A lot of people know what cryptocurrency is, a lot of people don't.
This post is for the people who don't know what a cryptocurrency is and how it works. I'm hoping that I can de-mystify the system a little bit and help people to understand what's going on under the hood without necessarily needing to be a computer programmer. I’ve tried to answer as many of the common questions and misunderstandings as I can.
1.What are the terms?
Ledger: A list of transactions and account totals
Block: A chunk of information on the ledger with that has been validated and signed by the network
Nonce: a random piece of information added to a block to change hash code of a block
Distributed Ledger: A copied and synchronised list of transactions shared across nodes
Wallet: A program a user uses to interact with their account and submit transactions
Transaction: A message
User: A real person who wants to store and interact with data on the network
Node: A computer operating the network software and storing a copy of the distributed leger in exchange for tokens
Miner: A person who sells processing power to nodes in exchange for tokens
Network: All of the nodes working together
Block-Chain: Synonym for ledger but also used to refer to the underlying technology as a whole
Token: A specific type of information attached to an account on the ledger (bitcoin, eth, nft,…)
Base token: A specific token used by the network to pay for transactions
Smart contract: A program that runs on the network and uses the ledger as a hard drive
Consensus: A system by which every node on the network proof checks information and a democratic vote is taken on the results of proof checking
Byzantine Fault Tolerance (BFT): How many nodes, as a percentage, of the network must malicious and co-ordinated to defraud the network in the exact same way at the exact same time
Encryption: A method for scrambling and unscrambling information using a password
Encrypt: scramble a message with a password
Unencrypt: unscramble a message with a password
Asymmetric Encryption: A method for scrambling information using a password and unscrambling using a different password
Man in the middle attack: An hack where the hacker intercepts communications and changes the message
Encryption Key: Password
Seed: a random number or piece of information used to pre-scramble the computer program that produces encryption keys so that the produced keys will be unique and reproducible
Private Key: A password the user keeps to themselves
Public Key: A password the user shares with everyone and is registered as a receiving address on the ledger
Receiving address: a unique number that tokens and information is stored inside under (Tokens, data for smart contracts)
Hash Algorithm: A program that creates a unique signature for a piece of information of a given size where the process is destructive so that the final output can’t be used to determine the input, such as SHA256, Scrypt, Ethhash,….
Hash Code: A unique signature generated by a Hash Algorithm
2.What are the steps involved in creating an account on the network and why is it considered secure?
In order to create an account on the network the user will typically use a program called a wallet. The wallet will give the user a list of words to write down and store physically. These words will be used as a seed in the asymmetric encryption program to generate a private key and public key. The wallet will then send the private key to network nodes to be registered as an account/receiving address on the distributed ledger.
Alternatively, sending tokens to a random string of numbers creates an account no one has access to and effectively locks the tokens away forever where no one can reach it.
Either is immune to user harm from a man in the middle attack, and would actually save the user in the case of sending money to a bad address.
3.How do I store my tokens?
You, personally, don’t. The nodes store a list of every time you’ve received or sent tokens. Your wallet program reads the list and presents you with the sums.
What you actually store is your private key. Keep it safe. Any one who gets it has “hacked” your account and there’s nothing you can do about it. Hard core cryptocurrency people use wallet where they have to type in their key manually each time they want to submit a transaction….
4.Okay, so how do I “send” cryptocurrency then?
You create a transaction using your wallet. The transaction is short and simple, usually something like “X of tokens->Receiving Address”
The wallet takes this transaction and creates a hash code for it and uses the private key to encrypt it and then sends it to the network.
The network receives the encrypted transaction and the hash code. The network then unencrypts the information with an account on the ledger and calculates the hash code for it’s unscrambling guess. If the hash codes match, it used the correct account number and has determined the sender of the message, if not, it tries the next account number on the list. The network then adds the message to a list of messages.
Nodes check that the transactions make sense, that account 0xABCD actually has 1 BTC to send to account 0xWXYZ, and tries to make thing work out so that if account 0xABCD only has 0.75 BTC and someone is sending it another 0.75 BTC it receives the 0.75 BTC before sending 1 BTC.
Nodes then looks for a nonce that results in a hash code that meets a specific condition like: Begins with X number of 0s. Once a node finds a nonce that works. It proposes the block of transactions to the rest of the network for consensus.
If the block passes consensus, the block will be added to the distributed ledger and the account totals are re-summed.
5.Where does the value come from?
It a synchronous and extremely redundant and secure information tracking system. The idea is for people to want to use it to track information in a secure manner. To incentivise random people across the world to use their computers for this purpose tokens were created. Utilising the network requires spending tokens. People running the network receive tokens for the use of their computers, they sell them to people who want to use the network.
At the end of the day, what really determines the value is the usefulness of the system and how many people want to use it. As long as the system is useful and people want to use it, they will need tokens.
Those are the conditions for a market. The value of the coin is simply the market price of the coin: supply and demand. Real world market economics.
This is why is cannot be said that the value of a currency is based on nothing.
It is based on the real world market economics of something that is used to access and use something else.
6.If they shut down the internet then won’t I just lose all of my bitcoin?
Not unless they also erase all of the hard drives on all of the nodes.
7.What is proof of work then?
This is a way of making it be a measurable level of difficulty to reproduce a hash-code for a block. By asking for more and more zeros at the beginning of the hash code for a block, you make it harder and harder to find a nonce to add to the block to create the hash code.
This is important because the network uses the total difficulty of all the has codes on a ledger to determine which ledger is the correct ledger and which is a forgery.
The nodes can proof check the hash codes to make sure they are valid and then the assumption is that because “1000” computers ran for “3” years to make this ledger, if you wanted to make a forgery, you would need “1,095,000” computers to run for a day to make a ledger that could have a sum total work to replace the accepted ledger.
This means that the older the network is, the more stable and secure the past history of the network becomes.
Proof of work provides a BFT of 50.00…1% as it is done via democratic proof checking.
8.Why proof of work, doesn’t it require a lot of power?
Yes, while it is not the only factor, the power consumption of the network is directly proportional to the security level of the network.
Proof of work exists in order to tie node/miner income to real world limitations, logistics and engineering problems. This means that the billionaire can’t just take over a network because he may be able to afford 1 million graphics cards, but he can’t outcompete the 500 million graphics cards already on the market.
9.Well what is proof of stake then?
Essentially you lower the difficulty of the network until it’s trivial, then you force people to put up collateral. Nodes are assigned to create a signature on a frequency based on how much collateral they put up. If a node proposes a bad block, the collateral is docked a fee penalty.
This requires more complicated algorithms to oversee and validate the co-ordination of nodes so that there is no central co-ordinating PC, or it requires a central co-ordinating PC. Either way, when the math is said and done, the BFT of these projects tend to reach the 33-48% zone.
10.What the hell, why proof of stake then?
Because it uses less power, it’s a green technology thing.
11.What is a hybrid network? This is a network whereby multiple networks are blended together and blocks have to pass multiple layers of consensus in order to be validated.
Let’s take the consider a precautionary example of a hybrid network: Example Coin (EXC) User creates transaction and sends to network Network consists of 5 sub networks SHA-256, SCRYPT, ETHHASH, AUTOLYKOS2, Proof-of-Stake Subnetworks individually reach consensus Subnetworks communicate to reach shared consensus Block added to ledger
In the example above you a malicious entity would need to overtake 3 of the 5 systems in order to corrupt the network. One merely need to corrupt 50% of 2/5th of the network on the proof of work chains and 33% of the proof of stake chain.
This would mean that the true BFT of the network is ((0.2*0.5)2)+(0.20.33))*100%=26.6%
Not all project are made equal. Something to watch out for. More complicated project have more complicated problems.
12.Why bother with hybrid networks then?
If the above example was well designed, they can reach BFT ranges in the high 80% to low 90% range. It is impossible to reach 100% as adding layers has diminishing returns on security.
13.Who makes cryptocurrency?
It depends on the project. For the most part, it tends to be teams of software engineers and the projects tend to be open source.
In the case of Bitcoin, no one actually knows who is the man behind the pseudonym. In the case of the runner up Ethereum, it was a skinny, broke autistic teenager of 1st generation Russian immigrants living in his parents basement.
Both projects have since exploded.
14.What is open source?
This is a method of distributing software in which the human readable code is the what is actually being distributed. The person wanting to use the software can read the code and change it if they want to or just read it to audit it. Either way they then are responsible for compiling the code into a program or “binary code” that computer can run.
Most modern open source projects are nice to end users and will also provide a download link to a “pre-built binary” code file, an “abc.exe”
15.If any one can change the code and build it, won’t that allow people to hack into the cryptocurrency?
No, that just means that specific node is malicious and will never pass consensus
16.What about the asynchronous encryption algorithm, if they know my public key, can't they just work out my private key?
Yes they can, which is why it's important to choose the best and most modern algorithm. The keys are mathematically related and the engineers know its. It's absolutely possible to mathematically find the private key from the public key. So they make the keys so big that it actually going through the process of cracking the key is impractical from a processing standpoint.
FIAT which is always faith based.
it doesn't necessarily have to be, though most of the ones today are.
There are some "stable coins" which have their prices pegged to a particular (non crypto) currency like the USD. Now if it's pegged to a FIAT currency then it's still basically FIAT.
but if it's pegged to a currency that is gold backed, like the Russian Ruble..... then it isn't.
Why not just trade rubles and not be tracked?
Digital is all about the convince factor. We can now see what the results are from giving up some hassle for convince.
Block chains are all public, could be hacked. Back actors could run block chain farms, have your buying data. IE, since the block chain is public record it sort of falls into the trash at the curb. They were throwing away their receipts, I just grabbed them. You want them to have to get a warrant for every bit of data.
Blockchains are not all public.
Ever hear of Monero? Aka XMR. Aka "the privacy coin". It uses a private ledger.
Digital USD has a lot of those same issues too. Plus an infinite supply. There could be a coin to replace digital USD and it could actually be better. But it could also be worse. It depends on the coin.
I am sure the CIA could not set up such a thing. Cough Facebook cough.
With Big Tech stepping on rights everyone here seems to want to be on the crypto train.
Let's go Big Tech! Big Tech will save the world!
C'mon man. Follow the Pied Piper.
https://www.youtube.com/watch?v=4tLvzyb3_Uc
Literally anyone can make a cryto currency. Dogecoin was made by 1 person in 1 night.
Crypto, like most technology isn't inherently good or evil. it depends how it is being used.
Exactly.
Really it's two side of the blockchain coin that people should be concerned with.
One side is PoW which is digital money sovereignty.
The other is PoS/CBDC. Billionaires can already 51% attack any pos coin they want because they can out-stake pretty much everyone and CBDC is just pos but the bank is the only node operator.
In a world where the top 1% of people control 90% of the wealth, pos is a short-bus idea.
There are silver and gold cryptocurrencies. Not sure if they actually have a vault full of gold but that would be the way to go. Use the “currency” like a check or a CC with the backing in the vault.
Kinesis is 100% allocated, fully insured, and fully redeemable with your name on the title. https://kinesis.money/
Do you use a bank?
You don't understand the difference between money and currency, do ya?
Wake up, friend.
Pureblood semen is the next cryptocurrency.
Cryptocurrency is what cryptids (critters that might or might not exist) and the living dead use to pay their bills and purchase goods and services.
"Money is Gold, nothing else"
"Gold shall destroy FED."
One of my go to talks for when I am trying to introduce someone to this space properly.
https://www.youtube.com/watch?v=l1si5ZWLgy0
Always remember, not your keys, not your coins.
Amazing write up however for those not technically savvy already.
Very informative. Thanks fren!
Where does it derive its value from, if not backed by pm or other commodity? I've avoided crypto simply because I know the only things of value either come out of the ground or is skilled labor. Thanks for the breakdown BTW...I always believed that it's a giant Ponzi scheme with more mental gymnastics than I want to entertain just to conduct trade. At some point I think it will be more popular, but the way I figure, I can always trade in Au or Ag for digital, so I'm just going to sit back and observe. Just like there being no free lunch, if I have to remember 2 dozen definitions just to make heads or tails of what the true story is, it's either complicated by design to confuse stupid people like me or there's something fishy going on... Thanks for the write up. I thought you might want to hear another perspective.
The real answer is Adam Smith: Wealth of Nations: something is worth what the fool will pay for it.
There is no inherent value except its use case. The use case then rest upon adoption. In that sense, it mirrors fiat. The only difference is, fiat currency is legally mandatory to pay taxes. .gov can make a crypto currency into legal money.
Some say that these coins increase the money supply. Some vehemently deny that. Personally, I see both.
For instance, a new coin may suck in fiat currency amounts. Just by putting it on the market place for trading does not increase its value in fiat or against other coins. Hence, the sheer creation does not increase the money supply.
Things change when the demand for such a coin starts to kick in, and there exists a viable way to use it to transact in it. (Monero is reasonably stable in value)
Let' s say that for a 1000 fiat you could obtain a 1000 new coins. It does inflate the money supply, as now, the seller has a 1000 fiat and you have a 1000 new coins to pay someone. That is 2000 in money supply. Ergo, the money supply has increased with 50%.
When all I do is keep it in the Crypto universe, nothing really happens. It does not matter if for those 1000 coins I obtain 1 coin or a 100.000. I could even, at a convenient moment change it back to the original coin. But instead of a 1000, I now have 2000. Nothing really changed.
The moment I take it out, that is where the money-supply changes, because now, both the seller has a 1000 fiat, with which to pay, and I have these 1000 or 2000 coins to pay something.
And somewhere, when we all would take out our coins for fiat, some people will see the result in a debt which has no securization.
These coins are simply nothing less than a messaging system, akin to Swift, the telegraph, a letter.
During the end of the 16th century, the Old Exchange Bank in Amsterdam was set up. In essence this was a full reserve banking institution, and its paper was worth the value in Silver or Gold. I will not go into the nitty gritty of its decline, save one remark: The moment these reserves were used to create debt, where the debt functioned as a reserve, that was the moment the paper lost value.
Then in 1780 the 4th Dutch-Anglo war broke out, and the UK seized all international commerce from the Dutch, causing the collapse of the VOC, which in turn caused the collapse of the Old Exchange Bank.
What is the value of a commercial instrument? How is that value secured? It is not the rules that make value, but force.
Had the Dutch been able to invest in their fleet, they could have given the UK a run for its money. But as is clear from the post: Silver stealers, the Opium/ tea trade, and the forceful tendency to demonetize Silver, it is quite clear, there was a reason the then stadhouder forced the issue by promoting the investment in the army instead of the fleet.
Rules do not make a security. Guns do. That is why you have the 2nd amendment.
Amazing: Witch hunts and burning, at least the process to get to the ashy part, is quite akin to the process of assessing the quality of gold during the same period of time.
See q&a # 5
Tl:dr Network is a secure system, people want to use it, using it costs tokens, miners/nodes are paid in tokens, miners sell tokens to people who want to use the system
Present a use case, convince people this is the best way to do it.
Perfect example is money. This is the most secure way to track finances digitally that had been invented so far.
The world runs on money. Money needs to be cheat free from a system point minimum, can't help scammers scamming idiots, so we should use the most cheat resistant thing possible.
So, you invent a blockchain, make it as secure as possible, market it's security and features and try to make it have many use cases.
Get it listed on a market and see what people will pay to use your blockchain.
If all transactions can be tracked, how will the massive amount of nefarious business be conducted? What will they use for money? This kind of crime is far and wide - absolutely massive - there has to be some way of keeping "cash" around... crime is keeping the stock market propped up among other things. I can't see the empire completely eliminating cash because the real world wouldn't work anymore. We'd all like to see the crime squashed, but the only people being tracked are going to be the average citizen, who believes a locked door will keep anyone but honest people out. Waiting to see how it all shakes out. Maybe the grassroots black market will be bartering and exchanging silver eagles again...
Haha, it's nuts. Yeah, crypto is basically an admission that people are shit and can't be trusted with money and so they need a system that doesn't trust them and makes all their shit public so that the lying finally stops.
the average person won't need to. Only early adopters and investors. Widespread adoption is already inevitable. I'm not talking about Bitcoin. I'm talking institutional adoption at the nation / central bank / bank / fintech / payment provider and P2P levels.
Everything of value will be tokenized on blockchain. It's the internet of value. Realize this and secure an early position. This market swallows all markets. Again, I'm not talking about Bitcoin.
...bitcoin eats fiat
Napster killed the music industry
T/u vry much.
a waste of electricity
the ones that survive won't be