I finally found an explanation that worked on my (non-tech-savvy) friends using an analogy. How Bitcoin works, consensus, and why ‘mining’ rewards money.

Why on Earth having a computer running all day earns money? My friends struggled with this concept.

This explanation was very well received. So I thought I’d share it with everyone.

Let’s play a board game

Forget about computers. It’s John, John’s brother, Mary, Mary’s sister and Garfield.

They’re five people, sitting in a circle, and they’re playing a turn-based game called MaryCoins.

The game consists of the following:

1. There’s an accountancy book where all transaction records are being kept. Basically who paid whom. Aka a ledger.
2. In each turn, during 30 seconds everyone shouts the transactions they wish to make. For example: John says out loud “I want to transfer 100 MaryCoins to my brother!”, John’s Brother says “I want to transfer 50 MaryCoins to Mary!”
3. After those 30 seconds, someone writes down those operations that have been shouted out loud onto a single page. Everyone can see what he wrote down.
4. After finishing, the ledger book is passed down to the next player to their right and the process repeats. The next player must start from a new page. They can’t start from the old page and continue from where the previous player left off.
5. Everyone starts the game with 1000 MC (short for MaryCoins)

Now this game is about trust. The trust in that whoever is writing down the transactions doesn’t cheat.

In the example above someone has to write down:

Now let’s suppose Mary is holding the ledger. And she decides to lie.

For example she rip offs John’s Brother and instead of transferring 50 MC she transfers 150 MC. That is, she stole an extra 100MC she wasn’t supposed to.

Or maybe she decides to rip off everyone, and what she writes down has nothing to do with what was shouted.

Now the thing is… everyone can see it. They’re 5, and 4 of them will say “Hey!!! What did you do?! That’s not what we agreed!”

Therefore everyone else rejects the page that Mary wrote down, and the ledger is passed on to John’s brother. His job is now to transcribe what Mary was supposed to do but failed.

Also Mary is now banned from writing into the ledger. Her MaryCoins aren’t confiscated, and she can still send and receive money. But she no longer gets to write into the book.

Family to the rescue

Now here’s the thing… let’s go back to the part where she lied. But now let’s say her sister jumps to defend Mary. She says “I too heard John’s brother wanted to transfer 150MC to Mary!”.

However it’s still 3 vs 2. Because John, his brother, and Garfield claim they heard 50MC. So Mary and her sister still get banned.

But let’s add another rule to the game:

1. Anyone can join or leave the game at any time.

So Mary decides to introduce her father and mother to the game.

It’s now 7 people. And her family is always on her side. They also say ‘I heard 150, not 50’. It’s 3 vs 4 now. They win. They impose ‘their truth’ over the rest.

However John can do the same thing! He can bring his parents too. Now there’s 9 people playing. It’s 5 vs 4. John’s side wins again.

The game needs an incentive for people not to lie. And for that we add another rule:

1. Whoever is writing to the ledger, is awarded up to 5 MC for their task.

So if Mary writes down the original operation (without cheating), she’s entitled for 5MC for herself:

So it’s in your best interest not to cheat. Because you get 5 MC for playing. If you cheat, you get banned from ever writing into the book and can never win any more MCs.

Wait where did those 5 MC go? Results???

In accountancy terms it becomes part of Equity.

In Bitcoin terms it’s called money emission.

In simple words when the game started there were 5 people with 1000 MC each. That is, there were 5000 MaryCoins in circulation in this entire game’s economy.

Now there are 5005 MC, and Mary owns those extra 5.

Who writes down to the book?

Now the game has an incentive not to cheat. But it’s not enough. And that’s because we have a problem.

So far we assumed each player passes down the ledger book onto the next player to their side.

But anyone can enter at any time. If Mary wishes to cheat, she can insert an endless amount of relatives that come right after her. So even if she gets caught cheating, the book would be passed onto her mother, who also cheats. And then her father, her uncle, her aunt, her cousin, and an endless stream of relatives.

Even if they are all caught cheating, the game never moves forward. No further operations can be made because “the next guy” who is supposed to do what Mary failed, also cheats.

Turns out passing the book “onto the next” when anyone can enter at any time is a really bad idea.

To solve this problem, the game uses the concept of Proof of Work.

Proof of Work

The game needs a new rule:

1. Instead of passing the book to the next player to your side, players must earn the right to write into the book by solving a puzzle. (Yes, for the purpose of this game a jigsaw puzzle is enough!)

The puzzle takes an average of 10 minutes for the players to complete. But everyone can tell with just a glance that it’s been completed successfully.

The first one to finish must yell “I won!!!” and all the players will look at the jigsaw to see if it’s correct.

If it’s well done, that player gets passed on the ledger and writes the operations down.

And now the process restarts: Solve a new jigsaw and after roughly 10 minutes somebody will yell “I won!!!” to get the ledger.

In order to enjoy this game you must be really good at solving puzzles. If Mary’s family is 100x better than everyone else at solving puzzles, then she can control the game and even cheat.

But John can hire highly intelligent people who are also good at puzzles, and thus compete with Mary’s family.

And that’s folks… how Bitcoin works!

All the nodes in the network can see all operations that piled up and must be written down. The problem is in deciding who is going to transcribe those operations.

For that, Proof of Work is needed. Computers work on a very difficult math problem that is hard to solve, but easy to verify once you have the result.

The results and contents of the puzzle itself is pointless beyond choosing who transcribes the operations.

And as PCs get faster, the puzzle becomes harder to solve. This happens automatically over time (it’s predetermined). The target is that the puzzle takes roughly 10 minutes.

And that’s why Bitcoin (and Blockchain in general) pointlessly consumes so much electricity.

So much energy wasted into something that isn’t really needed for the operation itself.

In a traditional banking system, the one designated to write down the operations are the bank themselves. And the Central bank is the only one with authority to create money.

We trust that banks won’t lie, and that the Central Bank won’t create too much money. Or if they do betray our trust, we ultimately trust that another institution like the Judicial System will intervene.

Proof of Stake

It may be worth mentioning that Proof of Work is not the only way to decide who writes down on the ledger.

In, Proof of Stake, players who want to write to the ledger must make a deposit as collateral. Let’s say the collateral is 50 MC.

If Mary plays by the rules, she gets her 50 MC back + 5 MC as reward. But if cheats, she will lose the 50 MC she placed as collateral. The bigger collateral a player places, the higher the chances she gets passed down the ledger, and also the more she has to lose if she cheats and gets caught.

Although there are concerns about the viability of Proof of Stake (as a way to deter cheating and keep fairness), it is estimated it could reduce electricity consumption by 99%, as it doesn’t rely on pointlessly burning computing power to solve puzzles.

What is a fork?

Let’s say that John’s family and Garfield got fed up from Mary’s cheating family.

So they decide to leave and play their own game, with their own rules. They photocopy the entire book and the currency is now called JohnnyCoins instead of MaryCoins.

Mary’s family plays her game with her rules, and John plays his game, with his rules.

There’s now 2 ledger books which are exactly the same up to page 23, but afterwards they diverge. That’s because the game was on page 23 when John and Garfield decided to leave.

That’s what happened with Bitcoin & Bitcoin Cash (they’re two different currencies).

Bitcoin was forked into Bitcoin Cash because some people believed the rules needed to change. There was a disagreement on how Bitcoin should scale to handle a larger number of operations.

It’s just a set of rules

All blockchain are just like a game with a set of rules.
These rules are arbitrary, but the objective of these rules is to prevent cheaters and keep a power balance between players.

Because if the game is unbalanced, there’s the risk that a single player could accumulate enough power and voting power to control the network (this is known as the 50+1 problem or 51% attack)

Bitcoin is one type of blockchain. Ethereum is another type of blockchain and has different rules, but they’re quite similar.

The rules are many and some of them are very technical, I don’t even know all of them. As long as they help to avoid cheating and power concentration, they’re good.

If you’ve understood the game so far, then you’ve understood everything or nearly everything on how cryptocurrencies work.

OK but what does this have to do their market value?

Short answer: It doesn’t!

Long answer: Understanding how Bitcoin works at a technical level explains little about their market value. Why did it peak to usd12,000 in 2019? Why is it now worth 60,000?

The thing about this is that it’s a popularity contest. Remember John who forked the game? Well, turns out everyone prefers to play with Mary.

Maybe she’s popular. Or it’s momentum because her game appeared on the local news. Everyone’s talking about the MaryCoins game.
John’s game? Nobody wants to play with him except Garfield.

As a result MaryCoins are worth a lot, and JohnnyCoins are worth nothing. It’s ironic, because actually Mary and her sister also own 1,000 JohnnyCoins. Let’s remember that the game was forked up to page 23.

Mary and her sister up until then each owned 1,000 MaryCoins. And because the game was cloned, they now also own 1,000 JC in John’s game.
But Mary and her sister are not interest in using those, since they’re worth nothing.

This is why some people liken cryptocurrencies to Monopoly money. It’s all made up money in a made up game with made up rules, and what gives them value is people’s perspective on them.

This is more a question for psychologist, sociologists and economists. Supply and demand. Not so much a question for computer nerds.

So are Criptocurrencies devoid of any real value?

Actually yes, they have some value.

Although obnoxious crypto-enthusiast want to apply blockchain to solve anything. For example if you find someone who claims “I will find a cure for world hunger with blockchain!”, that phrase makes as much sense as “I will find a cure for world hunger with a ledger book!”.

Because that’s what it is: a glorified accountancy ledger book (or more generically, a glorified database).

Yes, you can track food supply by writing down providers and contents in a blockhain database. But you can do so with any regular old-school centralized database.

But that doesn’t mean it’s devoid of any value. Blockchain’s main contribution is that it’s virtually impossible to falsify.

Bitcoin only writes money into the ledger book but blockchains such as Ethereum allow you to write arbitrary text into this book. And that gives operations publicity and date certain. It means that a real life contract can be uploaded to the Blockchain and once published is almost impossible to falsify, and it can be verified when was that contract uploaded.
The contract may have been agreed earlier than that date, but never later.

In other words they have the potential of partially replacing some tasks that are currently left to Public Notaries.

Other advantages is that cryptocurrencies can’t be counterfeited, and can’t be oversold unlike Gold titles.

What is mining?

Remember someone has to solve those puzzles?

And that whoever wins gets to transcribe the operations?

And therefore that person is entitled to some coins for themselves?

Well, the act of solving puzzles is called “mining” in blockchain lingo. And they’re obviously linked to the transcription and making some money.

If everyone suddenly decided to stop mining, then nobody makes any more money. But also all transactions will suddenly halt!

Because there is no way to decide who gets to transcribe the operations into the book, no operation can continue forward.

Are Cryptocurrencies completely detached from reality?

Although it seems that way, not entirely.

Because “mining” is a necessary and essential task for even basic operation, electricity cost and the price of computer parts play a key role.

More expensive equipment or energy means there’s less computing power to solve puzzles.
This means computers take longer to solve puzzles.
And ultimately it means the network cannot process enough transactions per second to satisfy everyone.

This puts a stress as demand for operations to go through, limiting supply (excess of demand), which raises its value.

Something I did not mention is that people who want to skip the queue can offer to pay a fee. Whoever is transcribing the operations can accept that optional fee to prioritize these people’s transaction over others. So miners make money both via the Bitcoins rewards and fees. There’s a minimum of free operations they must process though.

Cheap components / cheap electricity has the opposite effect.

However if the network loses too much computing power too suddenly, it could have the opposite effect: if operations are slowed down to a crawl, the cryptocurrency may be seen as worthless or that the tech is compromised (even if that’s not true), and trust in that crypto will be lost.

Again although real factors such as component and electricity costs play an important role, psychological factors play a much, much bigger one.

OK but who owns Bitcoin?

Does James Naismith own Basketball because he invented the game and set the original rules?

Can he prevent other people from playing Basketball because he doesn’t like them or because he thinks they’re doing it wrong?

Does JRR Tolkien own every book of Lords of the Rings just because he wrote the original script? Does he control every DVD of the movie adaptation ever sold?

Everyone who plays the game is following the rules “just because”. And everyone has a full copy of the entire blockchain database (ok it’s a bit more complex because some nodes can have have a partial copy). If my computer participates in the Bitcoin network, I have control over my machine. But I have no control over any of the other machines participating.

It’s a collective effort. No single person owns it or controls it (although the 50+1 problem does mean a single individual using millions of machines could in theory temporarily control what is being written down in the official record and later broadcast to every other computer as the ‘official truth’).

Closing words

Ok this is long already. I could go on but you should now have a good grasp (hopefully!) of how Cryptocurrencies and Blockchain works, why computers running magically make money.

I wrote this down because my friends had no clue how it works at technical level. They only knew you can make transactions and make (and lose) money. And entering the wikipedia articles are unfathomable. Definitely not beginner friendly.

Full of advanced topics without explaining the basic ones.

Because this article is likely going to attract the obnoxious crypto-fans I talked about (the ones who’d solve world hunger with Blockchain), those people are not going to let pass that I called Blockchain a glorified database, and also people who will point out every tiny difference between my analogy and real life blockchain, I’m going to close the comment section. You can criticize on Reddit or Hacker News.

Yes, this is not an Encyclopedia on Blockchain. It’s not meant to be perfect.

It’s an explanation to bridge that abyss of knowledge your mom or your neighbour has, about that piece of tech that every media talks about as if you’d be dumb to be left out, but nobody can explain how it works, and those who can get side-tracked on things like elliptic curve cryptography (a fascinating field, but not necessary to understand blockchains) or keep saying ‘mining’ without going into detail.