More of us are looking at the complex world of cryptocurrency since Bitcoin, the world’s leading cryptocurrency, started to hit record highs last year. But what is cryptocurrency and how can everyday people use it?
What is cryptocurrency?
Cryptocurrency is digital money. It is a decentralised online cash system that is very secure and, mostly anonymous.
What most people don’t know is that cryptocurrencies were invented by accident. Satoshi Nakamoto, the inventor of Bitcoin, succeeded where many bigger players failed as he did differently to previous attempts like DigiCash. He created a kind of peer-to-peer network, akin to the types used for file sharing.
Decentralised and Centralised Networks
It’s important to understand the difference between centralised and decentralised networks. To make digital cash work, previous attempts to create digital currencies used centralised servers to prevent one party spending the same amount twice. You could think of this centralised server as an accountant that makes sure that all transactions balance out.
A decentralised network does not have this server. Every party on the network does this job instead. Each peer in the network needs to have a list with all their transactions to check if transactions in the future are valid and to prevent the double spending issue. This relies on a consensus between every single peer on the network. If one thing breaks, everything breaks. Which is why many thought decentralised networks for transactions were impossible.
Satoshi Nakamoto managed to achieve this consensus with Bitcoin. This is how cryptocurrencies fundamentally differ from physical cash. It’s supply is not determined by a central source.
How do cryptocurrencies work?
- You request a transaction
- This transaction is broadcast to a P2P network of computers, also known as nodes
- The network validates the transaction and the user’s status [verified transactions include cryptocurrency, contracts, records or other info)
- Once validation is complete the transaction combines with others to create a block of data for the ledger
- The new block is added to the existing blockchain, making it permanent and unalterable
- The transaction is complete
What is Bitcoin mining?
Mining, when talking about cryptocurrencies, is somewhat of a misleading term. You are not mining as such but lending computing power to solve very complex computational puzzles. Solving these puzzles gains you Bitcoin or any equivalent cryptocurrency that you are trying to obtain.
The first person to solve the puzzle gets to place the next block on the blockchain and claim any released cryptocurrency. This is called a block reward.
The amount of currency released per block reward gradually diminishes, which assures a certain amount of rarity of your chosen currency.
What is a blockchain?
A blockchain is a shared database hosted by millions of computers simultaneously. It isn’t stored in one location, so it can’t be centrally hacked. Imagine it as a giant google spreadsheet showing a record of all electronic transactions that have taken place within a certain time frame.
Blockchain networks exist as a consensus, it checks in every ten minutes to reconcile itself and any new transactions are also added to the chain.
Only miners of a cryptocurrency can confirm transactions in a blockchain. Blocks are added to the chain when a miner successfully reconciles a computational problem.
Are there other cryptocurrencies besides Bitcoin?
There are indeed a whole host of other cryptocurrencies beyond Bitcoin each with their own advantages, disadvantages and quirks. The next biggest, in terms of market cap, after Bitcoin is Ethereum.
What can you do with cryptocurrency?
Once you have some cryptocurrency you now have various options on how you can spend and invest it.
What you can buy?
In the early days of cryptocurrency there were not a lot of options for actually spending it. Now the situation has radically changed. A lot of merchants, including big brands like Microsoft, accept bitcoin as a payment. Bitcoin can be used to pay for flights, hotels, clothes and even property in some parts of the world.
The other currencies such as Ethereum are not accepted as widely as Bitcoin; which is something to bear in mind if you are making an investment in cryptocurrency.
Anything else I should consider?
There may be possible tax implications for you if you make a profit from cryptocurrency. There is also talk of banks changing the rules so you can no longer purchase cryptocurrency via a credit card, which is a popular way of funding an investment for many people.
Cryptocurrency Market Cap Data
This data is correct as of January 11th 2018.