Despite the controversy surrounding cryptocurrency, I wanted to take the time to go through some of the intricacies of Bitcoin and its descendants, known as alt-coins. Simply put, when people like Patrick respond to a chat message with statements like “I don’t know how bitcoin works” or “Give me 15 minutes to look that up; I’m driving,” it tells me that people who should know what cryptocurrency is clearly don’t. It is my intention to change that.
What is cryptocurrency?
First and foremost, cryptocurrency is a currency. This is the hardest thing for most people to wrap their heads around. Questions like, “How is bitcoin the same as money?” and “How are bitcoins made?” or “Where can I get bitcoin?” are talked about in great detail all over the web. While I do encourage reading the information provided by places like the Bitcoin Wiki, I want to attempt to explain cryptocurrency the way I do when I’m asked in person.
Cryptocurrency is — in the simplest of terms — a type of foreign currency; referred to by many as a global currency. In comparison to your local currency (USD, GBP, or the Euro), its value fluctuates just like any other foreign currency. When you exchange money to travel from one country to another, it’s at the current exchange rate.
In the same way, the price of cryptocurrency (take Bitcoin for example, which will from here on be referred to as BTC) fluctuates based on the current trade volume and prices of the exchanges it’s sold on. There are many cryptocurrency exchanges, some more reputable than others. While the prices fluctuate in between them slightly, you’ll find the rates stay more or less in the same range. To reiterate, the people who use cryptocurrency create the value of it by buying and selling it on exchanges, and the rate is derived from the market trade volume. There is no secret as to why it’s valuable, it simply is because the users have deemed it so.
Now that you have a slightly better idea of where cryptocurrency gets its value, it’s time to understand some of the advantages — and possible disadvantages — of it over normal (fiat) currency.
As many are aware, crypto-coins are not coins, they are values and account identifiers represented in the form of cryptographic hashes. These hashes are stored in what’s called a blockchain — a public ledger shared between all the network nodes which reflects all transactions and current addresses (accounts) on the network. This means at any given time, anyone can take an address, transaction, or block (a hash containing multiple transactions made since the last block), and look it up using what’s called a block explorer. This allows them to find the value of an address as well as all the transactions sent to and from it. The closest analogy would be if your bank account statements were available for anyone to view.
One thing that this publically shared ledger does is ensure that no transactions (or coins) can be counterfeited because all the nodes on the network have to have a consensus about a given transaction. I can’t create a transaction in where I sent 10,000 BTC to myself if the rest of the nodes can’t confirm that the sending address has 10,000 BTC in it in the first place.
Furthermore, because a blockchain requires that each hash has a sum that is less than that of the previous hash, I can’t just force a bunch of blocks to be created on a node with a specific address, forcing the block reward to be given to that address. If I did throw a large amount of hashing power at a chain to do that, all the nodes on the network would have to agree that they were valid — I couldn’t create a bunch of blocks offline, then connect later. On a localized blockchain, mining a large number of blocks with my CPU or GPU would be relatively easy. However, since the rest of the network wouldn’t agree they were valid, there’s little reason to do this beyond testing purposes.
To better understand, imagine if you somehow managed to hack your bank account and faked a large balance. Other banks would accept a transaction from that account because the bank sending it sees the funds as valid. If this were a blockchain, the receiving bank would know the funds weren’t valid and refuse the transaction regardless of what the sending bank showed.
That wraps up the basics for cryptocurrency! In a future article, I’ll explain more on the hashing mentioned, in relation to what’s known as mining in BTC and similar cryptocurrencies. I’ll also explain how coins are stored and sent between users by use of public and private key pairs.
If you have any questions you’d like answered, put them in the comments below or on social media, and I’ll answer them to the best of my ability!
Image credit: Captial & Conflict