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Cryptocurrency, Bitcoin and more - explained for the lay man

 

In essence, Cryptocurrency eliminates the need for third-parties to verify a transaction as this is enabled by using the cloud. Cryptocurrency is a currency that has been digitalised. Cryptography (Greek, meaning hidden or secret), is about constructing protocols that prevent third party or public interference. A good example of early cryptography was seen in world war II in which the German military used the enigma machine (a cryptology machine) to communicate encrypted messages with their bomber planes to pinpoint bombing locations. Decryption of the enigma machine was achieved by the British, who capitalised on the procedural flaws of the Germans. Nowadays, the secret way of writing code are very efficient and it would require effort many orders of magnitude larger to decrypt it, (convert it back into text that you or the computer can read or understand) which is very unlikely. 

 

If you take away all the noise around cryptocurrencies and reduce it to a simple definition, you find it to be just limited entries in a database no one can change without fulfilling specific conditions. Confirmation is a critical concept in cryptocurrencies. As long as a transaction is unconfirmed, it is pending and can be forged. When a transaction is confirmed, it is set in stone. It is no longer forgeable, it can not be reversed, it is part of an immutable record of historical transactions: of the so-called blockchain. Within Cryptocurrency, the safety, integrity and balance of ledgers is maintained by parties referred to as miners. Miners are members of the public using their computers to confirm transactions. After a transaction is confirmed by a miner, It has become part of the blockchain - and is irreversible. 

 

Bitcoin became the first decentralised currency in 2009. Since then, numerous other cryptocurrencies have been created. 

 

In centralised banking and economic systems such as the Federal Reserve System, corporate boards or governments control the supply of currency by printing units of fiat money or demanding additions to digital banking ledgers. In case of decentralised cryptocurrency, companies or governments cannot produce new units, and have not so far provided backing for other firms, banks or corporate entities which hold asset value measured in it. The underlying technical system upon which decentralised cryptocurrencies are based was created by the group or individual known as Satoshi Nakamoto.  

 

Most cryptocurrencies are designed to gradually decrease production of currency, placing an ultimate cap on the total amount of currency that will ever be in circulation, mimicking precious metals. Satoshi (creator of bitcoin) set a rule (later mimicked by other cryptocurrencies) that the miners need to work on a sort of puzzle to  find a solution to building a block. This activity is rewarded by an incentive of awarding Bitcoin and this is the only way to create valid bitcoins.

 

Compared with ordinary currencies held by financial institutions or kept as cash on hand. Existing cryptocurrencies are all pseudo-anonymous (information can be linked to them by service providers or site administrators), though additions such as ZeroCoin may allow for true anonymity. 

 

The legal status of cryptocurrencies varies from country to country and is still unknown or banned in many countries. The ability for government agencies or finical institutions to handle cryptocurrencies is at the discretion of the government. Interestingly, in the USA Bitcoin is treated as property for tax purposes as opposed to currency.

 

Cryptocurrencies introduced to various markets have been susceptible to theft and fraud. GBL, a Chinese bitcoin trading platform lost $5 million after suddenly shutting down. In February 2014, $473 million (7% of all bitcoin in existence) of bitcoin was lost resulting in a massive drop in valuation.  Other cryptocurrencies are known as alt coins (alternatives to bitcoin) have been prone to Ponzi schemes up to the value of $20 million. 

 

Despite the inherent possibility of theft and fraud, digital currencies have regained their value. As of June 2017, 1 Bitcoin is worth €2270.60. Network effects play an important role in analysing the development of cryptocurrency markets. Since any given currency gains use value as the number of its users increase, popularity of a certain currency is integral in that currency's success. Economists postulate that large competitors (such as the most popular cryptocurrency: bitcoin) will attract more new users due to the size of their growing exchange pools and as a result will effectively dominate the market. That said, although Bitcoin’s value is increasing, its market share is falling - as another cryptocurrency - Ethereum is rapidly increasing in value.

 

Central to the genius of Bitcoin is the blockchain it uses store an online ledger of all the transactions that have ever been conducted using bitcoins, providing a data structure for this ledger that is exposed to a limited threat from hackers and can be copied across all computers running Bitcoin software. It is often asked whether bureaucracies  could gain control of Bitcoin leading to regulation. However, this is improbable due to the way in which Blockchain operates - as it allows all users to view the past transactions, meaning they could easily set up another system.

 

In a Blockchain, timestamps for a transactions are added to the end of a previous  timestamp based on proof-of-work, creating a historical record that cannot be changed. Proof-of-work is essentially proof that certain computational methods were completed and this is done by the miners. The miners are earn a vote for each proof-of-work completed and have the option of being paid in Bitcoin. As the Blockchain increases in size as the number of transactions increases, it becomes more difficult for attackers to disrupt as transactions are added. Miners can not alter previous transactions.

 

 

The code developed for Blockchain means you can trust the code without trusting the owners of any particular remote computer. A smart phone user in Albania can use the block chain to interact with a computer controlled by somebody in Zimbabwe, and they don't have to know or trust each other in any way, nor do they need to depend on the institutions of either's countries, for the underlying block chain computer to run its code securely and reliably. Regardless of where any of the computers or their owners are, the block chain computer they share will execute as reliably and securely as consensus technology allows and up to its limits. This is an extremely high level of reliability, and a very high level of security, compared to web server technology. 

 

 

A cryptocurrency can be divided into smaller units, just as the pound is broken into pence and the dollar into cents. In the case of bitcoins, the smallest unit available is called the satoshi. The satoshi represents one hundred millionth of a Bitcoin, the smallest unit is called the Satoshi. 

Small denominations make bitcoin transactions easier to conduct transactions with. The general unit structure of Bitcoin has 1 Bitcoin (BTC) equivalent to 1,000 millibitcoins (mBTC), 1,000,000 microbitcoins (uBTC), or 100,000,000 satoshis.

 

Because Bitcoin is not controlled by a single entity, decisions concerning changes are made through a consensus. Any changes proposed have to receive substantial support from the greater Bitcoin community. Once a new standard is accepted, previous software standards become obsolete. An organisation that pushes forward with a change that other groups have not agreed with can result in “forking”, which could eventualy lead to Bitcoin would splitting between two different standards. Bitcoin currently has governmental issues and forking could eventually lead to two categories of Bitcoin. 

 

Above I have noted the fundamentals of how Cryptocurrencies, Blockchain and Bitcoin operate. Although the market is very volatile, the idea shows great potential. Whether or not we are in a bubble is speculation, but in my opinion cryptocurrencies are here to stay. 

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