

Join our e27 Telegram group, FB community, or like the e27 Facebook page

Image credit: ximagination

The post Bitcoin and Ethereum simplified for a five-year-old appeared first on e27.

,
Etherum

Today, I am going down the rabbit hole on Bitcoin and Ethereum. When I am excited about a new space, I try to follow Feynman’s technique for learning anything:

Sahil Bloom Tweet

Richard Feynman is perhaps the most inspirational teacher I never had. His biography Surely You’re Joking, Mr. Feynman!”: Adventures of a Curious Character is my 2021 favourite book.

In a nutshell, Richard Feynman observed how people mask a lack of understanding with complexity and jargon. In turn, if you can explain anything to a kid, you must have an excellent knowledge of that topic. So always strive to strip down needless complexity.

This and the following few essays are my attempt to simplify what I have learned about Web3 so far, starting with Bitcoin and Ethereum.

Also Read: Why is there no crypto ETF yet in Singapore?

Bitcoin

Nothing illustrates a complex concept better than an analogy. So here you go, my favourite one.

In prison, there are no currencies. No one has access to money of any kind. But a prison, although small, is still a society. And society needs to trade goods and services.

Maybe someone is a barber. This person will cut people’s hair but wants something in return. Something that he can use to later go to his cellmate and give him in return for the book that he wants from him.

The cellmate also needs something in return for the book to use for getting himself another book.

How do you do this without money?

Well, they use cigarettes as a currency. A haircut is worth 20 packs. A chance to play basketball is worth 10 packs. A book is worth five packs and so on. There is a problem. There are not enough cigarettes inside the prison in each person’s hands to be able to do all the transactions.

But everyone knows that once a week a new supply comes in. So instead of getting the packs from each other, they start “owing” each other some packs of cigarettes.

Joey gets a haircut and he owes the barber 20 packs. The barber gets a book and owes John 5 packs. Once the new shipment comes in, everyone will settle their debts.

But how do we keep track of all this?

Well, everyone will have to carry a notebook with them. Whenever two people make a transaction, they both write it down in their books. Luke writes “I owe Johnny two packs” and Johnny writes “Luke owes me two packs”. This way we know who owes what to whom.

But we all write everything in the same format. One transaction after another. So it becomes a long chain of transactions. If I know how many cigarettes I had at any point and go through the transactions after it, I can figure out how many cigarettes I will have.

Last problem: how do we know what people wrote in their books are correct and no one is faking transactions? I can go steal someone’s book and write a fake transaction in it.

Also Read: Merkle Science nets US$5.75M Series A to help detect, investigate, prevent illegal crypto activities

Well, to overcome this we assign the wisest most trustworthy person in the prison as a witness. Whenever two people are making a transaction, he has to witness it and sign both books with his own signature. This way, we know that each transaction is witnessed by our trusted person and actually happened.

Cigarettes are bitcoin. Notebooks are ledgers. The agreed-upon text format in the notebooks is blockchain. The wise persons are bitcoin miners.

Most people, who are not crypto fanatics, have some vague idea of what Bitcoin is. But a few people realise how in just 12 years, the cryptocurrency has become the best investment of all time as it has reached ~3,000,000x appreciation.

You can think of Bitcoin as a decentralised currency. Meaning it was not issued by a central bank like any other medium of exchange. Instead, it was issued by a computer program.

“The world ultimately will have a single currency, the internet will have a single currency. I personally believe that it will be Bitcoin.”- Jack Dorsey, Founder of Twitter and Square

Not too long ago, China, the world’s second-largest economy and the most populous country declared all cryptocurrencies illegal. Yet, today’s price of one Bitcoin is ~US$61,095 (as of October 17, 2021). Proving that it’s hard to devalue it by governments.

Also Read: You don’t care about crypto but here are some things you need to know about DeFi

In simpler terms, it’s akin to gold. It leverages the scarce nature of gold, but it adds an element of digital transferability.

Every currency or store of value shares similar attributes. It must be scarce, portable, fungible, divisible, durable, and broadly accepted to be considered useful.

Bitcoin scores high on all that:

  • Scarcity – the supply of Bitcoin is only 21 million coins.

“There will only ever be 21 million Bitcoins. That property of saying there’s only going to be 21 million is guaranteed by the blockchain. It is not guaranteed by the creators of Bitcoin. It’s not guaranteed by the developers of Bitcoin, by Satoshi Nakamoto. It’s guaranteed by the very network architecture. That never existed before.”- Chris Dixon – The Potential of Blockchain Technology

  • Portability – Bitcoin is a lot more portable than gold. It can be transferred digitally around the globe in seconds. Therefore, it’s cheaper to store and transfer. Not to mention, it’s instantly verifiable, whereas gold can require a slow and manual process.
Image

Source: Michael B. Rihani

  • Fungibility – similar to any other currency, any two Bitcoins are interchangeable.
  • Durability – a lot more durable than paper money and do not degrade over time.
  • Broad acceptability – while it has not reached the acceptability of gold and US$ levels, Bitcoin has made impressive progress. That’s especially true in markets that are less stable politically.

Crypto adoption is dominated by emerging, frontier, and politically unstable markets.

“[Bitcoin] may not seem as compelling to some individuals who believe they live in stable monetary and financial settings, or under a government that respects property rights and the rule of law – but it becomes starkly relevant in their absence.” — Nic Carter, Bitcoin Net Zero

No one knows what the future will bring. Bitcoin is up against gold and traditional mediums of exchange. Regular currencies have centuries of proven track records.

Also Read: Crypto trading: How to be sure you are doing it safely?

Yet, looking at the loyalty of its community alongside the underlying innovation, it’s undeniable that Bitcoin offers an improvement over gold and fiat.

Ethereum

Imagine Bitcoin as a valuable and defensible citadel that has proven to be a great place to store your gold in. Everyone races to store their gold in that impregnable castle because no one has ever successfully attacked it.

Ethereum is the city around that citadel. In fact, you can think of it as a network of cities that trade with each other using Ether (ETH). Then gas fees are paid to miners to ensure each transaction takes place as per the desired outcome.

Ethereum is the streets, land, buildings, pipes, electricity infrastructure, and everything else you need to have in order to build on. So now you can go to Ethereum and build your real estate or whatever else that’s important to you.

Ethereum is the second most valuable cryptocurrency in the world. Today, the market cap of Ethereum is about US$420 billion.

Whereas bitcoin is a combination of currency, a store of value, and a medium of exchange, Ethereum is a lot more. You can think of it as a vast distributed computer that exists around the world. Entirely decentralised.

It is one virtual machine that runs across many computers at the same time. As a result, some people argue that Ethereum is one of the most important inventions of the past decade despite current limitations.

Ethereum is so many things at once, all of which feed off of each other. Ethereum, the blockchain, is a world computer, the backbone of a decentralised internet (web3), and the settlement layer for web3. Its cryptocurrency, Ether (ETH), is a bunch of things, too:

  • Internet money.
  • Ownership of the Ethereum network.
  • The most commonly-used token in the Great Online Game.
  • Yield-generating.
  • A Store of Value (SoV).
  • A bet on more on-chain activity, or the web3 future.

Also Read: DeFi is pushing finance towards its e-commerce moment

Developers can build applications on top of Ethereum using smart contracts. It is similar to how Excel works. In an Excel sheet, we can add a variety of formulas that are linked with one another.

Smart contracts work similarly. Each contract can be linked to another one. In the process, creating opportunities to solve complex problems.

A popular analogy for smart contracts is vending machines. You insert money into a vending machine, and it delivers something back to you. In the same way, if you pay a fee to the smart contract, the smart contract will execute an action. The fees are paid in Ether (ETH), often referred to as “gas” fees.

Another simple example is designing a smart contract to reward your family on their birthdays. Imagine developing a tool that pays each member of your family US$100 on their birthdays.

Then, add the birth dates for each family member, assign the reward (e.g., US$100/person), and the contract will handle the rest. Thus, annually on their birthdays, everyone in your family will receive US$100 without your intervention.

Currently, there are around 117M ETH. Like with everything else, the price is governed by supply and demand. More transactions and usage equals higher demand and thus higher costs. In simpler terms, that’s how a transaction on Ethereum looks like:

  1. You send your friend John 1 ETH
  2. You pay gas fees for that transaction. Let’s say .01 ETH
  3. Your account balance goes down by 1.01 ETH. Your friend John’s account balance goes up by 1 ETH.
  4. A distributed network of random miners on Ethereum gets compensated with 0.1 ETH to solve increasingly difficult cryptographic problems and thus facilitate the transaction.

“Owning ETH is like owning shares on the internet. Demand for ETH will go up with increased Web3 adoption, while upcoming changes will decrease the supply of ETH and let more value accrue to holders. It’s like a tech stock, a bond, a ticket to Web3, and money, rolled into one”, says Packy McCormick.

Lately, Ethereum has been in the epicentre of a lot of exciting innovations. Concepts like DeFi, DAOs, NFTs, Social Tokens have become all the hype around the world. Ethereum and other similar platforms are enabling people to cooperate like never before.

Also Read: You don’t care about crypto but here are some things you need to know about DeFi

The open, trustless, and permissionless internet finally has strong use cases. Cryptocurrencies like Ethereum and Bitcoin have shown us the potential behind Web3, and we are just getting started.

Unfortunately, current solutions are still slow and expensive. That was an intentional design; both Bitcoin and Ethereum are meant to be slow because of security reasons. Yet, the activity in Web3 is attracting the smartest people from all walks of life.

Strong financial incentives and incredible talent are usually a recipe for overcoming any obstacle. So I am sure that we will be able to have secure yet fast and affordable solutions in the near future. That’s why I am pretty excited about what’s coming next.

Editor’s note: e27 aims to foster thought leadership by publishing views from the community. Share your opinion by submitting an article, video, podcast, or infographic

Join our e27 Telegram group, FB community, or like the e27 Facebook page

Image credit: ximagination

The post Bitcoin and Ethereum simplified for a five-year-old appeared first on e27.

Leave a Reply