Bitcoin and Cryptocurrency Technologies Part 1

You’ve probably heard about Bitcoin–maybe even begun investing in it–but do you understand what it is?  What about the blockchain?  If your answer is no, you should probably stop investing your hard-earned cash flows into them. With that said, I must say that cryptocurrencies and their underlying technologies are the most exciting, interesting, revolutionary, and important invention of the last twenty years. The issue is that the general public lacks the knowledge necessary to intelligently invest in Bitcoin; it is this lack of understanding that caused the prices of cryptocurrencies to reach all-time highs, and likewise, is now causing values to tumble.  As I write this post, one Bitcoin (BTC) is valued at $6,794.98 US Dollars, a significant plunge from its all-time high of ~$19,000 only two months ago.  I think that to preserve the future of this currency which we all admire yet don’t understand, we should try to learn some stuff about it.  Thus I will explain what Bitcoin (and other cryptocurrencies) are, how they work, their influence, and their worth.  You may be wondering at this point, what makes an Icy Schemes culture contributor qualified to teach cryptocurrencies? And you’re right to do just that.  My response to you is this: I’ve been investing in and researching cryptocurrencies since 2016. I’ve read several books on cryptocurrencies and related topics (some good, some horrendous) and more important, I’m interested in sharing and “teaching” what I’ve learned from these experiences and books.

So, why is Bitcoin worth anything– or is it worth anything? Why is Bitcoin considered revolutionary, other than the fact that it’s the first successful cryptocurrency? Well, Bitcoin and other popular cryptos are innovative in their use of the blockchain. It is the blockchain that makes cryptocurrencies so robust and able to change our future in such areas as businesses, legal contracts, governments, and banks. Simply put, the blockchain is a Peer-to-Peer (P2P) distributed ledger, established by a consensus and combined with a system for transactions. Okay, it’s not that simple, but I’ll explain.  P2P, pioneered by the infamous Napster in 1999, is a network of computer systems which are directly connected to one another and equally share the computing power and storage to keep the Bitcoin world up and running.  The term “distributed ledger” just means the blockchain is like a public accounting book of transactions that are continually shared, updated, and synchronized across the P2P network. So anyone can look at the blockchain, check it against his or her copy, and verify that all the transactions are valid on the public ledger.

The next important Bitcoin term is “transaction,” which is just an event that lets the network know that the owner of some asset has approved the transfer of that asset to another owner. Here’s an example of a real bitcoin transaction.

To have a transaction, you need a few inputs: (amount sent, address) and outputs (amount received,address. 
    In the example, the sender sent 0.072584 BTC from the address:
             1GPqthhfXhixLZFwFCA9u7DaFSQDHfVNcX 
 And the the receiver recieved 0.0719849 BTC from the address:
             1BA92dKE5XHJyDxgg1ce9Rhbf1cSj1vBWj

Before the transaction is confirmed, it has to be broadcasted across the P2P network. Once the transaction has been communicated throughout the Bitcoin network, it needs to be verified before being added to the blockchain. Who verifies it? The miners do.

The miners are more like auditors than gold prospectors. Essentially, they perform two key services for the Bitcoin network.  First, they validate authentic transactions and reject invalid ones; secondly, they act as a central bank by creating new Bitcoins upon completion of a new block on the blockchain. The process starts when unverified transactions within the Bitcoin network are housed in limbo until a miner comes along, picks it up and places it into a new block. Usually, a block contains anywhere from 200 to 2,000 individual transactions. Now, why are miners doing this tedious job? Because they receive 12.5 BTC (a modest $85,000, at the moment) upon completion of a block.  The solution to the puzzle, aptly called the Proof-of-Work (PoW), serves as proof that the miner did close the deal and solve the block. The process of mining is one of the most critical components to the blockchain, so it’s disappointing that the media ignores it because it thinks the math is too difficult—it’s not.

Remember the transaction example above; well here is the block that it was bundled into. The first step in the mining process is to find and select the most recent block on the blockchain. The miner then adds the block header’s hash to the new block.  All you need to know about a hash is that it converts an input of letters and numbers into a randomized standard length of 256 bit. Next, the miner must summarize all the transactions. In summarizing all the transactions, the miner is taking 1,012,148 bytes, or 1 megabyte, and condensing it into a 32-byte value. Now the miner is ready to start the mining process.

For example, if I hash “Icy Schemes” I get:

   f269c68c61fa9e58964629e7c0e7fb3eb8d20ea53a557a73059a41eb079e03cd

However, altering just one letter (“Icy Schemez”),I get:

 5de45fbfdbb31f171c3278dd327938174cc9263a0f9879e3400b10ad8f171b03

The point of the hash function is that it’s effectively impossible to predict the input based on the output. The PoW puzzle does a similar thing, but with a twist. Instead, the PoW may ask for a hash with a target–for instance, maybe one zero at the front of the output. This can be attempted by just adding/altering a variable of my phrase “Icy Schemes,” this alteration is called a nonce.

    After 27 attempts at changing my nonce randomly, “Icy Schemec”   gave me:
   026f8918e07659420422ea6c5f08d8c60ba91ee0d8b37d7a986afcf7ccac0030

The point I’m trying to make is that the hash function’s result seems purely random; however, knowing the target of the puzzle does some things. The predefined target makes it possible for miners to measure the difficulty of the puzzle, and it also ensures that the PoW solution is costly (in terms of electricity), time-consuming and that no miner can solve the puzzle more efficiently than by trial and error. And yes, I must confess, I lied. The PoW would never ask for one zero, but rather, ask for many, many zeros, which means that the miner needs to make billions, trillions, and maybe quadrillion attempts to find the solution.

Okay, not too bad, right? Maybe you even want to start your own mining rig. Wrong. On my MacBook, the hash rate is near 120; this means that it would take about 98-99 years to solve a PoW.  Because of this, miners use huge warehouses with state of the art computers and cooling fans. The miner uses these quick computers to make faster guesses and hopefully profit from them, while other miners utilize mining pools. I’ll likely touch on this topic in another post, but it is effectively impossible to make a profit from mining BTC without these technologies, which may lead to issues soon.

Okay, that’s it. You should have a basic understanding of the blockchain and how it functions. The blockchain’s key innovation is that it manages transactions between users across the globe without the need of an intermediary (e.g., banks, governments, lawyers, etc.). Furthermore, the blockchain is supported by the decentralized P2P network, which not only ensures the security of users’ identities, transactions, and related data but also ensures trust among all the users on the network. I’d say you now have a firm basis for understanding the architecture on which BTC runs on, so next, we can examine BTC as an investment asset, an artifact, and digital money which is in the process of challenging and changing the global economy.

–Nicolaus (@NicStengl)

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