BITCOIN AND CRYPTOCURRENCIES EXPLAINED

altcoins

“Its nearly impossible to change a system from within – you have to go outside and create a new one that makes the old one obsolete!”

–  Buckminster Fuller

Cryptocurrencies are generated by computers that solve a complex series of algorithms and rely on decentralized, peer-to-peer networks.

As such, it is considered a DISRUPTIVE TECHNOLOGY because the current global financial system is dominated by government-backed currencies, regulated by an authoritative body and created by a central bank. As explained earlier however, this system ultimately answers only to itself, offers few options to its users, is usually highly inefficient in international funds transfer and transactions are subject to high fees. Further it has been dominated by the U.S. paper dollar (fiat) since 1971 and to a lesser extent the holding of gold reserves, to imply a trusted value.

With cryptocurrencies, currency is created when users with powerful computers solve puzzle-like algorithms. Much like mining gold, “mining” digital cryptocurrencies requires “work” on the computers’ part. Only a finite amount of each digital currency exists, in hopes that it will appreciate in value over time. The puzzles become increasingly difficult to solve as more people attempt to mine the currency.

The state and impact of the cryptocurrency ecosystem can be likened to your introduction to the new thing called “the Internet”, perhaps in the late 1980’s or early 1990’s.   The “Information Highway”.   The basic technology of allowing decentralized personal computing devices to communicate via the “world wide web” was in place but its practical applications were sketchy. Its real use was for porn and gambling sites, right? Why would I use “email”, I have a phone, a fax machine and regular mail for more formal communications?   If the internet was the highway, then where are the “on-ramps”? A Google had not emerged and there was no Amazon, Facebook or eBay.

If the Internet represented the “information highway” in the digital age, cryptocurrency and Bitcoin in particular represents the digitization of the 300-year-old money technology known as Sovereign Currency and the Central Banking system.

Cryptocurrencies are based on trust. While most of them cannot be formally traded for products and services, the big ones are increasingly gaining legitimacy.

Bitcoin is a form of digital currency, created and held electronically. No one controls it. Bitcoins aren’t printed, like dollars or euros – they’re produced by lots of people running computers all around the world, using software that solves mathematical problems. It’s the first example of a growing category of money known as cryptocurrency.

When we use and exchange centrally issued, country-based (sovereign) money (U.S. dollars, British Pounds, Euro’s, Chinese Yuan), the parties agree and trust that the paper (fiat) has a value based on the number written on the paper. The paper in and of itself has no inherent value. It only takes on value when the parties agree that it is so.

In Bitcoin, Math becomes the instrument of trust in establishing and maintaining a Value in the currency.

The Bitcoin system has been designed to limit the production of Bitcoins to 21 million. When this number of coins are in the system, no further coins will be issued. There are currently about 14 million coins issued in the system. As the algorithm becomes increasingly difficult to solve, the system is expected mine its last coin around 2033.

Bitcoins come into existence when a miner’s computer in the decentralized system solves the algorithm for any given transaction, verifying the validity of the transaction, then adds this transaction to the perpetual ledger that underlies the system, know as the Blockchain.

The Blockchain is the backbone of the system and can be thought of as a perpetual ledger of all transactions. Each time there is a transaction, the miner solving the math problem has verified all transactions in the chain going back to the beginning.   This becomes the evidence of validity of the transaction and as such, Bitcoin are impossible to counterfeit.

This is accomplished by the use of powerful cryptography many times stronger than that used by banks.  Instead of simply being “sent”, coins have to be cryptographically signed over from one entity to another, essentially putting a lock and key on each token so that a coin cannot end up in multiple places and so that copying doesn’t increase the amount you own.

In this way, data is permanently recorded in the Bitcoin network through files called blocks. A block is a record of some or all of the most recent Bitcoin transactions that have not yet been recorded in any prior blocks. They could be thought of like the individual pages of a city recorder’s record book (where changes to title to real estate are recorded) or a stock transaction ledger. New blocks are added to the end of the record and can never be changed or removed once written. Each block memorializes what took place in the minutes before it was created.

Every block contains a hash. A hash algorithm turns an arbitrarily large amount of data into a fixed-length hash (large hexadecimal number) . The same hash will always result from the same data, but modifying the data by even one bit will completely change the hash.

Bitcoin uses the SHA-256.   “SHA-2” is a set of cryptographic hash functions designed by the NSA (U.S. National Security Agency). SHA stands for Secure Hash Algorithm. Cryptographic hash functions are mathematical operations run on digital data; by comparing the computed “hash” (the execution of the algorithm) to a known and expected hash value, a person can determine the data’s integrity.  Generating a SHA-256 hash with a value less than the current target solves a block and wins you some coins.

This is the foundation of the “trust” in the system.  We trust essentially in the math, that “1+1=2″.   The integrity is guaranteed by being vetted by the vast network of decentralized personal computers that constantly are working on one transaction algorithm after another.

A software developer called “Satoshi Nakamoto” proposed bitcoin, publishing a paper via the Cryptography Mailing List in November 2008. He then released the first version of the bitcoin software client in 2009, and participated with others on the project via mailing lists, until he finally began to fade from the community toward the end of 2010.

He worked with people on the open source team, but took care never to reveal anything personal about himself, and the last anyone heard from him was in the spring of 2011, when he said that he had “moved on to other things”.

“Satoshi” means “clear thinking, quick witted; wise”. “Naka” can mean “medium, inside, or relationship”. “Moto” can mean “origin”, or “foundation”. Those things would all apply to the person who founded a movement by designing a clever algorithm.

The Blockchain protocol allows for the application of its use to be above and beyond its use as currency enabler.

This means any other transaction between parties where verification is essential for it to have integrity, can be applied.  Examples then include such new concepts as loans without banks; contracts without lawyers; and stocks without brokers, executed and recorded across hundreds of fully distributed servers at all over the world!

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s