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What are cryptocurrencies and how do they work?

The rapid increase in the price of Bitcoin and other Cryptocurrencies has attracted the attention of investors, financial companies, regulators and the media alike. While many have sparked their interest, it can be challenging to understand the basics of bitcoin and other cryptocurrencies.

There are some reasons for that. First of all, there is a lot of technical language involved, especially if you are trying to understand how the software works. In addition, many cryptocurrencies are experimental open source projects and there is a disagreement about how they should evolve among developers, miners and early investors who have large stocks and, therefore, a lot of influence. Then there is the question that the concept only challenges the conventional notions of money of many people. The cryptocurrencies have been denominated from the future of the currencies to direct scams and Ponzi schemes.

In this article we will provide a brief description of Bitcoin and cryptocurrencies, we will review how they are used and we will discuss some risks to consider if you are thinking of buying shares and ETFs (quoted investment funds) related to cryptocurrencies.

What are cryptocurrencies?

Cryptocurrencies, also known as Cryptocurrency, are digital currencies that are protected by unidirectional cryptography. Many of them rely on public blockchain technology: a distributed ledger of all transactions that is decentralized and can not be changed in most circumstances, as long as no one controls more than 50% of the computing power in the network .

Unlike traditional currencies, they are not controlled by any government or central authority. In the case of some of them (Bitcoin, Monero and Litecoin, for example), the supply of new coins is controlled by a process called mining, a computationally intensive process where computers (mining nodes) compete with each other to secure the network by solving mathematical equations, collecting bitcoins as a reward if they are the first to create a new valid block, which is then transmitted to the rest of the network and added to the block chain.

Other currencies are mined previously, where the extraction occurs before the public release of the coin. Pre-mined currencies are sometimes seen negatively as they are often heavily promoted to increase demand and increase price, allowing developers to withdraw money.

Since many of them have been created as open source software, they continue to evolve as developers work to implement solutions to address the problems that arise. Some of the common problems include scalability and security issues.

From the perspective of stock market capitalization, Bitcoin is, by far, the largest of all. As of December 17, 2017, bitcoin represents $ 328 billion, of a total value of $ 598 billion distributed among the 1,360 cryptocurrencies that the coinmarketcap site tracks .

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With Bitcoin, the original developer Satoshi Nakamoto set out to create a “peer-to-peer electronic cash system”, according to the Bitcoin technical document. The white paper was written under what appears to be a pseudonym and there is much mystery surrounding the true identity of the original creator. The people who track the initial activity of the Bitcoin network estimate that whoever Satoshi Nakamoto really is, has approximately 1 million bitcoins, with an approximate value of $ 18,600 million according to recent prices. To add more to the mystery, it seems that a minimum amount, if any, has been moved / spent of this bitcoin.

One of the great innovations of Bitcoin was the creation of a system that did not depend on reliable third parties to process electronic payments; instead, it was based on the consensus of the nodes in the network. He also created a currency where the supply could not be altered by any central bank or government. It may not seem so important in a country like the United States, but in places like Zimbabwe and Venezuela that have experienced hyperinflation due to the excessive amount of money printed by corrupt governments, this is cause for greater concern.

Beyond bitcoin, according to data from, there are 27 other currencies that have a market capitalization of $ 1 billion or more (since December 17). Ether, Ripple, Litecoin, Dash, Monero, Zcash and IOTA are just some examples.

The characteristics and purpose of different currencies vary. Several were created by developers who sought to solve the shortcomings of certain currencies or provide additional features that were not present in others. For example, Bitcoin is not completely anonymous. The ledger can be seen by anyone and the flow of funds can be tracked to and from different Bitcoin addresses, although there is no private information linking you to your Bitcoin address. Other coins have been developed to provide complete anonymity.

History of the Cryptocurrencies

The cryptocurrencies existed as a theoretical construction long before the first alternative digital currencies appeared. Early supporters of cryptocurrencies shared the goal of applying the latest generation of computer and mathematical principles to solve what they perceived as practical and political shortcomings of “traditional” fiduciary currencies.

Technical fundamentals

The technical foundations of cryptocurrencies date back to the early 1980s, when an American cryptographer named David Chaum invented a “blinding” algorithm that remains fundamental to modern web-based encryption. The algorithm allowed safe and unchangeable exchanges of information between the parties, setting the basis for future electronic currency transfers. This was known as “blinded money”.

In the late 1980s, Chaum recruited a handful of cryptocurrency enthusiasts in an attempt to commercialize the concept of blind money. After moving to the Netherlands, he founded DigiCash, a for-profit company that produced currency units based on the blindness algorithm. Unlike Bitcoin and most other modern cryptocurrencies, the DigiCash control was not decentralized. The Chaum company had a monopoly on supply control, similar to the monopoly of central banks over fiduciary currencies.

DigiCash initially dealt directly with individuals, but the central bank of Holland complained and annulled this idea. Faced with an ultimatum, DigiCash agreed to sell only to licensed banks, which seriously reduced its market potential. Later, Microsoft approached DigiCash about a potentially lucrative partnership that would have allowed early Windows users to make purchases in their currency, but the two companies could not agree and DigiCash went bankrupt in the late 1990s.

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Around the same time, an accomplished software engineer named Wei Dai published a white paper on b-money, a virtual currency architecture that included many of the basic components of modern cryptocurrencies, such as the complex protections of anonymity and decentralization. However, b-money was never used as a means of exchange.

Soon after, a Chaum associate named Nick Szabo developed and launched a cryptocurrency called Bit Gold, which was characterized by using the blockchain system that underpins most modern cryptocurrencies. Like DigiCash, Bit Gold never gained popularity and is no longer used as a means of exchange.

Virtual currencies before Bitcoin

After DigiCash, much of the research and investment in electronic financial transactions moved to more conventional, albeit digital, intermediaries, such as PayPal (itself a harbinger of the mobile payment technologies that have become popular in the last 10 years). A handful of DigiCash imitators, such as Russia’s WebMoney, emerged in other parts of the world.

In the United States, the most notable virtual currency of the late 1990s and 2000 was known as e-gold. e-gold was created and controlled by a company of the same name based in Florida. e-gold, the company, basically operated as a digital gold buyer. Your clients, or users, sent their old jewels, trinkets and coins to the e-gold store, receiving digital units in “e-gold” denominated in ounces of gold. Users of e-gold could then trade their holdings with other users, charge physical gold or exchange their e-gold for US dollars.

At its peak in the mid-2000s, e-gold had millions of active accounts and processed billions of dollars in annual transactions. Unfortunately, the relatively lax security protocols of e-gold made it a popular target for hackers and phishing scammers, leaving their users vulnerable to financial loss. And in the mid-2000s, much of the transaction activity of e-gold was legally dubious: its relaxed legal compliance policies made it attractive for money laundering operations and small-scale Ponzi schemes. The platform faced increasing legal pressure in the mid and late 2000s, and finally stopped operating in 2009.

Bitcoin and the modern boom of cryptocurrencies

Bitcoin is widely regarded as the first modern cryptocurrency: the first means of exchange used publicly to combine decentralized control, user anonymity, record keeping through a chain of blocks and built-in shortages. It was first described in a 2008 white paper published by Satoshi Nakamoto, the pseudonym of a person or group.

In early 2009, Nakamoto launched Bitcoin to the public, and a group of enthusiastic supporters began to exchange and extract the currency. At the end of 2010, the first of what would eventually be dozens of similar cryptocurrencies began to appear, including popular alternatives such as Litecoin. The first Bitcoin public exchanges also appeared at this time.

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At the end of 2012, WordPress became the first major merchant to accept payments in Bitcoin. Others, including (an online electronics retailer), Expedia and Microsoft, followed. Dozens of merchants now see the most popular cryptocurrency in the world as a legitimate payment method. Although few other cryptocurrencies are widely accepted for payments to merchants, the increasingly active exchanges allow holders to exchange them for Bitcoin or fiduciary currencies, which provides critical liquidity and flexibility.

How do cryptocurrencies work?

In a typical currency, such as the US dollar, transactions are handled through the exchange of cash or electronic transfers. These electronic transfers are managed by large banks that we trust to keep our money safe and our transactions honest.

To create a cryptocurrency like Bitcoin, we first have to take responsibility for tracking transactions outside of banks and managing it ourselves. The first step is to create a ledger of payments from everyone to everyone else. This ledger will keep track of who owes money to whom and will record each other’s payments.

The next step is to prevent people from cheating by adding transactions in which a party does not agree. An easy way to solve this problem is to require both people in the transaction to sign the payment. Each participant can add their “digital signature” using public / private key encryption so everyone knows that the transaction is legitimate.

But there is one last problem: to whom does the book belong? In a traditional currency system, a bank would maintain it, but we are supposed to be building a currency that does not need banks. Instead, everyone has their own ledger, and all transactions are made public, so that everyone updates their ledger at the same time.

In this way, everyone can exchange money safely without worrying about whether the people who manage it are trustworthy. Instead of trusting a central bank or government to secure our transactions, we can simply use cryptography to force everyone to play fair. While cryptocurrencies are still in their early stages, in a few years they could be the preferred way to make payments around the world.

What is the technology of distributed accounting or blockchain?

The chain of blocks of a cryptocurrency (sometimes written as “blockchain”) is the ledger that records and stores all previous transactions and activities, validating the ownership of all units of the currency at a given point in time. As a record of the complete transaction history of a cryptocurrency to date, a chain of blocks has a finite length, which contains a finite number of transactions, which increases over time.

Identical copies of the chain of blocks are stored in each node of the cryptocurrency software network: the network of decentralized server farms, managed by people or groups of knowledgeable individuals known as miners, who continuously record and authenticate the cryptocurrency transactions.

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A cryptocurrency transaction is technically not completed until it is added to the blockchain, which usually occurs in a matter of minutes. Once the transaction is finalized, it is usually irreversible. Unlike traditional payment processors, such as PayPal and credit cards, most cryptocurrencies do not have integrated reimbursement or chargeback functions, although some newer cryptocurrencies have rudimentary reimbursement features.

During the delay time between the start and end of the transaction, the units are not available for the use of any of the parties. Instead, they are held in a kind of escrow. The blockchain avoids double spending or manipulation of the cryptocurrency code to allow the same monetary units to be duplicated and sent to multiple recipients.

What is the cryptocurrency mining?

The miners serve as record keepers for the cryptocurrency communities and indirect arbiters of the value of the coins. Using large amounts of computing power, often manifested in private server farms owned by mining collectives composed of dozens of individuals, the miners use highly technical methods to verify the integrity, accuracy and safety of the block chains of the coins. The scope of the operation does not differ from the search for new prime numbers, which also require enormous amounts of computing power.

The work of the miners periodically creates new copies of the block chain, adding recent transactions, not previously verified, that are not included in any previous blockchain copy, effectively completing those transactions. Each addition is known as a block. The blocks consist of all transactions executed since the last new copy of the block chain was created.

The term “miners” refers to the fact that the miners’ work literally creates wealth in the form of new units of cryptocurrencies. In fact, each newly created blockchain copy comes with a two-part monetary reward: a fixed amount of newly minted (“mined”) cryptocurrency units and a variable amount of existing units collected from optional transaction fees (usually less 1% of the transaction value) paid by the buyers.

Through the instructions in their source codes, the cryptocurrencies are automatically adjusted to the amount of mining power to create new copies of the blockchain: the copies become more difficult to create as the mining power increases and easier to create as the mining power decreases. The goal is to maintain the average interval between new creations of the blockchain at a predetermined level. Bitcoin is 10 minutes, for example.

How are cryptocurrencies used?

There are some merchants that accept bitcoin and other cryptocurrencies directly from a user’s wallet. Although some of them have very high prices, they are divisible into very small fractions. Bitcoin, for example, is divisible up to a “satoshi”, which represents 0.00000001 of a bitcoin.

Some companies have created ATMs where you can use US dollars and other fiat currencies to buy bitcoins and sell them for cash. There are also companies that have created debit cards in which you can convert bitcoins into dollars and use them as you would with any other debit card.

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Other cryptocurrencies have more specific uses and are used to pay for services in a given network. For example, Ether is the digital currency used to operate smart contracts in the Ethereum network.

Common terms of cryptocurrencies

These are some of the basic and non-technical terms that you will probably encounter when reading about cryptocurrencies:

  • Address:  Like an email address, you can share your specific cryptocurrency address so that someone can send you that particular currency. Unlike email, people can have many different addresses and, in general, it is recommended to generate a single address for each transaction.
  • Altcoin: Abbreviation of alternative currency, the term is commonly used to describe any cryptocurrency that is not bitcoin.
  • Blockchain: A ledger or distributed ledger, cryptographically protected and composed of blocks that contain the transaction history. As the chain of blocks grows more and more, it becomes increasingly difficult to alter the oldest transactions.
  • Fork (fork): A software fork occurs when there is a change in the original program, which can result in a split of the original block chain and the creation of a new currency: Bitcoin Cash and Ethereum Classic are two examples of currencies created from forks. There can be hard forks, soft forks and accidental forks.
  • Hodl: No, I have not spelled it wrong. The term has become the battle cry for early adopters of cryptocurrencies that cling to currencies regardless of price volatility.
  • Initial offer of currencies (ICO): An ICO, also known as the sale of tokens, is a means of crowdfunding in which a company offers a new currency in exchange for a fiduciary currency (US dollars, for example) or a digital currency ( Bitcoin, Ether, Litecoin, etc.) In general, the funds they received are used to develop the new concept, and the token they issued will be used to carry out transactions in your network once it is launched. Both China and South Korea have banned ICOs, and the SEC has stated that the offer and sale of securities could be considered depending on the circumstances of the offer.
  • Smart contract: An agreement that is written in source code and is executed automatically when certain conditions are met. Some networks, especially Ethereum, admit smart contracts, while others do not.
  • Wallet: a cryptocurrency wallet stores private and public keys, which are necessary to send and receive coins. There are hardware, software and paper wallets. Hardware and paper wallets are often considered safer than software wallets, although there are advantages and disadvantages associated with each. If you lose your private key and can not access your wallet through backup methods, you will never be able to recover your coins and effectively remove them from circulation.

What will be the future of cryptocurrencies in the coming years?

Although Bitcoin is the most important cryptocurrency in the world, it is not the only one. It is estimated that there are now more than 1,300 digital coins available on the Internet, such as Ethereum, Litecoin, Zcash, Dash and Ripple.

Despite the proliferation of these currencies, governmental attitudes toward them vary throughout the world. The investigation carried out by Thomson Reuters showed that some countries have become global defenders, while others have banned cryptocurrencies altogether, with some countries adopting a position somewhere between the two extremes.

While Japan is at one end of the spectrum, when passing a law that accepts bitcoin as legal tender, Bangladesh represents the other extreme, with a law passed in 2014 that orders the imprisonment of anyone trapped using virtual cash.

The fundamental premise of cryptocurrencies that financial systems do not require a central government and a central bank also poses a challenge for governments to accept their widespread use.

The control of a currency is one of the most powerful tools of a government and cryptocurrencies can undermine it. They try to take some of that power away from governments, which could reduce the authorities’ ability to control a nation’s monetary system.

“While these digital currencies may not raise serious concerns at their current levels of use, more serious financial stability problems may arise if they achieve large-scale use,” Randal Quarles, vice president of central bank supervision of the central bank, recently warned. from USA UU

Remember, there is nothing wrong with remaining on the sidelines and observing everything until the cryptocurrencies have matured a little more. Do not let the “fear of losing” lead you to take an excessive risk and make emotional decisions with your money. In light of the unique aspects of these new currencies, it is a good idea to conduct a lot of preliminary investigations before investing a significant amount of money.

The post What are cryptocurrencies and how do they work? appeared first on Digital Bodha.

This post first appeared on Cryptocurrency News | Bitcoin Mining Hardware | Dogecoin, please read the originial post: here

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What are cryptocurrencies and how do they work?


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