#EXPLAIN – A friendly guide to cryptocurrency for yourself or your grandma

So, I’ve had a lot of friends ask me about Cryptocurrencies lately. Thanks to the meteoric rise of Bitcoin, and the hype around blockchain, the technology and all its related jargon are definitely floating around the media landscape right now.

It occurred to me there might just be some others out there who are eager to wrap their head around this trend, and so I thought I’d try and hash it out an explanation for anyone who’s currently confused by the concept.

For those of you who don’t know me, I’m a pretty nerdy gal who likes to keep on top of the changes and emerging trends in technology. I’ve been messing around with crypto since around 2012. (I even tried my hand at mining some, but alas, my PC didn’t really have the processing power for it to make me rich.)

 

So, what are cryptocurrencies?

Simply put, cryptocurrencies are money that exists electronically. An electronic, p2p (peer-to-peer) form of currency. The world’s first crypto was Bitcoin (BTC), and it forms the basis for every other cryptocurrency that’s cropped up since then. Originally created by the mysterious entity known as Satoshi Nakamoto back in 2008. Bitcoin was designed as a p2p system that relies on users, rather than financial institutions, to function. Bitcoin transactions and other cryptocoin transactions are recorded on a public ledger using the individuals WalletID. Identifying information like names and email addresses don’t form part of this ledger making it a fairly anonymous form of payment. Without knowing your WalletID, no one can know how many bitcoins you have, or what you’re using them for. They’ll just see the WalletID and the transaction values recorded in the ledger. (So, remember to keep your WalletID as safe as your credit card details guys c; )

This ledger is what is known as a blockchain and in many ways, it’s the applications of blockchain beyond cryptocurrency that has the tech sector so excited.

 

The reason Nakamoto created bitcoin in the first place was to try and fix what was seen as a number of flaws within the way we transmit money to each other in the 21st Century. Nakamoto wanted to bring an end to lengthy settlements for cross-border payments, as well as prevent financial institutions from acting as a middle-man and profiting from transaction fees. Cryptocurrencies bypass the traditional financial system by using this blockchain technology.

So it’s digital money?

Yeah. It is. If you haven’t seen the news, these days bitcoin is trading at around 7k. This is a huge jump from the humble days when I started messing around with it. (And believe me I am definitely kicking myself for cashing my bitcoin out to pay for holidays and booze benders, but we live and learn, right? c; )

Ok, but what the hell is a blockchain? How does that work?

So, as I already mentioned, blockchain is a ledger of all the transactions that happen with cryptocurrency. Every time someone transfers it to a friend or uses it to buy something, that transaction is recorded. Once it’s recorded, it’s there in the ledger forever. A copy of that ledger is stored on the computer of every person who uses a cryptocurrency. Each time a new transaction takes place, a new record is added to the ledger, and everyone with a copy of that ledger gets an update. This decentralization means that no single person, not even the creator of the coin, has a monopoly over transactions. This also means there is no single point of failure.

Imagine I’ve generously offered to give you some of my hard-mined cryptocoins, all you have to do before you accept is check that coins ledger, and make sure the cash being offered is valid and hasn’t already been spent on something. If everything on the ledger checks out, then you can accept my cryptocoin and go on your merry way with it fattening up your digital wallet. This records another transaction on the ledger, and a new update is sent out, letting everyone know that the coin in question has been transferred to your WalletID. And everyone else looking at the ledger knows that too.

If some hacker wanted to try and steal my cryptocoin, too bad, it’s not possible.
Why? First of all, the blocks (records of transactions) have to directly reference the preceding block to count as valid. Every ten minutes, the ledger is updated with the transactions and stored with a permanent time-stamp. Because the ledger is not stored on one single hard-drive, or held by a single institution, but on hundreds of computers and servers all over the globe. It’s stored on the network and the ledgers on all those computers are updated in real-time, whenever a transaction happens. So, there’s no way for someone to alter it without altering the entire history of the ledger on the network. Something that people would notice happening, seeing as the blockchain is public record.

Let’s try illustrate this with a real world example to break it down a bit more.

I buy a pack of delicious, grape flavoured bubble gum, and I give you a piece. Because we’re both there, we know I gave you the piece of gum. We don’t have to call my Mum to stand there as an independent third party to verify that yes, the gum was exchanged.

But what if this was some amazing digital bubblegum that I could send to you over the internet and you could taste without ever having to put it into your mouth? (There’s a black mirror episode waiting to happen.)

Without the physical action of you taking the gum from me, there’s nothing to say I ever gave it to you. You could easily dispute our digital gum transaction, and demand more delicious tasting digital gum from me. Or, alternately, I could lie about how much digital bubblegum I had to make you feel like the gum was worth more and trade me something really cool for it.

This is the problem that blockchain seeks to solve. It seeks to verify digital transactions in a way we can see, and ascribe value to.

What’s so great about that?

Well, this digital ledger we invented for cryptocurrency can actually be used to record basically anything of value to a society. A record of birth and deaths, voting, where those bananas you bought yesterday were shipped from and how many your local supermarket purchased… even a student’s grades at a University.

Basically, if we can express it in code, we can turn it into a blockchain and ensure the integrity and value of that data, whatever it may be. Blockchain helps create transparency and legitimacy for any kind of data. That’s why it’s got everyone so excited!

So, why is bitcoin specifically worth so much?

Aside from being the pioneer of the technology, bitcoin is also in finite supply. There will only ever be 21 million bitcoins in circulation. This fixed number of coins means there is no opportunity for a central authority, like a government, to create more coins, avoiding some sort of digital inflation which would make your bitcoin worthless.

What about that other big cryptocurrency,  Ethereum?

Bitcoin was created as a new p2p currency. Ethereum and Ether are a little bit different.  Ethereum was made as an application platform. What this means is that anyone can build an application on the top of Ethereum and use Ethereum’s blockchain as a digital ledger to store their data securely.

In fact, if you want to, you can use Ethereum’s blockchain to create your own cryptocoin. But the real selling point of Ethereum is smart contracts. 

What do you mean by smart contracts?

Smart contracts are accounts that are owned by code, not people. Anyone can build any application using Ethereums blockchain technology; smart contracts these applications, doing whatever they’re programmed to do and using Ether as the fee for doing them. What’s that good for? Well, a couple of things.

Firstly, it’s a bit of a boon for speculative investing. The way that investing in applications on Ethereum works is kind of like a Kickstarter or other form of crowdfunding. Start-ups and companies can specify a target amount of money they want to raise, and a deadline. Investors can then pledge ether to a holding account until the deadline arrives. If the target amount they set was reached, then just like Kickstarter, all that ether will be released to them. But, if they fail to meet that target by the deadline, all the ether is returned to investors.

Instead of just using the blockchain as a ledger, Ethereum allows companies to do things like specify the conditions under which a person can be paid. Once those conditions are met, the money will automatically go to that individual, without a middle man or outside interference of any kind. The smart contracts represent an agreement that is able to enforce and execute itself. It’s not just for money either. Smart contracts can also automate delivery of digital goods, or check for the validity of goods being sold digitally. That’s why big companies like JP Morgan and Alibaba are jumping on board with this technology.

Additional Reading

I won’t lie, blockchain and cryptocurrency aren’t the easiest concepts to digest. But, if this little primer has wet your appetite and you want to become a full bottle on this stuff, there are some really good resources out there on the web and I’ll link a few of my favourites below!

The Blockchain Economy: A beginner’s guide to institutional cryptoeconomics

The rise (and rise?) of Bitcoin

A brief attempt at explaining the madness of cryptocurrency

How to talk to your mom and dad about Bitcoin on Thanksgiving