Basics Of Cryptocurrency - Step By Step Understanding!

In this thread I will be covering the following:

1. Introduction To Cryptocurrency
2. Blockchain Technology
3. Cryptocurrency Mining
4. Decentralized Applications
5. Smart Contracts
6. Initial Coin Offering (ICO)
7. The Whitepaper
8. Hard Fork & Soft Fork
9. Proof-Of-Work & Proof-Of-Stake

1. Introduction To Cryptocurrency

Cryptocurrency is a digital currency that functions as a medium of exchange, utilizing the process of cryptography enables users to transact securely using these digital coins. Cryptocurrencies operate on a distributed ledger called a blockchain, where all transactions using a cryptocurrency is made public and permanently recorded. Units of a cryptocurrency are produced through a process known as mining, where special computer software is used to solve mathematical problems in exchange for a unit or more of that cryptocurrency. Due to the decentralized technology on which cryptocurrencies operate, the supply of a cryptocurrency is not subject to the control of a central authority; the total supply of a cryptocurrency is normally predetermined, which is made clear to all users.

Bitcoin possesses the title as the first ever decentralized cryptocurrency, originally conceived in 2009 by an individual or group under the pseudonym Satoshi Nakamoto. However, there are now numerous cryptocurrencies since the inception of Bitcoin, the number being well above 800+. These cryptocurrencies are known as ‘altcoins’, signifying an alternative to Bitcoin.

2. Blockchain Technology

A blockchain is a public ledger of all cryptocurrency transactions. Each group of transactions are referred to as a block, with each block then being combined chronologically into a chain. Information that exists on the blockchain is shared and public, therefore, every node connected to the network, possesses a copy of the blockchain. Each node will be able to have access to all transactions that have ever taken place, or will take place on the blockchain. The distributed nature of blockchain technology also means that the database cannot be controlled by a single entity, nor can it easily be hacked as there is not one single point of failure. Unauthorized changes to the blockchain would be unlikely, as overriding the network would require a tremendous amount of computing power.

The first implementation of blockchain technology was by Satoshi Nakamoto in 2008, where the technology was applied to the digital currency now known as Bitcoin.

3. Cryptocurrency Mining

Cryptocurrency mining is a process by which new coins are introduced into the existing circulating supply, as well as a process used to secure the network that the coins operate on. The people who mine a coin, are known as miners. Therefore, instead of having a central authority that produces and secures the money supply, this is spread out across the network.

The Mining Process

Transactions that occur on the network such as, “Alice sends 10 Bitcoins to Bob”, are collected by a miner and bundled up into a block. The miner then verifies that all transactions in the block are valid. If a miner attempts to submit a block with an invalid transaction, the block will be rejected. An example of an invalid transaction would be, Alice sending 10 Bitcoins to Bob, even though she does not have 10 Bitcoins to send.

After the miner has successfully verified that all transaction in the block are valid, he must then compute a cryptographic hash. It is necessary for miners perform this computation in-order to prevent just anyone from being able to create blocks, this therefore secures the network against fraudulent blocks. Computing a cryptographic hash requires a large amount of computing power, as hundreds of millions of calculations are needed to be performed each second. This process is known as proof-of-work. Once the miner successfully solves the hash, the block is then relayed to the network to be checked against the consensus rules. Once accepted, the block is then added to the blockchain network and the miner is rewarded with a set amount of the cryptocurrency.

4. Decentralized Applications

Typically associated with the Ethereum project, a decentralized application, or DApp, is an application that runs on a peer-to-peer network of computers, as opposed to a single computer. The key benefit of this is, users of the network do not depend on a central computer in-order to send and receive information.

In-order to fully understand the difference between a decentralized application and a centralized application, let us consider some examples of centralized applications such as: Facebook, Twitter and YouTube. These are all examples of centralized applications, because in-order to use them, the user is dependent on a network owned and operated by a central entity. This is in contrast with a decentralized application, where the user is not dependent on a central entity to send and receive information.

Even though a DApp does not necessarily require a blockchain from which to operate on top of, most DApps harness the power of blockchain technology using what are known as, smart contracts. Smart contracts are self-executing contracts designed to enforce the terms of an agreement. For example, if you want to purchase a house, this process would involve multiple third parties such as estate agents and lawyers, who would settle the purchase for you. However, with the use of a smart contract, the process need only involve the buyer and the seller. Once all the conditions are met, the smart contract would execute independently of any third party.

DApps rely on smart contracts in-order to access the blockchain and operate, much in the same way centralized applications rely on centralized servers to operate.

Here are some common requirements of an application before it can be truly considered decentralized:

Application must be open-source
Application’s data must be stored on a decentralized blockchain
Application must use a cryptographic token e.g. Bitcoin, or one inherent to the application
Application must generate tokens via a cryptographic algorithm, e.g. Proof-of-work

In-order to crystallise your understanding of what a DApp is, let us consider a real-world example of a decentralized application.

Eth-Tweet is a decentralized blogging platform that provides functionality similar to Twitter. However, because Eth-Tweet operates on top of the decentralized Ethereum blockchain, no centralized entity can control what a user decides to publish.

5. Smart Contracts

A smart contract is a self-executing contract that is designed to enforce the terms of an agreement created between two parties. Terms of the contract are recorded in a computer language such as C++ as a set of instructions, and are carried out automatically. The aim of smart contracts is to facilitate the exchange of money, or anything of value, whilst also reducing costs associated with the formation of a contract e.g. legal fees. For example, If Bob wanted to enter into a contractual agreement with Alice for the sale of a house, normally, both parties would seek the help of a real estate agent or a lawyer in order to form a contract. However, through the use of a smart contract, the parties respective wishes can be encoded and automatically executed, therefore, eliminating the need for middlemen.

Example of a smart contract:

Cryptocurrency Forum.png

A well-known use of smart contracts can be found on the Ethereum blockchain, where they are integrated into decentralized applications (DApps). The trust less and self-executing nature of smart contracts means that the operation of DApps need not depend on a centralized network. However, the use of smart contracts does not come without risk. The code included in a smart contract may contain bugs and security holes that are exploitable. This was the case when, in June of 2016, approximately $50 million worth of ETH was stolen from the Decentralized Autonomous Organization (DAO), due to an exploitable security hole in its smart contract.
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