Fortunately, there have been many people before you and there are plenty of them willing to help a hand, we’re one of them. Cryptocurrency, the Blockchain, Bitcoin are all confusing words for someone just starting in this field, and even though there is an abundance of resources to get you on the right track, a lot of people still remain with a lot of questions. Questions that we’re about to tackle in a manner that is hopefully easy to understand and if you want to dig deeper, we’ll suggest you the right sources.
We’ve crowdsourced a list of frequently asked questions. If you have one that’s not on the list, feel free to contact us and we’ll gladly help you out and add the question to the list!
What is cryptocurrency?
We’re just going to safely assume that you’re familiar with Bitcoin and that you’ve been reading into some resources to understand what Bitcoin is. You’ve probably read somewhere that Bitcoin is a cryptocurrency and that it’s a new medium of exchange that enables people to make transactions in a decentralised manner. But that still doesn’t explain what cryptocurrency is.
Essentially, it is a digital currency that is secured using cryptography, hence the word cryptocurrency. But fundamentally, cryptocurrency is purely a unique database entry — the Blockchain being the figurative database — that has specific conditions that needs be met before it can be changed. A good example of this is how we use regular currency: before someone can spend 10 dollars, that person needs to meet the condition that in fact, the person has 10 dollars. When that condition has met, a transaction is created.
Read more about cryptocurrency:
Why is cryptocurrency and the Blockchain so groundbreaking?
When we transfer money from one person to the other, we need a third-party to confirm that the transaction is valid and that all conditions have met. Furthermore, that third-party has to keep a record of that transaction and update the ledger accordingly. In most cases, this third-party is a bank.
However, in the world of cryptocurrency, everything is managed using peer-to-peer technology. Many of you might be already familiar with the technology from using BitTorrent.
A peer-to-peer (P2P) network in which interconnected nodes (“peers”) share resources amongst each other without the use of a centralized administrative system. — source
What makes Bitcoin and the Blockchain so special is that it has solved one single problem that digital currencies have always coped with and therefore always needed a third-party entity; the double-spending problem.
When user A decides to send user B 10 digital coins, it essentially sends that user a copy of that 10 digital coins. A similar scenario is when someone is sending you an email. The sender always has a copy of the mail he sent. Before Bitcoin, this problem was solved by using a trusted centralised entity — like a bank — to confirm transactions, keep records and hold balances. However, Satoshi Nakamoto came up with a brilliant idea that solved this problem using peer-to-peer technology, called the Blockchain. The Blockchain is essentially a ledger that is shared by everyone within the network, a public distributed ledger. Basically, a metaphorical bank that is controlled, monitored and secured by everyone within the network, making it a decentralised network.
The decentralised network enables digital currency to flow from user to user without any centralised entity for cross-checking. Everyone participating in the network makes sure to keep a tab of who owes who what — like a giant shared spreadsheet — and validates and records any transactions that are made.
Roughly said, in the unlikely event that we decide to trade in all of our cash for Bitcoins, we would suddenly have no necessity for banks, Wall Street would collapse and we would all live happy lives. But that’s just one industry that the Blockchain is already gradually, but inevitably, is going to change.
The Blockchain can be programmed to hold virtually anything of value. Every piece of unique data can be transformed and programmed to be stored in the Blockchain, so you can imagine how groundbreaking this is for practically any industry we now know today. Let alone the new industries it will it will shape.
What is the Blockchain Exactly? Is it a physical thing like a server?
Like we explained in the previous question, the Blockchain is a public distributed ledger. It is a network of people that share a public ledger, records transactions and makes sure that balances are updated accordingly. It is similar to how a bank would work when 2 people decide to make a transaction, with the only difference that the Blockchain is a bank that is owned and controlled by everyone in the network.
The Blockchain is not a physical system or entity. Where banks use servers for all their transactions and ledgers, the Blockchain uses the computing power of everyone participating in the network using peer-to-peer technology. Everyone has a copy of the ledger and all the transaction records that has ever taken place.
But how does the Blockchain really work?
Let’s say that Bob wants to send Alice 10 Bitcoins. Alice sends her wallet address to Bob and Bob makes a transaction:
- Bob clicks on send and the transaction is broadcasted to the network.
- The network tries to verify the transaction with an algorithm, checks if no double-spending has occurred and validates the transaction.
- Once validated, the transaction will be bundled together with a bunch of other transactions and forms a block of transactions.
- The block is timestamped and added to a chain of other blocks. Thereby making a permanent record of the transactions.
- Alice will see that the transaction has successfully completed and will see that 10 Bitcoins has been added to her wallet.
When a block is added to the Blockchain, it is timestamped and given a bunch of parameters that solidifies its position in the chain and makes it unalterable to any form of attacks. This is also known as the Block hashing algorithm.
Why should we trust the Blockchain over a bank? Is it really that secure?
Because of its decentralised nature, it practically cuts out any middleman for managing the ledger and verifying transactions, making entities like banks unnecessary. But how can you trust a bunch of random participants over an established reputable institution?
Those random participants don’t sit behind their computer and check every transaction. Rather, they provide their computation power and mathematics does the rest. So when a transaction is broadcasted, every participant in the network provides their computation power to process and validate that transaction by solving complex algorithms. The first participant that solves the algorithms will receive a reward in the form of Bitcoins. The whole process is based on mathematics and it’s nearly impossible to alter and corrupt this automated process.
What are the drawbacks of a centralised entity?
With a centralised entity, we have to trust that entity to make the right decisions, trust that they update the ledger accordingly and that the information is protected. Other than that, a centralised entity is susceptible to alterations and corruption from external sources. For instance, losing crucial ledger data due to a fire, a hacker making fake transactions, a bank that decides to alter the ledger for their own benefit.
So you can imagine the benefits of having a decentralised distributed ledger over a centralised entity and how it solves many issues that we have today.
About Blockchainby Wikipedia
What is Blockchain Technology?A step-by-step guide by Blockgeeks
An intro to Blockchain Technologyby Coindesk
Blockchain BasicsA Non-Technical Introduction in 25 Steps
Blockchain Fast and Simple (Book)What It Is, How It Works, Why It Matters: Understand the basics, join the revolution
The Essence of How Bitcoin Works (Video)A non-technical 5 minute guide
How safe are Blockchains? It depends.An article by Harvard Business Review
What are miners and what role do they play in the Blockchain?
We already discussed that when someone creates a transaction, that it is added to a block with other transaction and that said block is then added to a chain of other blocks, the Blockchain. However, that process of creating a block is often called mining.
Without going into the technicalities, a miner’s role is to process the blocks by solving a cryptographic puzzle based on a block’s content and validate every transaction. Using that information they update the general ledger and outputs a unique identifier — also called a hash — that is timestamped and given to the last block in the chain. This hash ensures that that particular block and each block after it are genuine.
This makes it nearly impossible to generate a random/fake block and put in the Blockchain. Because everyone would know about it. Furthermore, even if you succeed in putting a fake block in the chain and thereby alter the general ledger, you would need to have the same computation power as the whole network combined to keep up with the automated process.
Do they get something out of it?
As an incentive to help process transactions, miner’s are given newly generated Bitcoins as a reward for their work. Although it’s an automated process, mining does cost a lot of electricity, especially for those mining 24/7. This reward helps miners to earn money and cover any costs they make during the mining process.
Can I start mining as well?
Anybody can provide their computation power to start mining blocks for Bitcoins. But the fact is that over the years, this field has professionalised to a whole new level, that it’s nearly impossible for a single person to compete against huge farms of computation power built specifically to mine blocks.
Why is it called mining?
Mining is just an analogy for the people performing this work, who are compared to gold miners digging for gold. Essentially, these miners are running software on hardware (specifically built to mine) that are meant to process the blocks in the Blockchain.
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Where do Bitcoins come from?
To encourage people to help process these transactions, Satoshi Nakamoto invented a lottery-based reward system. This system rewards miners that successfully solved a block with newly created Bitcoins. This is basically how new Bitcoins are generated and distributed.
The block reward started with 50BTC for every successful block creation and halves with every 210.000 blocks. This is a central rule that is not easy to alter unless there’s an agreement from the entire Bitcoin network. The total supply that Satoshi Nakamoto has set is 21.000.000 Bitcoins.
Total circulation will be 21,000,000 coins. It’ll be distributed to network nodes when they make blocks, with the amount cut in half every 4 years. first 4 years: 10,500,000 coins next 4 years: 5,250,000 coins next 4 years: 2,625,000 coins next 4 years: 1,312,500 coins etc… — source
So in a sense, it is generated from thin air but the distribution of it depends on how quickly the transactions are mined. Then again, at the end, there can only 21 million Bitcoins.
What will happen after those 21 million are mined?
That’s a question many people, especially miners are asking. However, everytime someone sends a transaction, that person needs to pay a small fee as a form of payment to the miners. Whether this will be enough of an incentive for miners to work with when the quota is reached is something only time can tell and how Bitcoin is going to be adopted and whether the purchasing power of Bitcoin will increase.
After those 21 million Bitcoins are mined, the value of a single Bitcoin will only increase. Possibly increasing the purchasing power of Bitcoins, and making it more interesting for miners to collect valuable transaction fees.
Read more about how rewards are distributed and how Bitcoins are generated:
Can anyone create a cryptocurrency?
Yes! Anyone is free to create their own cryptocurrency. Bitcoin is an open-source project which enables anyone to take the original code to use it or change it for their own project. Because of this possibility, the market currently counts over 1200 different cryptocurrencies and tokens. Nonetheless, this doesn’t mean we’ll have to deal with 1200 different currencies, in fact, many of them are not even a currency, but a token. Similar to a coupon that you can use for a specific service.
So, if you have the technical know-how, it’s a matter of time and effort to kick off your own cryptocurrency.
What is the difference between a cryptocurrency and a token?
We’ve mentioned earlier that Bitcoins are somehow programmed to store value so it can be used as a medium of exchange. But anything of value can be programmed into coin or token. Bitcoin is commonly known as a cryptocurrency, a coin that holds value and is used to make certain transactions. But it can also be programmed to do something else.
Tokens for services or utility
SONM and Golem are 2 examples that provide tokens to anyone who wants to make use of their services. They provide a supercomputer that is created by a network of miners that can help you process a tremendous amount of data, solve extremely complex equations or algorithms, or render highly detailed 3D models or films. All you need are tokens that allow you to use the supercomputer for a certain amount of time. Those tokens are in turn, given to the miners, which they can then exchange back to anyone who wishes to use the service.
Tokens as assets or shares
Tokens can also represent a certain asset. It can represent a share within a company or real estate within a city or town. Aragon is an example whose goal is to create a decentralised jurisdiction where tokens can be used to run a whole organisation, allocate capital and company ownership etc.
Basically, anything that holds value and can be translated to data can be programmed into a coin or token. It is not exclusive to monetary value and it is just a matter of time before we see many other implementations other than what we have seen so far.
What is an Initial Coin Offering? (ICO)
You might have heard of Initial Coin Offerings or ICO’s and depending on the kind of project may provide a very nice return on investments. Imagine if you once bought Bitcoin back when it was $0,03. That’s a return of 69.000% at today’s rate ($7400).
Whenever a company decides to raise money for their project, they may decide to launch an Initial Coin Offering. Very similar to an IPO, or an Initial Public Offering often used by companies need to raise money.
An initial public offering (IPO) is the first time that the stock of a private company is offered to the public. IPOs are often issued by smaller, younger companies seeking capital to expand, but they can also be done by large privately owned companies looking to become publicly traded. — source
An ICO is a popular method for companies to raise early liquidity, raise awareness and form a community around the project. The way these ICO’s often operate is more similar to a Kickstarter project rather than an actual IPO. The communities that are formed often have the incentive to spread and raise awareness about the project as means to attract more investors, which may promote raising the value of a single token or coin.
What is an Altcoin?
Altcoins is simply a shorthand for Bitcoin alternatives or Alternative Coins. It represents all the coins and tokens that are not Bitcoin. Litecoin, Dash, Ripple are all known as altcoins. Many of them are built using the basic framework that Bitcoin uses but with additional features or some technical improvements in areas like transaction speed, privacy, proof-of-stake, DNS resolution and more. For instance, Litecoin offers faster transactions and Monero offers complete anonymity and untraceable transactions. There’s a huge variety of altcoins that have different competitive advantages over each other, but Bitcoin still remains in the lead of the pack.
So all altcoins are fundamentally connected to Bitcoin?
More or less! There are altcoins fundamentally different than how the Blockchain works. Ethereum is a good example that utilizes the Blockchain technology and therefore may look like another Blockchain platform in the bigger picture, but fundamentally has many differences than the Blockchain we’re familiar with. Ethereum revolves around the idea of smart contracts that play an essential role in how the Ethereum blockchain work. More on that in the following question!
What is Ethereum and what are smart contracts?
Ethereum is seldom perceived as a direct rival to Bitcoin even though both have distinctive purposes. Ethereum is the brainchild and creation of Vitalik Buterin. A brilliant young man who came up with the implementation of smart contracts with Blockchain technology. Smart contracts can be perceived as highly programmable digital money that allows users to automatically send and receive money only when certain conditions are met. For example, if an individual wants to purchase a house, it usually includes the involvement of multiple third parties, which makes the process unnecessary slow and fairly expensive.
So, how exactly do smart contracts work?
For example, smart contracts allow a seller to automatically transfer home ownership to the buyer when certain conditions are met. This type can be interesting for homeowners who wish to rent out or sell their homes without the need for third parties. So a smart contract perhaps looks like this:
A smart contract is programmed and based on mathematical formulas and conditions, it doesn’t require a third-party to check if all conditions are met. It acts as an autonomous agent and ensures that both parties receive what is agreed upon on the smart contract. Check out the following resources for more details: