Cryptocurrency

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The word “Cryptocurrency” consists of the two words – “Cryptography” and “Currency”. “Currency” here refers to a money as medium of exchange. Bank notes and coins are a type of currency. “Cryptography” refers to secure communication in such a way that any person for whom the communication is not intended is not able to read the said communication. Cryptography is the underlying concept behind cryptocurrency.

What exactly is Cryptocurrency?

We have read about Blockchain technology which stores data in blocks (i.e. chunks of data) where each block stores the following items for a particular transaction:

  • The details of entities participating in the transaction.
  • The details of the transaction, i.e. what the transaction is about and what & how much is getting exchanged.
  • The date, time and unique identification of the transaction.
  • A unique identifier which links the current block to the previous block. This unique block is generally a cryptographic hash of the previous block.
  • A cryptographic hash of the current block.
Blockchain

As we see, each block of the blockchain is connected with the previous block. This sequence of blocks is called blockchain. The first block is called “Genesis Block” since it does not have a previous block. We are also aware that there are 3 principles on which blockchain works:

  • Decentralisation (as the data is not stored on a single node)
  • Immutability (the data on a blockchain cannot be changed)
  • Transparency (the blockchain is a basically a public ledger of transactions)

Thus, if there is a certain currency whose transactions are stored in the blockchain, we can have a record of all the transactions taking place using that currency as a medium of exchange. This forms the basis of all cryptocurrencies. All cryptocurrencies are based on one or the other blockchain. Each block on the blockchain will store the following data:

  • The details of persons between whom the currency is being transferred.
  • How much currency is being transferred from the sender to the recepient.
  • The date and time of the transaction.
  • A cryptographic hash of the previous block.

Where is cryptocurrency stored?

Again, as the traditional currency is stored in your wallets, cryptocurrency is also stored im digital wallets. We know from the article a previous article that in Public Key Cryptography we have a set of two keys – Public Key and Private Key which are mathematically compatible with each other. The same concept is used in cryptocurrency too to make digital wallets.

Bitcoin Wallet

This digital wallet is basically a combination of public and private key. The public key can be used as the virtual wallet address to receive the cryptocurrency whereas the private key can be used to spend the same. This way, the owner of the key can give out the public key to everyone to receive cryptocurrency from others, whereas he will keep the private key to himself to spend the same.

Concerns about cryptocurrency

As opposed to traditional currencies which are centralised and regulated by the governments and banks, a cryptocurrency is a decentralized currency and is not regulated by any central bank. Besides, the sender and recipient do not need to use any real identities to make currency transfers. The sender and recipient deal in virtual addresses which are unique to a person and can be generated on demand. Thus, users can anonymously perform transactions using cryptocurrency by using such virtual addresses.

Generating Cryptocurrency

We know that when banks need more currency, they can print the same. But what about Cryptocurrency? There are two ways in which one can get hold of a cryptocurrency.

Mining

As was stated in the article on Blockchain

For addressing the trust issues with a blockchain, every blockchain implements tests called “Consensus models” for devices that want to be add blocks to the blockchain. These models require that the devices will have to submit some “proof” for participating in a blockchain. “Proof of work” is the most common model where the device has to do some work which is moderately hard for the device, but easy to cross-check for the nodes. The device does the work for sometime, comes up with a proof and the transaction gets added onto the blockchain if the proof is correct.

We already know from the article on Hash that a Hash is a cryptographically unique value for a given text. A function that generates a Hash generally generates a Hash Value of fixed length. Now, computers solve complex and complicated mathematical problems which revolve around these hash values. When a computer solves such a problem, it is awarded with a block containing some units of the cryptocurrency for solving that problem. This process is called cryptocurrency mining. Every cryptocurrency uses a mining algorithm and consensus model to award cryptocurrency to the successful miners.

Crypto Mining

Mining cryptocurrency is not an easy task now-a-days and it is an extremely resource heavy task. If you start mining on your desktop computer or laptop, the electricity bill generated may be more than the equivalent cryptocurrency that you would be able to mine. Here the concept of pooled mining comes into play where computing power of various computers is pooled together to mine the cryptocurrency. Once a block of cryptocurrency is mined, it is split between all the computers in the pool in the proportion in which they did the work during pooling.

This is the only way in which new currency is generated.

Purchase

Cryptocurrency Purchase

Mining cryptocurrency is a resource heavy task and takes time. But there exists another option for you to get hold of cryptocurrency. You can buy it on cryptocurrency exchanges – which are platforms that allow you to trade cryptocurrencies for other cryptocurrencies or conventional money. Since this purchase will deal with cryptocurrency transfer from the exchange to your account, that transaction will also land up on the associated blockchain.

What are the various cryptocurrencies?

Cryptocurrency

Bitcoin

Bitcoin is the most popular cryptocurrency in the world and uses the Bitcoin blockchain. It came up in 2008 and was invented by an unknown person/persons named Satoshi Nakamoto. It actually started in 2009 when its source-code became public. Surprisingly, the first adopters of Bitcoin were the black markets which accepted it due to its anonymous nature. Since then it has come a log way and it is now accepted as a valid payment method at various online stores.

You can generally see Bitcoin being represented by the ticker symbols “BTC” or “XBT” or simply the character ₿.

One feature of the underlying Bitcoin protocol is that only a total of 21 million bitcoins can be mined. The difficulty of mining bitcoins increases as more and more bitcoins are mined. Thus, when a total of 21 million bitcoins are generated, no more new bitcoins can be generated. This would keep a check on production of an arbitrary number of bitcoins in the world. Currently, every bitcoin block that is mined gives 12.50 Bitcoins, which is supposed to get reduced to 6.25 Bitcoins shortly in the year 2020.

Is Bitcoin the only cryptocurrency?

Bitcoin is not the only cryptocurrency in the world. In fact, new cryptocurrencies are coming up on a daily basis. For each of them, their underlying blockchain or usage domain is different. Some of the reasons for such a variety of cryptocurrencies are:

  1. Some have improved upon the Bitcoin – e.g. Ethereum (ETH) offers “smart contracts” and Litecoin (LTC) offers faster transaction confirmations as compared to Bitcoin.
  2. Some are scams which show users the possibility of earning good returns but then siphon off the money.
  3. Some were created for different applications – e.g. Monero & ZCash were created to hide details of the transacting parties, Ripple is targeted to compete with slow inter-bank, inter-company and international transfers.
  4. Some were created just for fun (e.g. Dogecoin).

Advantages

  1. It is easy to use.
  2. It has low transaction costs.
  3. There is no third party involved in the transaction.
  4. Some currencies like Ethereum allow execution of smart contracts. Smart contracts verify the conditions that two users agree on and execute the terms of contract when the conditions are met.
  5. Transcations can be made anonymously.
  6. Transactions are almost instantaneous.
  7. Since the blockchain is public, there is transparency in its operations.

Disadvantages

  1. It is highly volatile.
  2. It is being used by terrorists due to its anonymous nature.
  3. An insecure blockchain underlying a cryptocurrency can be hacked and thus may lead to finanacial losses.
  4. It is not widely accepted by all vendors.
  5. Payments once made cannot be reversed if the transaction has been incorporated onto the blockchain.
  6. Lack of awareness among common public also leads people to not invest in it.
  7. It is not legal tender in some countries.

For Wikipedia entry on Cryptocurrency, click here.

For more posts on Advanced Topics, click here.

For more posts in The Cyber Cops project, click here.

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