The Fundamentals of Cryptocurrency

When a new technology that is the result of several decades of research and labor emerges, individuals from various walks of life may question and criticize the potential revolution it may cause. On the other side, technological leaders could be surprised and adopt it. When it is eventually commercialized, people may question why its potential was not immediately apparent. Personal computers in the 1970s, the Internet in the 1990s, and Cryptocurrency in the 2010s are examples of technologies that underwent this process.

The Fundamentals of Cryptocurrency

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Evolution of technologies addressing the shortcomings of digital payments

In one form or another, money has been a part of human history for several centuries. However, from the barter system of exchanges to the current cryptocurrency system, money has undergone a huge revolution. With the beginning of the digital age in the 21st century, physical currency was replaced by its digital counterpart. To address the challenges in its current status and the economy, money took on a new shape.

Any digital payments system has always been plagued by two fundamental difficulties.

  • Assume there is no straightforward method for determining whether a person had adequate funds to pay their counterpart in a transaction. In such a scenario, he could engage in double spending, or many fraudulent transactions, and leave the other unpaid.
  • Alternatively, if a person gave all the necessary private information to demonstrate that he has adequate funds, the funds may be stolen before they could be utilized for the transaction.

The time-tested answer to this issue is the involvement of a trustworthy third party with access to confidential information regarding the availability of funds. This ensured a secure exchange between the parties without the loss of dollars or data. However, these intermediaries charged exorbitant fees for their services, and the current cost to consumers for cross-border transfers is estimated to be 6.5 percent.

There is also the issue that these intermediaries can be hacked, exposing enormous quantities of sensitive information. This is illustrated by the Equifax hack of 2017, in which the private information of around 145 million Americans was compromised.

Cryptocurrency and its underlying technology, Blockchain, can solve this issue by substituting a centralized trusted authority with a distributed network of users, thereby producing a decentralized peer-to-peer payment system.

What exactly is a cryptocurrency?

A cryptocurrency is a digital or virtual currency that is protected by encryption, making it nearly impossible to counterfeit or double-spend. The majority of cryptocurrencies are decentralized networks utilizing blockchain technology, which is a distributed ledger enforced by a dispersed network of computers.

Specifically, cryptocurrencies enable payments or other transfers of information between individuals without central authority (like a government or a bank).

What is a blockchain, and how does it function?

A blockchain is a distributed database that is shared among the nodes of a network. As a database, a blockchain maintains information in digital format electronically.

The key cryptographic mechanism utilized by Blockchain is the cryptographic hash function, a mathematical algorithm that maps random data to a fixed-length bit string.

The function of cryptographic hashing is unidirectional, and it is impossible to decipher. SHA-256, on the other hand, is a popular cryptocurrency hash algorithm that generates a digital signature for any 256-bit hash input data.

Any given hash can only be cracked through brute force, i.e. trial and error. This assures that the original message cannot be easily reconstructed from the hash value and that two distinct messages cannot generate the same hash value. In addition, this functionality enables the peers of the network to observe the transactions between any two parties.

Each fresh batch of transactions is bundled into a single block. The information on each block of transactions generates a unique hash or digital signature for that block. A further piece of information given in each block is the hash of the block immediately preceding it in the chain.

When implemented decentralized, this data structure guarantees an irreversible data chronology. Therefore, when a node attempts to make even the smallest alteration to the ledger, the hash it generates will not match the hash of the other blocks and will be discarded. This ensures the system’s complete security.

Classifications of Blockchain systems and their business applications

Permissioned and Permissionless Blockchains are categorised by their manner of operation. Permissioned Blockchains are centralized-authority-controlled distributed ledger systems. No centralized authority governs permissionless Blockchains.

While both permissioned and permissionless Blockchains provide comparable value propositions, the control and consensus processes of each make one more suitable than the other for particular applications.

Utilization of Permissioned Blockchain Systems in Business

IBM worked with Walmart, Kroger, Nestle, and Unilever to assure food safety through the implementation of its IBM Hyperledger Fabric system.

The goal of this program was to connect diverse portions of the supply chain onto a single, standardized system in which each stage of the transaction was time-stamped and recorded; for instance, isolating food from a farm contaminated with a virus from food manufactured for shelves. This might potentially reduce food waste and provide consumers with more information about food origin.

Business applications for permissionless blockchains

Cryptocurrencies are the most prevalent use case for permissionless Blockchain systems:

Ethereum, one of the most famous blockchain networks, was the first to develop smart contracts and NFT (Non-Fungible Token) capabilities. A smart contract is an algorithm that is written to execute automatically when specific circumstances are satisfied. In addition, it enabled the storage of virtual assets on a decentralized platform, making them impossible to counterfeit. Popular NFT use cases include digital arts, songs, and even films.

Sia — “Decentralized storage for the post-cloud era,” as its website states, improves blockchain technology for file storage. Zach Hebert, the company’s founder, asserts that in the future, cloud storage solutions governed by a central authority will no longer be necessary. This is owing to the fact that these cloud storage platforms may fail if their regulatory authority ceases to exist or ceases functioning for unforeseeable reasons. Rather, based on consensus procedures, these decentralized Blockchains will survive even if the entity that built them ceases to exist.

CarVertical — This Estonian startup has implemented blockchain technology to track the car histories of individuals wishing to purchase old automobiles. CarVertical compiles information on vehicles from multiple sources, such as lease and insurance records, in a single ledger. Using the data gathered in the ledger, it then generates a comprehensive report on the automobile’s history.

Drife — A ride-sharing application now running in Bangalore, India, uses a system of’smart contracts’ between drivers and passengers. To be selected for rides, Drife’s native token can be staked by drivers. Rather than paying a commission on each ride, Drife drivers can pay an annual fee to use the app.

Blockchain operation of cryptocurrency

Blockchain’s most popular use is cryptocurrency. There is a fixed supply of cryptocurrencies on the market. Miners or nodes in the Blockchain network receive them as a reward for approving transactions and adding transaction data to the Blockchain through a process known as mining.

Mining cryptocurrency

Technically, any network node can add a new transaction block. To add a block to the network, a node must solve a complex mathematical puzzle based on a hash function that can only be solved by brute force, and then submit proof of the solution to the other nodes so they can also solve the puzzle. The node that solved the riddle will receive fresh bitcoins as a reward, hence increasing the market supply of cryptocurrencies. This is referred to as mining. As compensation for approving the endeavor, the remaining nodes receive a portion of the transaction fees. This entire system is known as the consensus mechanism.

A consensus mechanism is a fancy way of explaining rules that are agreed upon by all parties concerning who updates the ledger. Proof of Work and Proof of Stake are the two most often used consensus mechanisms in the crypto community.

Evidence of work

Proof of Work is a decentralized consensus technique that underpins the security of the Blockchain and the legitimacy of the mined blocks in order to establish confidence in a decentralized network.

To mine a block, miners must solve a difficult mathematical equation. The first miner to solve a problem will broadcast his solution to the network, allowing others to validate it and receive a portion of the transaction fee. Thus, it can be ensured that only miners who have performed sufficient labor will gain the privilege to update the Blockchain.

Proof of Work, on the other hand, demands a substantial amount of computational power and energy, which will only increase as the number of nodes in the blockchain grows. Energy-intensive mining consumes an estimated 132,5 terawatt-hours each year, according to reports. This has resulted in miners banding together to build more powerful computer systems to validate transactions and earn cryptocurrency, so rendering decentralization meaningless.

As a result, Proof of Stake, an alternative consensus technique, was developed.

Evidence of Stake

Proof of Stake dictates that in order to mine, a miner must keep some coins in stake. Therefore, a miner’s mining power is determined by the number of coins he wagers. It is an alternative consensus algorithm that attempts to overcome the PoW mechanism’s scalability and environmental sustainability issues.

This procedure increases the miner’s obligation to carefully validate transactions. This is because he would have placed a portion of his bitcoin at risk, which would be slashed if he verifies a bad transaction block.

Comprehending a cryptocurrency exchange

To show how a cryptocurrency transaction works, we can depict a Bitcoin transaction graphically. Bitcoin, which was created in 2009 and marketed as the world’s first cryptocurrency, is currently the most popular and valuable cryptocurrency, with a market capitalization of about $1 trillion. Proof of Work consensus approach is utilized.

Conclusion

Cryptocurrency is still in its nascent stages of development, but its long-term stability is anticipated to be exceptional. This currency’s stability makes it a more reliable store of value and expands its business applications. Governments and central banks can use this time to their advantage and control it more effectively to maximize its potential. Blockchain, its underlying technology, has already been applied in a number of corporate use cases. In addition, the development of the Metaverse concept bodes well for its future.

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