Cryptographic Currency (Bitcoin) - A Simple Introduction

I am The Druid and I present my observations, views, thoughts and beliefs on various subjects. With this blog, I aim at those Minds with limited or no knowledge on cryptocurrencies and attempt to provide them with a basic understanding of this concept as well as with keywords for further research. I do encourage people to familiarize themselves with cryptocurrency and blockchain technology, as I believe in its potential benefits to the societies. But I do not encourage anyone to perform any financial act, nor I provide any financial advice whatsoever. Please read responsibly and feel free to comment/challenge/ask/start a conversation.

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What is Cryptography?

The term itself is a compound word deriving from 'κρύπτη' ('secret' in Greek language) and 'γραφή' ('writing' in Greek); secret writing. Cryptography has its roots at the ancient times and it is claimed that the earliest evidence can be found in Egypt circa 1900 BC. There are different views on whether cryptography is a science, a form of art, or an act of engineering yet its concept remains the same: secure communications through encryption and decryption. Cryptography is studied and practiced under two primary disciplines: classic cryptography and modern cryptography. One example of classic cryptography application is the ‘scytale’ used by the ancient Greeks, where they used it to exchange important messages during battles. ‘Scytale’ involved one cylindrical object, split in two parts, and special and predetermined methods to write (encrypt) and read (decrypt) the message on it. Therefore, it involved a publicly known object (the scytale, or the public key in the case of cryptocurrencies) and secret information known only by the two parties exchanging the messages (special methods of writing/reading, or the private key for cryptocurrencies). It was essentially a puzzle, almost impossible to solve it. Modern cryptography uses mathematics and algorithms, it is integrated within computer code – software, and it is a subject of high complexity.

What is Cryptocurrency?

As the term indicates, it is a form of digital currency with elements and dependency on cryptography. It is true that only the past 9 to 10 years a cryptographic currency has been materialized and become available to the general public (Bitcoin), but this idea has been discussed as far back as in the early 1980's. Bitcoin, and any other cryptocurrency currently known to me, besides cryptography it is also based on a new technology called Blockchain. I understand blockchain to be the network upon which the cryptocurrency or coin is ‘running’ (or ‘supported’ if you prefer). In other words, if blockchain doesn’t exist, then no coin exists either.

Bitcoin project was introduced in 2008 by someone presented himself as Satoshi Nakamoto. By reading the white paper at bitcoin.org, I understand that his main motive was to create the foundation for a decentralized economy. With conventional money, if you wanted to buy a service/product online you would use a credit card or a provider such as PayPal and the internet; Bitcoin and other coins use the same approach but instead of a credit card or PayPal you are using the coin, and instead of the PayPal login page or the credit card 3D authentication page, you are using the coin’s software. The idea is the following: credit card company and PayPal are companies ran by a small number of people with main purpose to generate as much profit for them as possible, hence they charge high fees to provide their services. Whereas Bitcoin is ran by you, me, your grandmother, the university lecturer, the park janitor and all people with the aim to exchange value, hence the fees are kept to the lowest possible level. And with such an approach, a less-manipulated economic structure could potentially emerge. But how does it actually run?

Put it as simply as possible, let’s say 10 people all use the same program on their PC. We can call this program Bitcoin ‘client’, whereas Bitcoin can be any coin. The client incorporates certain functionalities, such a digital Wallet and a digital Ledger. The ledger will be the same across all 10 users and it is constantly updated, whereas the wallet is unique and has static details for each user – besides the balance! In the ledger, which is called Public Ledger being a shared one, are registered all the transactions made with Bitcoin and it is updated via internet – yet this does not imply that to make a transaction with cryptocurrency an internet connection is constantly required. The public ledger is also called ‘public’ because it is publicly accessible to view the transactions made, yet only certain details of the transaction are available due the nature of cryptography and blockchain technology. No implication is made that cryptocurrencies are 100% anonymous, or that there isn’t any available that can provide such high levels of anonymity. The digital wallet is what is used to make any transaction; it is basically the debit/credit card in conventional terms. Cryptography is used here for the encryption and decryption of the wallet’s details, while these are transmitted into the blockchain’s public ledger via the creation of blocks. A block is a set of transactional details, messed up by algorithms, and some details from a previous block, hence the term blockchain. An algorithm is a set of steps that aims to resolve a problem. Each of the 10 users that run the client, the software uses a high capacity of their PC’s computational power to use algorithms and try to resolve the mess created previously – mess being the problem, which is basically the transactional details encrypted. Once the PC has solved the problem, or decrypted the transaction’s details, then the result is registered on the blockchain and the transaction is registered on the public ledger. In theory and in our example of only 10 users, all users need to validate the transaction (resolve the problem) and only then the transaction is executed. But in real-life examples different rules apply and thresholds have been set, otherwise it would be impossible to think worldwide and be able to validate a single transaction, due to unavailability of all users at the same time. The users, or the PCs running the client, in cryptocurrency terms are called nodes, and the entire process of validating/maintaining the blockchain is called ‘mining’. In the example of Bitcoin, the miners are rewarded with bitcoins and the number of available coins is gradually increasing along with the number of transactions.

Each block of the blockchain contains the details about a number of transactions and has a certain digital size capacity. To create specifically a Bitcoin block, or to validate a certain number of transactions fit in a block, there is a need for a certain computational power which is determined by the difficulty levels set by the blockchain developers. The difficulty level for Bitcoin has dramatically increased since its inception, just as its price in FIAT has increased. There is a need to control this measure because there is a limited number of Bitcoins that can ever be produced, 21 million. When the project started, it was developed in such way that a single PC was sufficient to do the work (test), but if this was static then probably now there wouldn’t be any coin left to mine, and a very low value – and potentially low price too. Blockchain ensures the public ledger is not compromised, hence trust to the users that the system is valid. It does so by ways that become too technical for the purpose of this blog but, briefly, one of the key features of a blockchain is that any change in the software (i.e. its rules set, or laws in the monetary system) needs to be agreed by the majority of the users. If users do not agree on the change, they are able to act by not installing the latest software update and, hence, continue running with the old rules. This is when a hard fork occurs and it is up to the wider community to decide what rules they prefer and they choose software accordingly. Similarly, if a malicious user from the 10 of our example could change the details of their transaction, this transaction would not be registered in the public ledger due to incompatibility with the version of the transaction the other 9 users would have to validate – i.e. the majority of the users would have validate a transaction for $10, the agreed amount between the two parties, whereas the malicious user tried to change the transaction to $100 which was the minority and, hence, it failed to register. Remember, a transaction is between two parties and details are sent to the blockchain by two parties.

Therefore, cryptography ensures secure creation of a message/transaction and blockchain ensures secure transmission and storage/book-keeping of the message/transaction. I do imply here that cryptocurrencies and blockchain technologies are not only used to exchange financial value. There is a massive potential to use these two technologies for voting purposes – the coin is the means of voting, the blockchain is the consensus of the voting and the public ledger is the registry. All users hold equal number of coins (or voting power) by mathematical proof and open-source code and the blockchain is impossible to be violated – although there are studies suggesting quantum computing will soon bypass the computational difficulty levels of Bitcoins.

How is Cryptocurrency currently used?

Depending on the country, there is a limited number of service and product providers that do accept Bitcoin and other cryptocurrencies as a form of payment. There are problems with Bitcoin, and the more it gets accepted and used the more these problems grow. Scalability is the main one from which others derive, such as higher fees or high waiting times for a transaction to be executed. This is simply because the number of transactions is significantly growing, along with the coin’s adoption, yet the number of transactions fit in a block remains the same. More computational power is required due to more coins being in circulation and higher difficulty level set, therefore the more money someone puts on fees the higher priority their transaction takes inside the network and the quicker gets executed. Mainly because of this and the high price volatility, retail acceptance is still lagging.

Then there are the exchange markets, which have attract a lot of general public interest over the past 6 months, and it is where the trading of cryptocurrencies take place. At the time of writing this, the entire cryptocurrency market is valued at $536b as per Coinmarketcap. It is an entire different and long topic that will be explored at a later blog.

Another way cryptocurrencies are currently used is to provide their holders with certain services or rights. These are not (should not be) called exactly cryptocurrencies but rather ‘altcoins’ and they are still traded onto exchange markets, but they are not designed to be used for financial transactions.

Conclusion

Cryptocurrency is a digital form of exchanging value, providing services, providing voting rights and a way to decentralized central markets. This is achieved mainly by the use of cryptography and the blockchain technology. It seems to me there is a whole new world of opportunities to apply this technology on existing centralized organisations/services/processes. It is a new world, no best practices currently apply but are explored. No much innovation is required, the technology is here as the centralized services required decentralization are.

Peace!