I often find myself explaining the basics of digital currency (AKA crypto currency) to friends and family. I thought it might be a good idea to simply describe it in one place where I can send anyone looking for information.
First, I need to define digital currency in the very broadest terms as I am going to explain it in this series of articles. Digital currency is technically anything used as a medium of exchange which exists only in digital format (not physically). In almost every case, these currencies are completely Internet based, and use a ‘decentralized blockchain’ for accounting. By the time you are done reading this page, the term decentralized blockchain will make much more sense.
Bitcoin is by far the most popular and well known digital currency, but there are hundreds of others out there commonly referred to as altcoins. New coins are being created all the time, and vary drastically in value. Each coin is part of a project which has a unique idea or vision for the future of their currency. For example, some of these altcoins have a goal of improving on the security or transaction speed of Bitcoin. Other projects are using the unique properties of these digital currencies to create online marketplaces, games or other real world applications.
These altcoins are typically purchased on exchanges specifically set up to trade them. They are traded world-wide, so the exchanges base altcoin value on the one coin most widely accepted and valuable of all, Bitcoin. A typical altcoin trader purchases Bitcoin (symbol: BTC) with their local fiat currency, and transfers it to one of these exchanges where they use their BTC to start trading in the other coins. I am going to cover the value and investment side of digital currency in another article.
Earlier I promised to define the term decentralized blockchain. I will explain decentralization first. It is simply the distribution of activity or administration from a single source to many sources. Think of the fiat currency in your nation. It is completely controlled by a government. They print the money. They distribute the money. They even manipulate the money by printing more or monkeying with the interest rate it is loaned at.
Decentralized currency is administered by many on a large distributed scale. For example, Bitcoin has tens of thousands of computers doing the accounting for its transactions. Anyone who wants to download the software can put their computer on the Bitcoin network and attempt to assist as well. Each person with this software can see all of the transactions done for Bitcoin going back to the very first block ever created. In this way those thousands of computers assure nothing ever changes in the accounting ledger. Nobody can manipulate the entries already created without everyone noticing.
This brings us to the blockchain. Each digital currency has a time period associated with each block of accounting data. For Bitcoin each block contains ten minutes of transactions. Every ten minutes, the latest block is attached to the end of this blockchain for all the other thousands of computers to see and agree upon. The only way the blockchain could be manipulated is by what is called a 51% attack. To do this one entity would have to control 51% of the computers attached to the Bitcoin network, and would have to agree that a different version of the latest block, one they created, was correct. This has never been accomplished, but it is technically possible and helps illustrate the effectiveness of the blockchain system.
Associated with the blockchain is also the term mining. All of these thousands of computers on the Bitcoin network are competing to assemble all of the transactions in the previous 10 minutes more quickly than the others. The first processor to do so and add the block to the end of the current chain is rewarded with a specific number of Bitcoin for their effort. The race to win this reward is called mining. With BTC currently so valuable, only the fastest computers in the world have a chance of winning this race, and most of us without deep pockets will not be able to compete. Don’t worry, there are still other altcoins without the popularity for average guys like us to mine.
I want to explain the transactions I have been talking about as well. When you own any digital currency it is kept in a wallet. This wallet is typically on an exchange, or it may be on your personal computer. These wallets have addresses associated with them like the one below, which is a Bitcoin address I use.
This wallet address above is an anonymous hash string. Each altcoin uses encryption for these strings based on its programming. At the push of a button inmost wallets, you can create a new anonymous string to send or receive from. In this way it is nearly impossible for anyone to track the transactions happening from a particular wallet. When a transaction heads out to be completed, it contains the encrypted information such as the from address, to address and amount sent. Processors world-wide have access to this information as they try to add it to the end of the blockchain, but there is no personal information within the transaction itself, even if they could break the encryption.
A quick note on sending any coins from one wallet to another. Double check the address you are sending to before hitting the send button. If the address you are sending to is incorrect, the transaction gets lost and may not be recoverable. Some coins are working on fixing this problem by returning funds back to the sender when they are not delivered.
For each coin, all of the miners are working on the same blockchain. The blockchain for each has specific characteristics built into it such as the size of the blocks. Occasionally the project developers will want to change these blockchain characteristics. To do this they ‘Fork’ the currency to a new blockchain with the new characteristics, and give program updates to all of the miners to assure they are working on the new, correct blockchain. Sometimes forking has unintended consequences. In 2016 a coin called Ethereum forked against the wishes of many in the community. As a result, some people decided not to mine on the new blockchain, but instead keep mining the old. The result is a currency now called Ethereum Classic, which some people say is the only true version of the coin.
If you have found the information here helpful, it is widely encouraged in the crypto world to send a small tip in appreciation. You won’t find many crypto sites charging fees. Instead people share ideas, information, and even programs freely in exchange for voluntary donations. On one of my other sites I received only .002 BTC in the last year, so I am always appreciative of anything people are gracious enough to give.
Those are the very basics of digital currency. I want to go into more detail in regards to different aspects of the crypto world. Take a look into the other articles I have posted to find more specific information on topics that interest you.