If you’ve head of Bitcoin, you’ve likely gotten yourself curious about its nature and how does it exactly work. After all, it’s quite interesting to hear about a currency that you can’t physically touch yet is still making the rounds in markets, right? This article will be your insider guide to cryptocurrency – just what is it, how does it work, and why is it popular?
It’s important to have a disclaimer as early as now that this isn’t the “perfect” guide to cryptocurrency, and this won’t make you extremely rich afterwards. Getting into crypto is just like getting into any other venture – it takes time, patience and effort in order to successfully pull off.
What is cryptocurrency? Is it just another mythical wonder, or is it really the future of money? It’s important to remember as early in this discussion that cryptocurrencies have started to become a global phenomenon that took the world by storm. Despite the reality that most of the people who know about cryptocurrencies are consider “geeks,” a lot of companies, governments, and banks aware of just how much of an impact cryptocurrencies have on the global economy. For the uninitiated, this is your insider guide to cryptocurrency: just what is it, how does it work, and why is it popular?
What Is Cryptocurrency? Is It The Future Of Money?
It’s very hard to find an institution these days that haven’t researched or thought about cryptocurrency, especially when it comes to governments, software companies, accounting firms, or major banks. Even United States Senator Thomas Carper said that virtual currencies such as bitcoin have captured the interest of a lot of people – but it sure made an effort to confuse others, and scare others with its potential as well.
It’s normal for a lot of people to be unaware of how exactly cryptocurrencies work – especially since its release were really behind-the-scenes. In fact, not everyone knows that bitcoin really emerged as a side effect of another invention.
Bitcoin was conceptualized by Satoshi Nakamoto, an anonymous figure that, ironically, never even intended to create a digital currency. What Nakamoto really intended to build was “A Peer-to-Peer Electronic Cash System.” In its 2008 release on SourceForge, Nakamoto said the invention was to “realize” a factor in digital cash people didn’t realize during its early development, and that’s using a peer-to-peer network in order to help mitigate double-spending. As a result, it doesn’t have a central authority, any servers, and it’s completely decentralized.
This might be a lot of jargon to most readers, but this will all be dissected as you read through the article. Point is, the emergence of bitcoin is important as Nakamoto’s finally been able to create a decentralized digital cash system. All efforts to create and popularized digital money failed in the 1990s, which makes Nakamoto’s invention quite the stunner.
Nakamoto noticed that a lot of the failed efforts towards digital cash failed because they were using a central authority, so Nakamoto wanted to create a peer-to-peer system that didn’t have a central authority. This means it’s going to decentralized and non-trust. Think of it as how you make a Peer-to-Peer network to share files, but in this case you’re going to share currency – and this is perhaps the most important benefit bitcoin brought to the table.
Decentralization: One Big Conundrum To Solve
The primary problem with digital cash in the 90s is how the entire system will be stabilized. Of course, if you’ve dealt with banks or records before, the main components of any cash system will be a payment network consisting of transactions, balances, and accounts. One problem every network has to solve is to make sure double spending isn’t done – as in, one entity shouldn’t be able to spend the same money twice.
In digital systems, one central server is in charge of recording these balances – but this is hard to do when one server is in charge of every single account in a digital system.
With bitcoin, you don’t have a central server – every single member of the network will be “doing” this job. All members will have a list of all the transactions to counter-check so all future transactions will be validated.
In theory, this is confusing, as after all how will everyone keep a record of all transactions? If validity is certified when all members of the network agree to the transaction, just one system disagreeing will crush everything – the same way a jury can’t decide on the verdict of a case if the vote wasn’t unanimous. There has to be an absolute consensus in a decentralized banking system – which goes back to the need for a centralized servers, but then again this spirals back to the problem of overloading a servers with transactions.
Nakamoto solved this rather confusing conundrum with a solution that other people didn’t even think was possible.
The Basics Of Cryptocurrencies: A Decentralized System
When you think of cryptocurrencies, it’s important you forget all the jargons you’ve been hearing in reports. Minus all the digital terms, a cryptocurrency is simply a database with limited entries that you can’t change without fulfilling special requirements.
That’s it – because that’s how currencies actually work. For instance, isn’t your bank account really just the summation of a database with entries of money entering and going out? In terms of notes and physical coins, what are they but “entries” in a public physical database that can only be changed if you own and not own certain amounts of notes and coins?
In essence, money really is about everyone acknowledging that you have the commodity in a kind of database that records transactions, balances, and accounts. Cryptocurrencies work in the same manner, albeit with digital factors to make sure nothing can be cheated in today’s conveniently technological age.
It might help to explain cryptocurrencies by differentiating its many elements – but its most important element is its peer network. Every peer or bitcoin user has a complete “record” of the history of all transactions that occur in the system, and as such has a record of the balance of all accounts in the system as well. Imagine having a digital ledger that everyone has a copy of.
This means, a transaction file that says “Steve gives X Bitcoin to Joe” will be recorded in the digital record and is signed by Steve’s private key. A private key is simply a special “passcode” that allows only Steve and the person he “gives” the key to in order to view a specific file, and that is Joe. This is one of the basics of cryptography, which is a commonly-used way to secure files.
When the transaction file has been “signed,” it’s broadcasted into the network, and all peers will receive a copy of the file – like in Peer-to-Peer technology. By the time everyone has a copy of the file, it needs time to get confirmed.
Miners And Transactions: Creating The Coin In Bitcoin
Confirmation is the most important element of cryptocurrencies, as it “validates” the existence of the transaction into the system. When a transaction is unconfirmed, it can be forged. When it’s confirmed, however, it’s all set in stone and can’t be tampered with. It becomes immutable and becomes part of the public record – called a blockchain. The latter concept, blockchain, will need an entirely new article to be explained.
Think of blockchain as a public document like in Google Docs – where all users have the ability to make changes to the document and it will be recorded. Unlike in Google Docs, all entries can’t be changed. This is also similar to a normal ledger in accounting, where all transactions will be recorded. Only this time, it’s digital, everyone has a copy, and everyone needs to confirm it.
In the case of bitcoin, “everyone” refers to miners, as it’s their job to confirm these transactions and “stamp” them as legitimate. Miners need to use sophisticated and powerful computers in order to make these confirmation, and they get a form of compensation in the process – bitcoin, in this example.
Everyone can be a miner, but not everyone can handle being a miner in the long run. In order to avoid breaking the system because everyone can just “fake” confirm the transactions, Nakamoto made the validation process of bitcoin transactions extra special.
To validate the addition of a transaction into the digital ledger/system/blockchain, they need to find a hash that connects the old block to the new block. A hash is simply a solution to a cryptographic function. Nakamoto calls this proof-of-work, and bitcoin miners need to be able to do this using the SHA 256 Hash algorithm.
Not everyone needs to understand how SHA 256 fully works – it’s just that it can be a basis to a kind of “puzzle” miners need to solve in order to validate the transaction. When a miner finds the solution, they can build a “block” out of that solution, add the transaction in it, and link it to the blockchain. As an incentive, he can add a coinbase transaction to the file that gives him a certain number of bitcoins – and this is the only real way to earn them.
Bitcoins can be earned only when miners get to solve these puzzles. Given how much computing power is needed to solve these puzzles, there’s only a certain number of bitcoins that can be created in any given amount of time. This ensures bitcoin won’t inflate, as a certain number of bitcoins are only ever allowed to circulate around the network.
Math And Currencies: The Revolution Digital Currencies Needed
When you look at bitcoin as a whole, you’ll see less a collection of money and more of a collection of transactions in a universal bank account – kinda like how currencies work in general. Only this time, there’s a lot of numbers involved. In essence, cryptocurrencies really are just entries in a decentralized databases that are confirmed in a consensus.
They’re called “crypto” currencies because the consensus-keeping process is validated and secured through the help of cryptography. In fact, cryptocurrencies ride on the bank of cryptography – unlike centralized systems, cryptocurrencies are secured by math instead of trust.
As such, there are a lot of properties of cryptocurrencies that are shared, but these are not surefire properties of every kind of crypto.
Transactions: Anonymous, Secure, Protected
Unlike bank accounts, cryptocurrencies do offer a few perks to people who use them. Part of these are special transactional properties of cryptocurrencies that make them stand out from the rest of global currencies we are aware of.
Irreversible: All transactions done with bitcoin are irreversible by anyone – which means absolutely no one can reverse any transaction. No authority – not even Nakamoto – can change what you do with your bitcoin. You spend it, you spend it. You send it to a scammer, you send it. There’s no safety net if you use it recklessly.
- Anonymous: Transactions aren’t connected to real-world identities because bitcoins are received through “addresses,” which are chains of around 30 characters. Though it’s possible to analyze the flow of transactions, it’s not necessarily feasible to connect the addresses with identities.
- Global and fast: Transactions with cryptocurrencies are spread in the network instantaneously, and can even confirmed within minutes. Since confirmation happens through a network, the system doesn’t care about your physical location.
- Security: Bitcoin users have their “wallets” that contain the bitcoin addresses they receive. They are locked in a public key cryptography system, where private keys are needed to access them. Only owners of private keys can send out cryptocurrency to others – and with strong cryptography protecting these addresses, it’s impossible to penetrate.
- No Permissions: Anyone can use cryptocurrency. You only need the appropriate software to use it. There’s no gatekeeper that validates accounts. Only bitcoin transactions are validated.
Monetary Properties: More A Commodity Than Money
In the case of cryptocurrencies such as bitcoin, they also have some perks that a lot of people find attractive more than money in the real world. For instance:
- Controlled Amount: A lot of cryptocurrencies are attractive because the “tokens” or actual supply of tokens are limited. In the case of bitcoin, its supply decreases in time and will reach its final number at around 2140, based on Nakamoto’s programming. All cryptocurrency systems control the number of tokens via a schedule in its code. This means there’s a chance people can calculate a rough estimate of how much of a given crypto can exist in the future.
- No Debts, Just Pure Crypto: In terms of bank account, the Fiat-money is created by debt all throughout. The numbers you see in your ledger are debt. In the case of cryptocurrency, it represents itself – the commodity. Bitcoin are anonymous, irreversible, and permissionless – which means using bitcoin as means of payment is a direct attack towards banking institutions. You can’t disallow someone from accepting or sending payments, you can’t stop someone from using bitcoin, and you can’t ever undo a transaction. Being a currency with a limited amount, it can’t be changed by any institution. They take away the supposed centralized control of banks and other institutions.
Is Cryptocurrency Heralding A New Economy?
Given the many properties of bitcoin, it’s important to consider just how much impact it can create in the world economy when Satoshi Nakamoto didn’t even intend to create it in the first place. Bitcoin, however, had something that inspired fascination and enthusiasm.
It can be remembered that cryptocurrencies are like digital gold – and they are more secure than political influence. Crypto is a comfortable and fast ways to pay for things globally, and it’s anonymous and private enough for users to want to use it in the long term, and even in black markets. Cryptocurrencies are money in its rawest form – if you can buy something with crypto, you can but it with crypto. The only thing you need to do is to make sure transactions are verified.
This volatile nature of cryptocurrencies, and the potential it holds, has heralded the arrival of quite a lot of exchanges and cryptocurrency types.
For instance, shapeshift, poloniex, and Okcoin allow the trade of hundreds of cryptocurrencies that rose to prominence after bitcoin. Meanwhile, the Initial Coin Distribution of Ethereum (…another concept to be explained) has given creatives a means to create crowdfunding projects that can collect millions of dollars.
Of course, the volatile nature of crypto allows even a single -coin to gain 10- to 100-percent in a day, and to have just as much losses in the next. As such, despite the attractive nature of cryptocurrency, those who choose to invest in the concept should still be careful about how it’s going to be used.
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