Cryptocurrency is a making news headline literally everyday especially since Bitcoin have surged almost 950% in last one year. However, many people have wondered what is the relationship between Cryptocurrencies (e.g. Bitcoin) and blockchain and how it all started. Let me try and explain.
Back in 2007/08, during sub-prime crisis, a need was felt for a decentralized mechanism to circumvent the trust issues that caused the whole financial meltdown. That’s when someone with pseudo name “Satoshi Nakamoto” published a whitepaper for peer-to-peer distributed network which is open and transparent to everyone. Which essentially is the basis of the all cryptocurrencies and blockchain in general.
Now to understand the how it works, let’s looks at how people in Yap, a Pacific Island, used to trade back in days. They used a limestone called Rai stone, with a whole in the middle, to represent value.
The stones were big, sometimes more than size of a car, so it was not possible to carry them. However, each stone has an owner and everyone in the community knows who it belongs to, but was rarely moved. The ownership of the stone was changed in presence of minimum number of community members and was inscribed on the stone. Since, inscribing on the stone was laborious task, the person doing it, the inscriber, was given a reward in form of the part ownership of the stone.
Note:- Parts of this story are created to help understand the concept.
Since, anyone could have carved a new stone and generated the currency, the supply of the stones kept increasing and the value decreasing, the currency became useless after a certain time.
The concept of cryptocurrency is somewhat similar where everyone knows what everyone else have, using a distributed public ledger, eliminating the need of central authority like a bank. At the same time, the problem of too much generation of the currency is controlled using the techniques halving, which I will explain later in the article.
Let’s take the analogy of Rai stone and see how the Cryptocurrencies work. The stone is the currency, albeit in software form, and inscription on it the open electronic ledger. The people who believes in that system are called nodes, the participating computers. The community is a set of computer nodes, where each one has a copy of the ledger. Each ledger contains every transaction since the beginning of the currency. The inscribers in this case are special computer nodes, called Miners.
When the transfer of the ownership must happen, one of the parties submits the transaction to the community, along with attached is a mathematical puzzle. The transaction is published to all the nodes. The miner modes start solving the puzzle at the same time. The first one to solve the puzzle publishes the solution to the network and claims the reward. At that point rest of the nodes just validates the answer and agrees to add the transaction to the chain.
One important factor to note is that node solving the puzzle also checks if the transaction is valid, that does the initiating party have enough balance to make the transfer. The node can do this validation as it has a copy of all the transactions from beginning of the currency. The transactions are published for validations in a block, every 10 seconds in case of Bitcoin, and the whole ledger is a chain of blocks, hence the name Blockchain.
To solve the problem of over generation, cryptocurrencies use a process called halving. In this process, the award made to the Miner node is halved every 210K blocks. The current reward for a Bitcoin miner is 12.5 bitcoins, which will be halved to 6.25 on 20th June 2020 and subsequently halved again to 3.125 and so on.
Every cryptocurrency has a hard limit as to how many currency units will be produced ever. e.g. there will be maximum 21 million Bitcoin produced. The limit is expected to reach by 2140 at which point there will be no more Bitcoins produced and the only once in the circulation will remain.
I hope it would have given you a glimpse of how cryptocurrencies work.
But, many question will pop into your head like:
– Where and how the cryptography is used in this?
– What kind of mathematical puzzles given to be solved by Miners?
– How does all other nodes agree to the solution given by one of the miners?
I will be publishing a series of blogs to answer these questions.
Author: Rajan Kashyap, is a software architect with expertise on cloud, Blockchain, Cryptocurrencies and other new technologies.
Cryptocurrency and Blockchain — The Basics was originally published in Data Driven Investor on Medium, where people are continuing the conversation by highlighting and responding to this story.