OK, let’s get right to it: if you have a fuzzy, hazy, nebulous understanding of cryptocurrency — which is a nicer way of saying you’ve heard about it many times but don’t have a clue what it really is or how it works — then rest assured, you aren’t alone. In fact, you’re in the vast majority.
What’s more, to understand the fundamentals of cryptocurrency you don’t need a PhD in mathematics, or to be the kind of uber geek that ordinary geeks worship and admire. Here are the basics that will make you a hit at your next dinner party, and might even convince you to throw you investment hat in the cryptocurrency ring one of these days (just make sure that you don’t lose your shirt in the process!).
What is a Cryptocurrency?
Cryptocurrency is a form of encrypted digital currency, which is transferred between buyers and sellers (a.k.a. peers), and tracked in a decentralized public ledger called a blockchain. This tracking process is known as mining, and is facilitated by a network of servers around the world.
Let’s say that Joe wants to purchase a banner sign for his new store. He searches online, and eventually lands on the website for the Landmark Sign Company. He finds the banner sign that he needs, and sees that the seller accepts Bitcoin (a type of cryptocurrency). Since John has some Bitcoin, he decides to use this method of payment instead of a credit card.
As soon as John completes the purchase, a record of the transaction is created. This is called a block. John’s personal and private key are added to the block, which is then distributed across the network. Once the block is verified (more on this below) it is added to the chain, and then added to the decentralized digital ledger. Finally, ownership of the block transfers over to Landmark Sign Company. Ultimately, John’s digital wallet contains fewer bitcoin, and Landmark Sign Company’s digital wallet contains more bitcoin. The transaction is therefore complete.
Verifying and Mining
Unlike a conventional credit card or debit card transaction, the verification process is not managed by a central bank. Rather, it is facilitated by a global network of very powerful computers — known as ASICSs — that compete with each other to guess a number that solves a system-generated equation, and which verifies each transaction as legitimate. The computer (a.k.a. miner) that wins this race — and in doing so, provides an essential public service to the cryptocurrency community — is awarded a fee.
If this seems like easy money, however, then think again! While it’s true that computers do all of the heavy lifting, setting up and running a network that has the capacity to verify transactions is expensive and requires a massive amount of electricity — which is one of the reasons why cryptocurrencies are having trouble penetrating into developing countries that don’t have the infrastructure. For example, bitcoin mining currently consumes more electricity than over 20 European countries combined.
It’s a foregone conclusion that cryptocurrency will continue developing, and will probably go through a few re-inventions in the years ahead; especially as governments get in on the action. However, it’s also an absolute certainty that cryptocurrency is not going to be consigned to some geeky alternative payment marketplace. It’s going mainstream, and when that happens it’s going to change a lot more than just how people choose to pay for goods and services. It’s going to change the dynamics of commerce itself in ways that we can imagine — and probably in many more ways that we cannot.
photo credit: verchmarco Goldener Bitcoin mit Reflexion auf weißem Hintergrund via photopin (license)