Understanding Cryptocurrency – Everything You Need to Know

There’s been a dual opinion attached to cryptocurrency. Is it the biggest thing that’s going to change the world after the internet? Or is it the hype that is going to burst out of its bubble? Is it going to be 0? Or is it going to be 1?

While these questions still hang in the balance, it is important to know what cryptocurrencies are. Cryptocurrency is now a global phenomenon that people at least know about, even though they don’t understand everything about it. Most people, banks, governments and many large firms are aware of the potential change and importance that this system brings.

This article is going to walk you through about the entire story of cryptocurrency.

The origin of cryptocurrency

Crypto-currencies actually emerged as a side product of another invention – bitcoin. It is said that Satoshi Nakamoto invented the first and still the most prominent cryptocurrency, but he/she/they had not initially intended to invent a currency. I say he or she or they (for this article, we will be using ‘he’ since it seems like a male person’s name) because nobody knows who Satoshi Nakamoto is. It could be a Japanese person or a group or anyone. What is known though is a paper had been published authored by ‘Satoshi Nakamoto’ with the title ‘Bitcoin: A peer-to-peer cash system’.

Bitcoin - Understanding Cryptocurrency

Image source – Maxpixel.net

Satoshi’s intent was to build a digital cash system and during his attempt, he was able to build it in a decentralized mechanism. During the 90s, many attempts had been made to create digital money, but all of them faced failure. Seeing the centralized attempts fail, Satoshi created the digital cash without a central entity. (Note: For those who don’t know, a centralized system is where a powerful server is connected to all the other elements and controls different elements in the network to bind them together.)

Announcing Bitcoin on SourceForge on 9th January 2009, he says, “Announcing the first release of Bitcoin, a new electronic cash system that uses a peer-to-peer network to prevent double-spending. It’s completely decentralized with no server or central authority.

In an email to Dustin Trammell, Satoshi Nakamoto writes, “….after more than a decade of failed Trusted Third Party based systems (Digicash, etc), they see it as a lost cause. I hope they can make the distinction, that this is the first time I know of that we’re trying a non-trust based system.

The missing piece was then to decentralize the system. You might be wondering from the quote what double-spending is or what peer-to-peer network is and what it has to do with cryptocurrency. Worry not. I will try to make it as simple as possible.

To understand cryptocurrency, you must first understand digital-cash. Digital cash is “a system that allows a person to pay for goods or services by transmitting a number from one computer to another.” The numbers of digital cash are unique, just as the serial numbers of a bill. Each of the digital cash is issued by a bank and is equivalent to some money. For digital cash to work, there should be a payment network with accounts, balances, and transactions. Simple till now?

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The difficult part is the problem associated with this network. The payment network needs to prevent double spending. Literally, double spending means that each entity spends the same amount twice, and is mostly associated with the digital information. Let’s say you are paying someone by cash. You give them the cash physically, so there will not be any problem. But in a digital system, there are risks that someone with a digital cash can make a copy of digital token (or the unique number of the cash) and send it to someone else while still retaining the original digital cash. Thus, the system needs to check that this problem is addressed.

In the most cases, this is done by a central server who keeps record about the balances. But since digital cash was difficult to implement in the centralized system, the alternative was to create it in a decentralized network, which was Satoshi’s attempt.

But there is a catch. In a decentralized network, there is no central server that can check the double spending. So, every entity of the network needs to do the job. This means that every part of the network needs to have a list of all the transactions to check if the transactions are valid or not, or do they attempt to double spend.

The question now is how is this possible? How can all of the entities agree about each of the records? Because if even one of the entity cannot agree, then the entire network breaks. In the central authority, it is the central server that checks the correct state of balance. But without the central authority, how can every part of the network maintain consensus?

It does seem quite impossible, right? But Satoshi emerged out of nowhere with his bitcoin concept and provided the solution to this problem. It was through bitcoin and its complex mechanism that the elements of each network were able to maintain a consensus, even without a central authority. And this feature is why it is disrupting the modern world, and it is also why it is considered to be the biggest thing that is happening to the world after the Internet.

Defining Cryptocurrency

I’ve read many definitions of cryptocurrency, and perhaps the most simplistic and powerful definition that circulates around the internet is “limited entries in a database no one can change without fulfilling specific conditions.”

Just take a look at your bank account. What do you see more than entries in a database that can only be changed if specific conditions are made? Physically, currency such as notes and coins are nothing but limited entries in a public physical database which can only be changed when the notes and coins are legally changed by the authority. Cryptocurrency, thus, is all about verifying the entries in a database of accounts, balances, and transactions.

The mechanism

How miners create coin and how the transactions are confirmed.

As discussed before, cryptocurrency is a peer-to-peer network where each peer in the network has the record of all the complete history of all the transactions. What is a transaction? To put it in simple language, it is a file that contains information about who gives what amount to whom (For instance, Alex gives 10 Bitcoin to Diana) which is signed by a private key. This is basic public key cryptography. This transaction is transferred from one peer to another peer until all the peer has received this information. This is basic Peer-to-Peer technology. Only after a specific amount of time, the transaction gets confirmed.

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Confirmation is a vital part of cryptocurrency. If a transaction is unconfirmed, then it can be pending and can still be forged. But when it is confirmed, it is not reversible.

Who confirms these transactions? The miners do. They collect the transactions, assign them as to being legit and spread them in the network. When the transaction is confirmed, all the nodes add the transaction to the database. When miners perform this job, they are awarded cryptocurrencies, such as bitcoins or Ethereum or so on.

How do Cryptocurrencies work? (Source – Coinheight.com)

Crypto-mining in brief

With the right set of devices, everyone can be a miner. But since there is no authority to control the delegation and work of the task, there needs to be a mechanism so that the system cannot be abused. Just think of how anyone can forge data or transaction and spread the forged transactions throughout the network. The system would be pointless.

To make sure that this doesn’t happen, Satoshi created a separate rule. The miners have to invest some work of their machines to qualify for the task, which is to find the hash. Consider hash as a way of decrypting and encrypting information using some sort of function. This hash connects new blocks with the predecessor, and the mechanism is known as “Proof-of-work”. The algorithm used by Bitcoin is based on SHA 256 Hash algorithm. It is not necessary to understand the detail about SHA 256. But just think of it as a basis of cryptologic puzzle miners can use to solve the puzzle. When a solution has been found, the miner builds a block and then adds it to the blockchain. The miners are thus given a specific number of Bitcoins/cryptocurrency for this process.

Breaking SHA 256 algorithm takes time while solving the problem, and thus requires great computational power the miner has to invest in. So, only certain amount of task can be completed in a given amount of time. That is why there is only a specific amount of cryptocurrency token and this is also how the network system cannot be broken.

Properties of Cryptocurrencies

Transactional properties

  1. Irreversible: When a transaction is confirmed, cryptocurrencies cannot be reversed. Once you send the money, it is gone. Not even the President of United States or Russia will be able to retrieve the money once it is sent. There is no safety net.
  2. Permission-less: Unless deemed illegal, you don’t need any permission to send or buy cryptocurrencies. It is based on software that everyone can download for free, and there is no gatekeeper that can block you from your transactions.
  3. Fast and Global: Once confirmed, the transactions are propagated nearly instantly in the network. And it doesn’t matter where the location is, if you send it to your friend near you or to someone a whole world away, it takes the same time.
  4. Pseudonymous: The accounts and transactions are not connected to the real-world identities. There are addresses with around 30 characters. You might be able to connect the flow of transaction, but you won’t be able to connect the real-world identity of users with the addresses.
  5. Secure: The cryptography used in cryptocurrencies is near to impossible to break with current computational power. It is even said that one bitcoin address is securer than Fort Knox.
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Monetary Properties

  1. Bearing not debiting: The money on banks are created with debts, and the numbers are nothing but debts. That is how the banking system works. But cryptocurrencies are not about debts. It represents itself and has value just like coins of god.
  2. Supply in control: There is a limit to the supply of tokens. For instance, the Bitcoin supply is limited and is said to reach its number around, more than a century from now. This is controlled by the schedule written in the code.

With these two crucial properties of cryptocurrencies, it has revolutionary impacts on not only on various sectors but also more importantly on the control of governments and central banks because it attacks the scope of monetary policy in that it has the power to manipulate the monetary supply.

The Start of Something New and the Chain Reaction

One cannot deny how the dawn of cryptocurrency has got people talking with enthusiasm and fascination that it has become more of a religion than the technology itself. It’s become the new digital gold which is secure from any political influence. While it has a worldwide scope, people have been speculating that it serves as the mechanism for black markets and other illegal economic activity as it so anonymous and private.

Even though the main aspect of cryptocurrency is its payment mechanism, it has now become a commodity that can be speculated and traded. So, it has attracted a large pool and market for investors and speculators. The daily trade volumes on exchanges such as Okcoin, poloniex or shapeshift is so huge that it can even exceed the major European stock exchanges.

The rise of cryptocurrency has also given the rise to ICO – Initial Coin Distribution, which is mostly facilitated by Ethereum’s smart contracts. This has given ways for successful crowdfunding projects that can attract millions of dollars in one offering.

However, one cannot deny the volatility of the prices. One day a coin can gain 200% and the next day can reduce to 300%. In 2017, Bitcoin has seen a massive change. By the time I am writing this sentence, it currently stands at 16,550. Check it when you are reading this and don’t be surprised when you see the percentage of change.

Where does it go next?

Bitcoin remains the most popular cryptocurrency in the market. But there are thousands of cryptocurrencies. While this article is being written, there are currently 1372 recognized cryptocurrencies by coinmarketcap.com. Each day, a new cryptocurrency emerges and dies; someone gets wealthy with the rise of value, someone loses tons of money. But we must understand that this new technology has come with a promise and as mentioned right at the start, it can either be 0 or 1. Some speculate blockchain as a currency is the future. And some speculate that blockchain will be wiped out. With big companies such as Bank of America, Amazon, McDonald’s accepting cryptocurrencies, one cannot deny that the “applications of blockchain” are here to stay.