A businessperson’s guide to bitcoin & cryptocurrency – Part Three
THIS is the third part of our guide to cryptocurrencies. In part one, we looked at some of the aspects of what makes cryptocurrencies such as Bitcoin and Ethereum different from so-called ‘fiat’ currencies – the concept of money we’re all used to.
Part two of the guide looked at some of the ways that businesses could get involved in cryptocurrencies, including mining, trading, accepting transactions and so forth.
This third part is a slight detour of from our path, in that it tries to explain some of the underlying technical concepts behind cryptocurrencies, but hopefully remaining readable and understandable by anyone who doesn’t necessarily spend all their time ensconced in high-end server rooms!
The accepted banking and transaction system is based on databases – that is, in accountancy terms, a series of ledgers held by organizations.
A ledger, or database, held by a bank, for instance, holds a list of its customers, and how much money they own, or owe.
On instruction from the bank account owner, or person(s) authorized by the bank account owner (including the bank itself), the ledger keeper, or banker, will change its database entry, increasing or reducing the figures held against the account.
So, when you pay for an item on Taobao, Tmall or eBay, you’re asking your ledger-keeper to decrease your ledger entry and instruct the vendor’s ledger keeper to increase the vendor’s ledger entry by the same amount.
Note that banks have a ledger entry themselves (in order to track bank charge flow etc.), and, also worth noting, governments also are ledger keepers – they can issue bonds, instruct money to be printed or throttle money supply according to demand.
The issue that concerned the inventor of the original cryptocurrency Satoshi Nakamoto, and several generations of would-be digital currency creators that came before him, was that the ledger keepers wield enormous amounts of power, and are not in the ledger-keeping game to be a positive societal force.
What cryptocurrencies achieve, is to make the ledger contain a record of every single transaction in the world. Additionally, the ledger is publicly accessible by everyone. In fact, everyone effectively has their own copy of the ledger.
This public ledger is called the blockchain, and no-one has overall control of it.
Whenever there’s a cryptocurrency transaction which becomes confirmed (see below), the blockchain is updated to reflect the transaction’s details, and everyone’s version of the blockchain is also updated. Because there’s no central ledger, everyone needs a copy so that everyone can check the validity of every transaction.
From this position, we can now accept that cryptocurrency doesn’t exist as an object itself. If you own five Bitcoins, for example, you don’t own a chunk of code or a piece of paper that says you do. All you own is access to the blockchain that lists all the transactions that led up to you owning that five Bitcoins (and every transaction since, by the way).
Every transaction in cryptocurrency is known pretty much immediately by the whole network. But only after a specific amount of time does the transaction get confirmed.
Confirmation is the critical concept of cryptocurrency.
Confirmation and miners
Transactions are confirmed by miners.
To be a miner, all you need is some computing power. Miners, or rather, their computers need to find a ‘hash’. That’s found by combining the new block of data with the existing blockchain by means of a strong cryptographic application, the code of which is open source.
Working the cryptography isn’t trivial, and so it takes some serious power to successfully confirm a transaction.
Miners take transactions, ensure they’re legitimate by hashing, and spread them as confirmed to every node in the network. Every node has to add it to its database. The transaction has become part of the blockchain.
Anyone can be a miner, and no-one can appoint miners or prevent anyone else from mining – the system’s decentralized nature precludes this.
The cryptologic puzzle is what miners compete to solve – the more attempts you (or your bank of power-hungry computers) can make, the better the mining outcomes. After finding a solution, a miner builds a block and add it to the blockchain.
Miners take a small reward for their hard work (payable in cryptocurrency), called a coinbase’ transaction’. Mining is the only way to create cryptocurrency.
Over time, the difficulty level of the encryption process varies – if there’s been a lot of successful mining, the difficulty increases. If things are quiet, the cryptographic puzzle gets easier. Working on the cryptography is (a cryptocurrency buzz phrase) ‘proof of work’.
There is a finite limit, often, on the amount of cryptocurrency available. In the case of Bitcoin, for example, the finite supply will dry up – at present mining rates – in about 2140.