You might have heard about cryptocurrency and blockchain technology but don’t understand how the whole thing works. This post will explain the meaning of cryptocurrency, blockchain technology and also give you a simple explanation of how cryptocurrency and blockchain technology works.
Lets start by explaining the meaning of cryptocurrency.
What is Cryptocurrency?
A cryptocurrency is a digital/virtual asset/currency designed to work as a medium of exchange. By being virtual in nature, they use cryptography technology to process, secure and verify transactions.
In Cryptocurrencies, individual coin ownership records are stored in a ledger existing in a form of computerized database, using strong cryptography to secure transaction records, to control the creation of additional coins, and to verify the transfer of coin ownership. This ledger is called blockchain (I will explain the meaning of blockchain later).
What is a Digital Asset?
A digital asset is anything that exists in a digital format and comes with the right to use. (eg Word documents, photos, videos, marketing content). Think of it like you have money or something like gold that exists in digital form.
What is Cryptography?
Cryptography is the art of writing or solving codes. So before a transaction is verified or stored, computers on the blockchain (network) will solve difficult mathematical/cryptography problems.
Now that we have explained the meaning of crypto currency, let me show you examples of cryptocurrencies.
Examples of Cryptocurrencies
Some examples of cryptocurrencies are:
- VeChain Coin
- Zilliqa Coin
What is bitcoin?
Bitcoin is a cryptocurrency / digital asset/money, so just like a Dollar or Naira, bitcoin is a currency that is only exists in digital form, you cannot hold it the way you hold your paper money, but you can use it to make transactions. Bitcoin is a cryptocurrency invented in 2008 by an unknown person or group of people using the name Satoshi Nakamoto. Bitcoin is the largest cryptocurrency by market capitalization.
What is Ethereum?
Ethereum is a decentralized open source blockchain featuring smart contract functionality. Ether is the native cryptocurrency token of the Ethereum platform. It is the second-largest cryptocurrency by market capitalization, behind Bitcoin. Ethereum is not just a currency; it is also a platform that allows other blockchain applications to be built on it. The Ethereum platform uses a currency called Ether, which is used to pay for transactions. Ether works more like fuel than a normal cryptocurrency. Just like you need gasoline or diesel for your car, you need Ether to run the smart contracts and applications on the Ethereum blockchain.
A smart contract is an agreement between two people in the form of computer code. It is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of code. The code and the agreements contained therein exist across a distributed, decentralized blockchain network. Read more about smart contract
Cryptocurrency as a digital currency
When we talk about cryptocurrency, we must talk about digital currency. A digital / virtual currency is a digital representation of value, It is entirely digital and acts in the same way as physical, traditional – or fiat – money. They are not issued by a central bank, credit institution.
Cryptocurrency is a form of digital currency that are powered by algorithms, they are used as tokens in select online communities and backed by certain technologies, assets or projects.
Cryptocurrency is considered secure, reliable and trustworthy as it is based on cryptography.
Cryptocurrencies use Blockchain and a decentralized ledger, which means that no single individual or supervisory authority controls the actions in the network. It is pure decentralization.
Why is it called cryptocurrency instead of just digital currency?
It is cryptocurrency because it is produced (mined) when computers solves difficult mathematical problems (cryptography). Unlike fiat currencies like Dollar or Naira that government can print or increase the number in circulation. Bitcoin and other crypto currencies have a finite amount available, once they are all produced or mined, new ones cannot be created. Some cryptocurrencies, a consensus can be reach by the community to print new coins.
Digital currencies vs crypto currencies
While cryptocurrency is a digital currency, a lot differentiates it from other digital currencies. Here are differences between cryptocurrencies and digital currencies:
- Digital currencies are centralized, meaning that transactions within the network are regulated in a centralized location, like a bank. On the other hand, Cryptocurrencies are decentralized, and the regulations inside the network are governed by the majority of the community.
- Digital currencies are not transparent. With digital currencies, you cannot see transaction history of others except they give you access.. This information is kept strictly confidential and private. But cryptocurrencies are transparent, anyone and everyone is able to see any and all transactions made and received by any user, as all revenue streams are placed in a public chain – the blockchain.
- Digital currencies have a central authority that can deal with any problems or issues. This central body can, for example, freeze or cancel transactions on the request of the participant or the authorities. Cryptocurrencies are regulated by their respective communities.
Brief History of Cryptocurrencies
Cryptocurrencies came into being as a side product of Satoshi Nakamoto, the brainchild behind Bitcoin cryptocurrency. Nakamoto did not intend to develop a currency but a peer-to-peer electronic cash system for facilitating transactions without any central oversight.
The decentralization aspect of the network means there is no central server where transactions are hosted or controlling authority. In a decentralized network like Bitcoin, every transaction is displayed for everyone to see. Each transaction file also consists of senders and recipients public keys.
Difference between conventional currency and cryptocurrency
- Traditional currencies are physical while crypto currencies are virtual
- The core of traditional currency is located in a specific country or group of countries while crypto currencies are global
- Central Banks and financial reserves control traditional currencies while Cryptocurrencies are controlled by all users and blockchain technology.
- Traditional currencies are Issued by governments while cryptocurrencies are issued through decentralized mining offers
- fiat currencies are relatively stable while crypto currencies are volatile
Examples of traditional currencies: euro, peso, dollar, naira, pound sterling.
How do cryptocurrencies work?
Cryptocurrencies use decentralised technology to let users make secure payments and store money without the need to use their name or go through a bank. They run on a distributed public ledger called blockchain, which is a record of all transactions updated and held by currency holders.
What do you mean by mining in cryptocurrency?
Mining is the process where a computer or set of computers run a node (e.g. bitcoin node) and solve/decrypt difficult computational problems while verifying transactions on the cryptocurrency ledger called the blockchain.
Meaning of Blockchain Technology
Blockchain technology is simply defined as a decentralized, distributed ledger that records the provenance or history of ownership of a digital asset. Blockchain is a system of recording information in a way that makes it difficult or impossible to change, hack, or cheat the system. A blockchain is essentially a digital ledger of transactions that is duplicated and distributed across an entire network of computer systems.
First of all, to properly understand what blockchain is, you have to know the meaning of a database. A blockchain is a type of database.
A database is a collection of information that is stored electronically on a computer system. Information, or data, in databases is typically structured in table format to allow for easier searching and filtering for specific information.
Think of a spreadsheet, Database is like a bigger and more capable spreadsheet.
Spreadsheets are designed for one person, or a small group of people, to store and access limited amounts of information. A database on the other hand is designed to house significantly larger amounts of information that can be accessed, filtered, and manipulated quickly and easily by any number of users at once. Large databases achieve this by hosting the data on servers that are made of powerful computers.
One key difference between a typical database and a blockchain is the way the data is structured. A blockchain collects information together in groups, also known as blocks, that hold sets of information. Blocks have certain storage capacities and, when filled, are chained onto the previously filled block, forming a chain of data known as the “blockchain.” All new information that follows that freshly added block is compiled into a newly formed block that will then also be added to the chain once filled.
A typical database structures its data into tables whereas a blockchain, like its name implies, structures its data into chunks (blocks) that are chained together.
So all blockchains are databases but all databases are not blockchain.
This system of chaining in blockchain makes an irreversible timeline of data when implemented in a decentralized nature. When a block is filled it is set in stone and becomes a part of this timeline. Each block in the chain is given an exact timestamp when it is added to the chain.
Features of Cryptocurrency
- It is secure, reliable and trustworthy
- It has no physical form as it exists only on the immutable blockchain
- Attributes of a crypto currencies are determined by majority members of it’s decentralized network instead of a central authority.
Decentralization of Cryptocurrencies
Like a database, most cryptocurrencies needs a collection of computers to store its blockchain. This blockchain stores every transaction ever made. In most decentralized cryptocurrencies, and unlike most databases, these computers are not all under one location or central control, and each computer or group of computers is operated by a unique individual or group of individuals.
Imagine that a company owns a server comprised of 10,000 computers with a database holding all of its client’s account information. This company has a warehouse containing all of these computers under one roof and has full control of each of these computers and all the information contained within them. Similarly, cryptocurrency consists of thousands/millions of computers, but each computer or group of computers that hold its blockchain is in a different geographic location and they are all operated by separate individuals or groups of people. These computers that makeup cryptocurrencies’s network are called nodes.
In this model, a cryptocurrency’s blockchain is used in a decentralized way. However, private, centralized blockchains, where the computers that make up its network are owned and operated by a single entity, do exist.
In a blockchain, each node has a full record of the data that has been stored on the blockchain since its inception (all transactions). If a node loses some records it can reference other nodes to update/correct itself. This way no can tamper with the record of transactions, as all other nodes would cross-reference each other and easily pinpoint the node with the incorrect information.
For Bitcoin, this information is a list of transactions, but it also is possible for a blockchain to hold a variety of information like legal contracts, state identifications, or a company’s product inventory.
In order to change how that system works, or the information stored within it, a majority of the decentralized network’s computing power would need to agree on said changes. This ensures that whatever changes do occur are in the best interests of the majority.
Is Blockchain Secure?
Blockchain technology accounts for the issues of security and trust in several ways. First, new blocks are always stored linearly and chronologically. That is, they are always added to the “end” of the blockchain. If you take a look at Bitcoin’s blockchain, you’ll see that each block has a position on the chain, called a “height.” As of February 2021, the block’s height had crossed 670,150 blocks.
After a block has been added to the end of the blockchain, it is very difficult to go back and alter the contents of the block unless the majority reached a consensus to do so. That’s because each block contains its own hash, along with the hash of the block before it, as well as the previously mentioned time stamp. Hash codes are created by a math function that turns digital information into a string of numbers and letters. If that information is edited in any way, the hash code changes as well.
Here’s why that’s important to security. Let’s say a hacker wants to alter the blockchain and steal Bitcoin from everyone else. If they were to alter their own single copy, it would no longer align with everyone else’s copy. When everyone else cross-references their copies against each other, they would see this one copy stand out and that hacker’s version of the chain would be cast away as illegitimate.
Succeeding with such a hack would require that the hacker simultaneously control and alter 51% of the copies of the blockchain so that their new copy becomes the majority copy and thus, the agreed-upon chain. Such an attack would also require an immense amount of money and resources as they would need to redo all of the blocks because they would now have different timestamps and hash codes.
Due to the size of Bitcoin’s network and how fast it is growing, the cost to pull off such a feat would probably be insurmountable. Not only would this be extremely expensive, but it would also likely be fruitless. Doing such a thing would not go unnoticed, as network members would see such drastic alterations to the blockchain. The network members would then fork off to a new version of the chain that has not been affected.
This would cause the attacked version of Bitcoin to plummet in value, making the attack ultimately pointless as the bad actor has control of a worthless asset. The same would occur if the bad actor were to attack the new fork of Bitcoin. It is built this way so that taking part in the network is far more economically incentivized than attacking it.
How to Store Cryptocurrency
Just like your fiat currency, you are also required to store your crypto currency for safe keeping. Typically, you store your fiat currency in a bank or deposit box. Cryptocurrencies are stored in a wallet (digital wallet). The digital wallet can be hardware-based or web-based.
What does the wallet store?
Like I explained earlier, transactions and coin ownership records for cryptocurrencies are publicly stored in the blockchain. Each transaction/record is signed with key by the initiator before being verified and subsequently stored on the blockchain. Every owner of crypto has what is called an address, the address must be used together with a secret key to process any transaction on the blockchain. If you lose access to your address or secret key, you won’t be able to access your coins/assets on the crypto network.
What is cryptocurrency wallet?
A cryptocurrency wallet is a piece of software that keeps track of the secret keys used to digitally sign cryptocurrency transactions for distributed ledgers and also store the address on a blockchain where a particular asset resides.
A wallet can be on mobile device, on a computer desktop, or kept safe by printing the private keys and addresses used for access on paper.
There are two main types of crypto wallets: hardware (cold storage wallet) and software (hot storage wallet
A cold wallet is a wallet that is not connected to the internet. These wallets store a user’s address and private key on something that is not connected to the internet and typically come with software that works in parallel so that the user can view their portfolio without putting their private key at risk. Cold storage wallets are downloaded and reside offline on a piece of hardware such as a USB drive or a smartphone. Examples are Exodus.io and Dash QT.
A hot wallet also known as online wallet are wallets that run on internet-connected devices like computers, phones, or tablets. Example of hot wallet is wallet provided Coinbase.
There are also paper wallet generators, which create keys that can be printed out or rendered as QR codes.