Bitcoin has inspired a lot many kinds of cryptocurrencies. Bitcoin and other Alternate coins (Altcoins) intend to serve various useful functions along with serving as money. Find out how this programmable money is set to revolutionize our lives.
What are cryptocurrencies?
Cryptocurrencies are digital assets. They are designed to work as a medium of exchange using the principles of cryptography. Cryptography ensures the security of the transactions. Consequently, it makes the trustless transaction possible through the use of blockchain technology.
How do they work?
For cryptocurrencies to function they are primarily required to solve two main problems. Firstly, it must not be possible to make perfect copies of the coin. Secondly, it should not be possible to use the same coin twice for making transitions. Moreover, trustless transactions should be possible and it should be very difficult to tamper the network. There must also be a math-based model of how new coins are going to be created. Cryptocurrencies ensure all this in the following ways:
When a transaction is made, it is broadcasted to the network. A certain number of transactions are pooled together into a block of a certain size. In Bitcoin, we have one block of 1MB size being made for about every 10 minutes.
When a block is made, it needs to be attached to the previous block with mathematically generated codes/hash strings. This codes/hash string ensures the integrity of the blocks formed by linking them continuously like a chain. The math that goes into making these codes use the principles of cryptographic encryption. This chain of blocks formed is called the blockchain. Bitcoin uses proof-of-work scheme for its blockchain.
Other cryptocurrencies use various other schemes like proof-of-stake for their blockchain.
Since the required codes/hash strings are like probabilistic puzzles, we need computing power to find the codes. This process of finding the code is referred to as mining.
Mining makes it possible for the transaction to be processed. Every time a new block is attached to the blockchain we have a certain number of new coins created and awarded to the miner who finds the required code/hash strings. This serves as a system of the money supply. Miners also receive the transaction fees associated with the transactions of the block they mine.
Mining also keeps the blockchain secure because for anyone to change the details of transactions recorded in the blockchain, they need to use more than 50% of the total mining power running the blockchain. Such a person losses an economic incentive to disrupt the blockchain to steal the coins as he can better participate in mining and earn coins as rewards.
The blockchain keeps a record of all the validated transactions made publicly. It hence serves as a public ledger available for everyone to verify. The validity is achieved through consensus and so blockchain enables a decentralized system. Every full node that runs the software associated with a particular cryptocurrency maintains a full copy of the blockchain and hence the full record of all the validated transactions.
Two conflicting transactions do not form a block. So, two blocks are formed with each having one of the conflicting transactions. The next block decides which block needs to be considered for the blockchain and consequently, the other block becomes orphaned and the conflicting transaction belonging to that block is not validated. This solves the problem of double spending a coin.
By keeping a ledger of all the coins ever produced and by using the criteria of every transaction referring to previous transactions, the blockchain ensures that no perfect copies of the coins are created.
Cryptocurrency transactions are:
A transaction once signed with your private key cannot be reversed. It is strongly recommended to double check the address before confirming a transaction.
Cryptocurrencies function through a system of public addresses and private keys. The public address has to be generated randomly and the key associated with it should be a kept secret. The public address is a string of alphanumeric characters, something like your bank account number. Unless someone publicly declares that a public address belongs to him/her, no details about the ownership of a public address can be known just from the public address itself. Since the blockchain is a public ledger, it is strongly advised not to reuse a public address.
Cryptocurrencies use very strong encryption functions. Private keys cannot be generated by using the public address. But when you sign a transaction with your private key, the network knows that you have used the private key without the need for you to reveal the private key to the network.
Smart contracts are simply a piece of code that lives on the blockchain. They are self-executing contracts and are designed to enforce the terms of an agreement. Smart contracts make it possible to design a wide variety of decentralized applications.
Decentralized Applications (dApps)
dApps make use of the conceptual idea of cryptocurrencies to design decentralized peer-to-peer digital applications. Through the use of smart contracts and tokens that serve as a medium of internal currency or/and also award voting rights, dApss ensure that there is participation from everyone. This removes the need for a central entity and ensures transparency.
Initial Coin Offering (ICO)
An Initial Coin Offering (ICO) is a means by which funds are raised by a new cryptocurrency startup project. ICOs grant tokens in exchange for investment in the startup with cryptocurrencies (Bitcoin, Ethereum etc). These tokens award voting rights or/and serve as internal currency. By opting for an ICO, start-ups avoid the cumbersome processes required to meet the regulatory requirements.
Cryptocurrency is quite new. Although a novel invention, they have a long way to go before they revolutionize money. The blockchain that serves as the backbone of cryptocurrencies offers immense possibilities to change the way we have been doing things. Cryptocurrencies and their associated technologies are here to stay and so leave no stone unturned to understand more about their functioning.