Tag Archives: bitcoin

Cryptocurrency Fundamentals

2014 will be a year of revolution, not politically but economically. Sweeping reforms are coming that will forever alter the way our financial system works. In order to understand how cryptocurrency will be so revolutionary, you need to understand who it was made by, why it was made and how it works.

Cryptocurrency – “is a medium of exchange designed around securely exchanging information which is a process made possible by certain principles of cryptography.” (cryptography means keeping information safe by making it into a code)

Imagine there were a group of ten nomadic tribes in a valley with a lot of hills. One day they discover a hundred precious stones all with  unique symbols written on them. To decide how best to regulate trade and prevent theft and fraud, the tribes decide to make it law that whenever a stone is traded between villages, both of the tribes must record it on this huge wooden board placed where the stones were first found with the stone’s unique symbol telling the other villages that that stone has been traded. They do this when no one is looking and keep their stones hidden from each other. If a stone changes hands without it being recorded on the board, then you know it was a theft or fraud.

Leaving the analogy: the tribes are now computers, the smoke signals are the internet, and the precious stones are Bitcoins. Bitcoin is only one of many hundreds, even thousands, cryptocurrencies out there. Cryptocurrency has three main advantages over national currencies like the US Dollar.

1. It is decentralized; the currency is regulated by the market and community, not by a central bank like our Federal Reserve.

2. It is anonymous; users can spend their money on whatever they want without fear of being tracked by the government.

3. It is digital; you do not need to carry them around with you (even though you can).

Bitcoin – is just one of many cryptocurrencies (AKA altcoins, alternative currencies, etc). It was the first and most famous, mainly for its mob associations in the Silk Road. It was created by an individual or group of individuals known as Satoshi Nakamoto (Personally, I think it’s a small team). It has the greatest market capitalization (as in the quantity of Bitcoins times the value of each Bitcoin given in dollars) of all cryptocurrencies.

Here is a visualization of the market capitalizations of all the cryptocurrencies.

Most cryptocurrencies have nothing unique to them. Some may even be scams, but far more are simply unimaginative wannabes. They are developed by anyone from a leading company to a hacker in his parent’s garage (although you can easily tell). The top fifty cryptocurrencies are usually the only ones with anything creative or innovative about them. But to reach the top you cannot merely have creative mechanics or features to your coin, you must have a community. Coins that want to be in the big boys club must reach out to a group of people online who identify with something about the coin. Often it is as simple as having a “cool” name, like the amusingly blatant Potcoin. A community of people who support and use the coin means that it will have consistent trading and mining and will maintain its value. But don’t take that to mean that you don’t need a well-constructed coin itself. Several times has a coin emerged with a huge opening to a lot of fans before suffering from a massive technical failure and breaking down (looking at you Ripplecoin). This is why we should think of cryptocurrencies as investments like high-volatility bonds than actual mediums of exchange for the time being. Volatility will fall with mainstream adoption and market maturation just like with stocks and bonds.

The competition between altcoins is cutthroat. If your coin/exchange/mining pool gets a bad name as a scam then it will be plastered all over the main cryptocurrency forums (don’t knock forums, these are more influential than maintream media news stations in the crypto community) and your coin/exchange/pool will be ruined. If a coin/exchange/pool comes up just like yours but with that little extra awesome thing about it (I mean literally ANYTHING) then your users can easily notice the rival and switch to it. In order to stay profitable a coin/exchange/pool must not only have value innovation when it release but must continue to create more value and innovation for the user.

Mining – mining is how coins are introduced to the market. In incredibly simplified terms, people with computers download a program that solves very very complex algorithms to generate a unique solution. Each solution is recorded in computer-speak, forming a new cryptocurrency coin. To reclarify: this is almost an oversimplification of the process. This can work in two ways: Proof-of-Work, and Proof-of-Stake. In PoW, you get more blocks containing coins the more work you have done mining that coin in the past. In PoS, you get more blocks containing coins the more total coins you own (so if you continue to own 1% of all the coins then you will continue to receive 1% of coins that are mined) Some cryptocurrencies have a hybrid of both, in which people can mine for coins via PoW or receive them via PoS. Each has its own advantages and disadvantages.  If you want to challenge your reading comprehension and computer science skills try reading the articles on both linked above.

PoS (Proof of Stake) was first proposed on Bitcointalk here.

You may think it’s kind of unfair and weird that someone can just go
out and mine cryptocurrency coins “for free” using just a computer, that
makes the coin “not backed by anything.” This belief is full of logical
fallacies. Firstly, the miner must spend money to get computers,
internet access, etc in order to even do the process. Then he must spend
time, effort, expertise and electricity generating the coin. Then he
may sell it. Sounds easy? Wrong. You can similarly trivialize the
process of mining gold, or silver, or any other precious metal. All you
have to do is spend some money to buy a pick, a shovel and a pan then go
out to a river in Oregon and squat in it.

Just because something doesn’t require physical labor doesn’t mean it
isn’t hard, or worthless. Not everyone can or wants to mine, that alone
restricts the supply. In addition, the more miners there are, the
higher the difficulty rate goes. The difficulty rate
decides how many coins are given out in a given time to a given miner;
the higher it is, the less coins the miners get. This also helps to
restrict mining. Today the difficulty rate of Bitcoin is so high that
they are completely mined by big companies with powerful non-personal
computers.

Think of each cryptocurrency as its own precious substance like gold
or diamonds. Gold isn’t “backed by anything” either. Your US Dollar is
only backed by your neighbors’ home mortgages and the debt our banks owe
to other banks. Both cryptocurrencies and precious metals can be mined
“for free,” but that doesn’t mean it is not hard to do so. They may not
be “backed by anything” other than human desire, but that doesn’t mean
they are devoid of value.

Blocks/ Blockchains – here
you can see a infographic explaining how the blockchain system within
Bitcoin works. The blockchain is basically a record of everyone who has
owned each Bitcoin, which Bitcoins they owned, and when. It is a perfect
ledger of all transactions. You may say, “but wait what about
anonymity?” Just about to get there. The ledger doesn’t record your
name, your social security number, your fingerprint etc just your wallet
address. This is not the same as your IP address.
Whenever you want you can go online and download a free unique wallet
with its own address (given anonymously) from the website of each
cryptocurrency. This will sit, just like any other file, in your
computer. While you cannot exactly open it and read or copy the data
within (and thus expose Bitcoin to fraud) you can rest easy knowing your
money is at least digitally in front of you. If you just did something
like buying ten porn magazine subscriptions, you can go download another
unique wallet and toss the old one. This ledger is pretty much useless
for tracking all the transactions, but it does help if one wants to
investigate huge sales that happen all at once.

One of the most important things about cryptocurrency is that it is
not controlled by any government. The most they can do is ban or
restrict it in some way by law, which drives down the price of the coin.
However, this is imprecise and as more countries and companies adopt
the technology, not only will the impact of these laws be lessened but
governments will be face more obvious economic incentives not to. The
fearful prohibitions (which don’t even work as evidenced by at least two
of the top ten crypto exchanges being Chinese at all times) are not
evidence of cryptocurrency’s instability. Rather, they are proof of the
lengths governments which heavily manipulate their currency and repress
their people will go to keep this technology out.

Cryptocurrencies’ decentralized system contrasts greatly with
national currencies or fiat currencies like the dollar or euro. The
federal government has a great deal of control over the US Dollar. I’m
not going to go into the federal reserve
here because I’m sure many non-Libertarians roll their eyes when they
see us go into that stuff and it’s too much for this article. But you
can check it out here:

Want to see a debunking of all those scary things you hear about Bitcoin and cryptocurrency in general? Here.

Written by Mars

Open your free digital wallet here to store your cryptocurrencies in a safe place.