Cryptocurrency Basics for Investors, Traders, and Revolutionaries
Cryptocurrency. The name itself sounds faintly sinister, but it’s not.
Put simply, it’s nothing more or less than digital money.
Beginning with the release of the first cryptocurrency, Bitcoin, in 2009, the idea of digital cash has worked its way into the global frame of reference. While a majority of people have a passing knowledge of its existence, few really comprehend how it operates and the game-changing possibilities of a “free agent” currency and the underlying blockchain technology that powers it.
Keep reading. There’s a good chance you’ll know more about cryptocurrencies at the end than you do now. You can thank us later.
It Started With Bitcoin
In 2009, a mysterious inventor using the pseudonym, Satoshi Nakamoto, released upon the world the first decentralized, digital currency which he called Bitcoin.
See that word “decentralized” back there? It’s a big deal. Bitcoin represented the first attempt to build a non-trust based currency. In other words, people who use it don’t have to simply hope that the bank and/or government controlling it plays a fair game.
With cryptocurrencies, we have the first successful attempt to go outside the concept of using a central database to keep everything organized.
To understand how cryptocurrencies work, you first need to realize it is constructed much like a peer-to-peer (P2P) network where hundreds, thousands, or even millions of computers power the system - kind of like Napster for those who remember that 1990’s era music-sharing service. The important thing to remember about a P2P network as related to cryptocurrencies is that its decentralised nature makes it essentially unhackable.
Removing the Fluff
We could talk ourselves silly using terms like decentralised and non-trust based but putting it simply, a cryptocurrency is nothing more than entries in a database that cannot be changed without specific conditions having been met.
Just like in a traditional currency system, those entries represent value to you. When you think about it, unless you hoard your wealth in bills buried in Mason jars in the backyard or piles of gold coins under your bed, what you think of as your money is nothing more than notations in your bank’s database either.
While your banker is in charge of verifying debits and credits to your account, the idea of cryptocurrency takes him or her out of the mix and pushes the responsibility of verifying and recording transactions out to each member of the network. This automatic, algorithm-powered approval process is what we mean by a non-trust based system. No single entity is in charge, which makes it almost impossible to manipulate. Are you listening governments around the world?
How a Cryptocurrency Transaction Works
The human brain likes to think in steps, so we’ve broken down the process of a cryptocurrency transaction for your further study or consternation.
#1. Someone requests a transaction (this is how you spend your digital cash).
#2. The transaction goes out to each node of the network.
#3. Each node uses certain algorithms to match the transaction to the identity of the one making the request.
#4. The transaction is verified and added to the blockchain, which is simply a complete digital ledger of the cryptocurrency that exists on each computer in the network.
There you have it. Cryptocurrency in action.
We should note plainly that a cryptocurrency has no intrinsic value. Though some folks are making a fortune buying and selling it in a manner similar to stock trading, a cryptocurrency has no physical form and the supply is not determined by a government or central bank.
In case you haven’t guessed it by now, government’s hate the idea of a private currency they can’t control. Banks, on the other hand, are starting to see potential in the concept of the greater security inherent in blockchain technology.
The beating heart of this whole cryptocurrency thing is the idea of confirming transactions. This is where the heavy lifting is done. Once confirmed, a transaction is set in stone, so to speak, and distributed out to the network as a data block to be added to the ledger.
Whereas the traditional currency system consisted of a single ledger sitting on a bank’s database somewhere, a cryptocurrency ledger is recreated in its entirety on every node of the network with every confirmed transaction. By now you should start to understand how much of a security upgrade this process is. A bad guy doesn’t just have to hack into one system - he has to hack them all simultaneously, which would require a feat of unimaginable timing and computer resources.
So, what is this Bitcoin mining stuff you keep hearing about?
It’s just a term to describe the transaction confirmation process. Each node of the network is a Bitcoin (or any other cryptocurrency) miner.
It’s a computer loaded with the cryptocurrency software that applies the algorithms to a transaction, verifies it’s legit, and sends it out to the network. Do they do this out of the goodness of their hearts and an unmeasurable abiding love for humanity? Umm, not really. They do it because they get paid in cryptocurrency.
Of course, it’s not as easy as turning on your computer and watching cryptocurrency “coins” shoot out like hitting the jackpot in Vegas as payment for your mining. When he invented the system, Satoshi implemented a rule that requires miners to search online for a hash (don’t worry, there won’t be a test on this stuff), which is a cryptographic product that connects a new transaction to the old ledger. It’s a never-ending Easter egg hunt with each new transaction and it requires a substantial amount of dedicated computer resources to participate.
Serious miners have built standalone systems that do nothing more than look for transaction hashes around the clock. Since infinite computer power does not exist, the hash search is a built-in factor that limits how quickly transactions can be confirmed and new Bitcoins generated.
The Bottom Line
We hope the preceding discussion was some help in understanding the sometimes mysterious world of cryptocurrencies. Though we used Bitcoin in many of the examples, you should realize that the same principles apply to other variations, of which there are dozens and new ones coming online every day.
One thing is for certain. We’re still in the early stages. Stay tuned. This is going to get interesting.