Bitcoin and Cryptocurrency Explained
In our last blog post we broke down blockchain technology and how exactly cryptocurrency is sent securely from one user to another. This week we will be discussing how the technology powers cryptocurrencies (including Bitcoin) as well as explain mining.
To begin, let’s clear something up: blockchain and Bitcoin are often used interchangeably, as cryptocurrencies and their underlying frameworks are easily confused; however they are two separate entities. It’s helpful to think of them along the lines of this: Bitcoin can be compared to an email service whereas Blockchain is the Internet- the technology that powers email, or in this example, Bitcoin.
Here’s an overview of Bitcoin, now let’s break it down.
To start, what exactly is cryptocurrency? Simply put, it’s a decentralized digital currency, meaning it’s not centrally held by any single entity. Rather than relying on a trusted third party (your bank), security is ensured using cryptography, with every transaction published and verified on a public ledger. Cryptocurrency differs from fiat currency in that it is not tied to any one country or bank and has no central issuing body. With Bitcoin, the first and most popular cryptocurrency, there’s also no minting: only 21 million Bitcoins will ever be released, creating scarcity. Today however, there are thousands of other cryptocurrencies, or altcoins, all with varying amounts of coins in circulation. Bitcoin was created by the unknown person or persons going by the pseudonym “Satoshi Nakamoto.” The project launched on January 3rd 2009, when Nakamoto mined the first (aka genesis) block of Bitcoin.
So what are the advantages of cryptocurrency? Well, by cutting out the middlemen, cryptocurrencies have much lower fees and can be used in any country without having to transfer the coins into that local currency. Because cryptocurrencies work off of a decentralized model, accounts cannot be frozen or seized. There are also no prerequisites to opening a wallet, no minimums on how much you must have in your wallet and no limits on how much you are able to send and receive. The Blockchain is based on open source (public) software that can be accessed and audited by anyone at any time, making it transparent. Another great feature of cryptocurrency is that there are no chargebacks and it’s free to begin accepting crypto. Cryptocurrency wallets are almost all free and are where you store your coins; for more info on them check this article. These wallets generate a public and private key (very strong encryption), and provide the addresses to send and receive cryptocurrency. Your public key is where people can send coins to and your private key is what decrypts the funds and allows you access to them. You can share you public keys, but should never share your private keys- that would be like sharing the key to your bank vault.
To understand public private key encryption, here’s an example: two people (A and B) want to complete a Bitcoin transaction. Each of them holds a private and public key, which creates a secure digital identity (public key+private key=digital signature). The process begins with A taking their private key and making an announcement to Bitcoin software that they’re sending a specific amount and attaching it to B’s public key, resulting in a transaction record. This record is then added to a block that contains the transaction’s digital signature, a timestamp and other relevant information, which is then broadcast to all the nodes in the network and mined. Once confirmed, B then uses his private key to unlock the transaction and receive the funds.
So how do I get cryptocurrency, like Bitcoin for example? Well there are three ways: you can buy it, earn it or mine it. To buy Bitcoin, you would visit an exchange, where you would create an account and enter your credit card or banking information, and from there purchase however much Bitcoin you want. You can keep your crypto on the exchange wallet, but the best practice is to keep it in your own software, hardware, or paper wallet. Cryptocurrrency exchanges let you buy, sell and trade whichever crypto is supported on the platform, but do need to perform a basic industry standard Know Your Customer process. As with anything financial related, always be cautious and do your research when choosing an exchange. For an in depth look into cryptocurrency exchanges, check out this guide
When you purchase Bitcoin for example, the coins are sourced from either a wallet the exchange holds or from someone selling a Bitcoin on the exchange. The transaction is then broadcast the to the network that the coin has transferred ownership. The nodes on the network check that the exchange has the Bitcoin and that the address it is being transferred to is legitimate and the correct one. Once approved, this transaction is added to a block and when mined, the block is then added to the blockchain network, where everyone’s ledgers get updated. If you want to view a copy of this ledger, you can visit blockchain explorer to see every Bitcoin transaction ever made.
This brings us into the second way to get crypto which is mining, a process many people have heard about but not that many are familiar with, so lets break it down. Bitcoin works as a currency as well as an incentive, since when valid blocks of transactions are submitted and approved, the miner who added them is rewarded with coins. Mining creates incentive to submit valid blocks as well as store and continually check the validity of the blockchain network. Miners verify and approve transactions and are awarded Bitcoin (or whichever cryptocurrency they’re mining) for lending their computing power to the network. Every 10 minutes all the valid transactions that have been broadcast to the network are added into a block and hashed, meaning all the information is compressed into a string of numbers and letters. Then, the miners on the network compete to solve the hash, which is a difficult mathematical problem based on a cryptographic hash algorithm. The solution found is called the Proof-Of-Work. This solution proves that a miner spent the time and resources necessary to solve the equation. The first miner to solve this problem then broadcasts the result to the rest of the network so that they can confirm that the solution is valid. When a block is ‘solved’, the transactions contained are considered confirmed, and the coins in the transactions are spent. Anyone who wants to participate in updating the public ledger (the blockchain) through mining can, no matter who or where you are (it is worth noting however that some countries are looking to ban mining). To prevent one person from throwing a huge amount of computing power on the network and forcefully approving transactions, thus taking all the rewards or approving false transactions, there is something called mining difficulty. Mining difficulty is determined by the amount of mining power on the network and adjusts accordingly, so that on average a new block is added to the chain every 10 minutes.
New Bitcoins are only minted to reward miners for lending their computing power to run the network. These Bitcoins can then be traded or sold for other currencies, services, etc. just as any other fiat currency would. Currently, a miner is rewarded 12.5 Bitcoins for adding a block to the ledger. When you buy and receive Bitcoin the coin hasn’t been minted for your transaction, rather pre-existing coins are sourced. There will only ever be 21 million Bitcoins in existence, and the rate at which they are released during mining is halved every four years.
It’s important to note that Bitcoin and other cryptocurrencies are not physical coins. Decentralized copies of the ledger are what make up the blockchain, with the ledgers showing all transactions and balances. So, when you own Bitcoin, it means that you have the ability the access a specific Bitcoin address in the ledger and send and receive a specific amount of funds from it to a different address. Unlike fiat, which exists online and in the form of cash, cryptocurrency exists only online.
As we’ve mentioned, in addition to being the means of generating new coins, mining creates the blockchain that verifies and stores every transaction. The block reward (in the case of Bitcoin), received by placing a new block on the blockchain, is what acts to advance the public ledger of verified transactions. This is an essential function since it allows the currency to be safely and predictably created without any centralized regulation in the form of a bank or federal government. So, mining is not only about creating new coins but is the mechanism that allows the blockchain to be a decencentralized platfrom. It secures the blockchain system and enables the system to run without a central authority.
Building upon what we discussed in the previous blog post, Bitcoin and other cryptocurrencies relies on the combination of three key technologies: private key cryptography, a distributed network with a shared ledger, and the incentive to service the networks transactions, record keeping, and security.
So what if I want to mine Bitcoin? Well currently the industry standard is an ASIC mining device. They are powerful hardware devices that are tailored specifically to mining cryptocurrency. You can either purchase one of these devices or buy into a mining pool (where you rent a devices mining power). An alternate approach to buying your own miner include cloud mining, where you don’t buy a physical device but rent computing power from a mining company, however watch out for these since they are full of scams. Other alternatives is mobile mining is done through apps that act as mining pools for mobile phones, and lastly there’s web mining, which is when website owners hijack their visitors CPU for their mining power. Bitcoin takes a massive amount of computing power and energy to run, so the best option is an ASIC miner or buying into a legitimate pool. To learn more about pools click this link However, you can still mine altcoins, like Ethereum, using GPU.
The last way to receive Bitcoin is to earn it. This can range from being rewarded by completing tasks like replying to comments or writing articles, to innovative programs like Lolli where you earn Bitcoin for shopping at certain online retailers.
So there you have it, a complete crash course in Blockchain, Bitcoin and mining! We hope you’re confident enough to start exploring the exciting world of Blockchain and cryptocurrency, and as always feel free to leave your questions in the comment section below.
Stay tuned for the next blog post, a guide to our recommended wallets, exchanges and altcoins!