A Dummy’s Guide to Cryptocurrencies: Part 1
What is a cryptocurrency?
A cryptocurrency is a digital asset designed to work as a medium of exchange using cryptography to secure the transactions on a ledger that is typically publicly viewable. A community guarantees the authenticity of the transactions in addition to the creation of additional units of the currency (Victor, 2017).
What problems is bitcoin trying to solve?
Bitcoin is currently the most popular cryptocurrency. The problem bitcoin is trying to solve is an important one faced by many people across the world. Leo Tolstoy said, “money is a new form of slavery.” By controlling money, vast power is wielded in today’s world. The enormous amount of money in circulation is primarily controlled by bankers and they wield the powers of inflation and currency debasing as methods of increasing and controlling product prices throughout the economy (Donk, 2017).
Centralized and institutional control of currency is the problem bitcoin is trying to solve. Bitcoin, like many other cryptocurrencies, gives power to the people using the cryptocurrency as they do not require authorities in a centralized system to do business and make purchases. By being peer to peer (P2P) and decentralized it lets people trade without having the rules of the transaction dictated by third parties. Cryptocurrency enables users to act anonymously and this removes power traditionally held by financial institutions.
What is the blockchain? A look at the basics.
At first the blockchain might seem complex but in reality, it’s very simple. The blockchain is just another type of database for recording transactions – once a transaction occurs, it is copied to all of the computers in a participating network and this is sometimes referred to as a ‘distributed ledger’.
Data is stored in ‘blocks’, and there are two main features about ‘blocks’ to know:
- Content: mainly a list of instruction statements and digital assets (such as transactions made) and the amounts and addresses of the parties to those transactions.
- Header: metadata, such as unique block reference number, the time the block was created, and a link back to the previous block (Deloitte corporation, 2016).
Given the latest block, it is possible to access all previous blocks which are linked together through a chain (blockchain). As participants in the network grow it becomes harder for malicious actors to overcome the verification processes that are completed by the community (Deloitte corporation, 2016).
What are ‘Miners’?
Mining is a way to create bitcoins. A core motivation to mine is the ability to stay anonymous. If you solve a block (a lot of computing power is necessary to achieve this, but once solved, you are remunerated with bitcoins) and use Tor (anonymous browser) it is possible to obtain bitcoins while remaining completely anonymous (Sterry, 2012).
Bitcoin can be simplified into three things: first, is the set of rules (protocol) that dictates how the network should be operated; second is the software that actualizes the protocol; the third point is the large network of computers that run the software that enables the protocol. Essentially, this is a chain of computers that serve as the fundamental basis of the system. That activity of the third point is what is called mining. The process of mining involves verifying transactions, collecting transaction fees, preventing double-spending, and creating the currency supply. Mining is also a computational protection for the system since a large amount of processing power is being piled on top of past transactions. Miners verify transactions by assessing them against previous transactions. Transactions cannot spend bitcoins that were spent before or do not exist. They must adhere to the rules defined by the protocol (Sterry, 2012).
Mining and blockchain are the keys that enable a cryptocurrency and both of these are just at the beginning stages.
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