A Casual Rambling Explanation of Bitcoin, Cryptocurrencies and The Blockchain
I started a Slack group that’s very dear to me. It’s populated by ex-coworkers and their ex-coworkers. It’s called Ex-Coworkers Forever for obvious reasons. Someone in that group had a question about cryptocurrencies and how they work. He said he has zero knowledge and needs to learn whatever he can in a weekend. I intended to let him know “what to google” and write a few-sentence high-level summary but went on sorta a lot. I’ll leave the transcript here in case it helps other folks looking for a somewhat meandering cryptocurrency primer.
If you’re doing some exploration on your own, I might recommend you limit your searches to
bitcoin rather than
cryptocurrencies as a whole. If you’re starting from zero understanding it would probably be helpful to narrow it down first. Then once you understand the basics of how digital tokens and the blockchain work, expand out to the intricacies of other cryptocurrencies, outside of bitcoin.
In fact, starting with
blockchain along with
bitcoin, as search terms might be even better.
Here’s a few-sentence explanation to get you started:
Millions of computers around the world keep a copy of a ledger of transactions. I use an app on my computer to pay you $5, my computer broadcasts that transaction to the network, everyone else’s computer logs it, we all have it recorded and we can’t change it. Everyone knows I have $5 less and you have $5 more and this record is immutable. That is very hard to ‘hack’ or ‘fake’ because of the massively distributed and mass-verified nature of it.
That’s essentially what
the blockchain is. A distributed, shared, verified ledger of transactions. (
Distributed because lots of different parties have copies of the data. Rather than
Centralized, where one company has one database of data that they control.)
Bitcoin and other cryptocurrencies are the “$5” units, “coins”, that get sent back and forth on those networks. Each cryptocurrency (bitcoin, ethereum, litecoin, whatever) has its own blockchain where the transactions of its “coins” take place and are recorded.
Minting, Mining, and Network Resiliency
Where do those coins come from, you ask? That’s where it gets complicated.
Sort of: some number of those millions of computers on that network of ledgers are sitting there doing computery work to prove that I sent you 5 coins. They do this through some complicated math that we don’t need to worry about now. They are expending energy and CPU work doing this proving so that when computer X over there says, “Hey, did Vinney really send Anthony 5 coins? Did Vinney even have 5 coins to send?” they can be sure the answer is “yes”. That goes to the resiliency and un-hackability of the blockchain. A majority of the network must agree that that transaction really did take place the way it was claimed to have taken place. This record is immutable.
We were talking about the origin of the coins: Randomly, some of the computers doing that proving work will get rewarded (also called mining) with a coin of the blockchain its on (a bitcoin, or a litecoin, whatever).
So there’s some incentive for doing that energy-expending, transaction-proving CPU work. Do enough of it and you’ll eventually get some free cryptocurrency. If the coin is worth enough (see bitcoin’s current price around $8,000) the value of that reward can be significant…
But naturally, the more people doing the work, the less chance lucky you have of getting that reward. Plus over time there are fewer and fewer rewards handed out - which keeps the currency scarce. Plus plus, there is a finite number of total coins that will ever be rewarded out in that way. And as time goes on and as there are less coins remaining to come out, it gets harder for a CPU to do the proving work (“it gets harder” in that the algorithm that dispenses the rewards demands more work from the computers before it provides a reward). This is by design and you can read more about it in the bitcoin whitepaper linked at the end.
Another slack member interjected: “a visual representation:
[this is a funny video about the lack of intrinsic value in any given currency.]
What’s It All Worth?
To the point in the video above, for cryptocurrencies that don’t have a utility, they’re essentially like beads, wampum, bits of gold - anything that gets traded between people for goods and services. They only have value because some group of people is willing to agree that they do. (this isn’t really any different than US dollars or any other fiat currency)
Crypto “Fuel” for Applications
BUT, counter to that, some cryptocurrencies (let’s call them tokens. its easier) do stuff. Ethereum, for example; The
ether token is used as “gas” to power web applications.
Take the example of this website where people can trade cartoon digital pets1 . You want to buy a digital pet from me? It’ll cost a fee of X
ether to enact the trade across the app. Want to breed your pets? That’ll cost Y
ether to do, etc. So it’s a way to use an electronic service. A ‘fueling’ fee.
A lot of people think those tokens (the ones that do stuff) will, in the long run, be more valuable and long-lived than bitcoin and others that are merely stores of value or fiat currencies. The jury is out on that one.
Further illustration of useful tokens: Imagine you want to send messages on this new token-powered encrypted secret messaging service. It costs
1 secret-messagey-coin to send a single message. You spend $100 of real US dollars to buy
10 secret-messagey-coins and now you can send your 10 encrypted messages on the system.
Of course, people being people, some other folks might just horde
secret-messagey-coin because there are other people who want to buy them in order to use the encrypted messaging app. So there becomes a trading economy around the app. This might drive the value of
This works like stocks. Crypto Exchanges are places where people can buy and sell “shares” of
secret-messagey-coin and other tokens. You can use US Dollars, Euros, even other crypto currencies to buy some number of whatever token you’re interested in. Just like a stock exchange.
Further (Required) Reading
I’m not sure if this will be too technical, but at some point you should read the bitcoin whitepaper: https://bitcoin.org/bitcoin.pdf
It’s sort of a cultural artifact at this point, since it announced Bitcoin, which kicked off the crypto revolution.
And that was the end of that. I’m posting this right after this took place, so who knows if some amazing discussion took place afterwards.
I’m referring to “Crypokitties”. They’re basically electronically-tradeable beanie babies. google it! ↩