What are Cryptocurrencies?


As I outlined in my first blog post, I feel that cryptocurrencies will be one of the 3 factors that will drive change in our culture. Money is used by humans to communicate scarcity. It is an artificial construct and is only real because we humans think it is real. Money evolved out of a barter ledger that was locally managed by a trusted 3rd party (a common misconception is it was direct barter). So, if humans did not exist, money would not exist. I realize this is a simple explanation, the topic of money is complex and I recommend to get a quick primer on what money is. If you think it’s just digits in a bank account or paper in your wallet this is further reason to pay attention to this blog. Understanding the true nature of money will help you prepare for the future. View the video below for a quick overview of money from Peak Prosperity.

A relatively recent monetary innovation was the creation of Bitcoin. Bitcoin is a peer to peer network that is used to exchange digital value without a central authority’s (company/government) consent. Bitcoins are not actually sent over the internet, instead, transactions are recorded on a decentralized public ledger called the blockchain. See more on decentralization in my previous post, “Centralized vs Decentralized Systems”. Since the Bitcoin network is run by open source software and not controlled by any individual it allowed the system to be copied and replicated. The first replication of blockchain technology was Litecoin and that continues to this day where there are over 2000+ cryptocurrencies that can be purchased on the free market.

To keep the basic primer on cryptocurrencies simple, I will use Bitcoin as an example of how cryptocurrencies work. The Bitcoin public ledger consists of “blocks” that are created every 10 minutes and are recorded permanently to the blockchain (Take a look at https://insight.bitpay.com/). Who creates these blocks? Bitcoin miners do! Miners are the payment processing engine for Bitcoin. The miners are computers with specialized processors that listen to the Bitcoin network and record a list of all valid transactions that were made since the last block. As they gather the transactions they are also solving a mathematical “puzzle”. The first miner to solve the puzzle wins the block reward (currently 12.5 bitcoins) and publishes the block with all of the transactions they gathered for all other miners to see. All miners on the network then validate that this “puzzle” was solved correctly and then they start to mine the next block and repeat this process. The new block that they start mining references the block that was solved; they build on top of the previous block.

The transactions that miners are listening for are created by Bitcoin wallets. A Bitcoin wallet will typically generate and save a “private key”. A private key is 52 alphanumeric characters randomly generated by the wallet (interesting enough, it can even be created offline by rolling a single die many times). This private key gives the wallet holder control of the corresponding address (this key should be kept in a safe place and not shown to anyone). With this private key, the wallet software generates the corresponding Bitcoin address (this is the public address that you can show everyone) and scan the blockchain to determine how many bitcoins belong to that address. When someone sends bitcoins to another address the wallet will use the private key that it has stored to send out a signed message to the network indicating the quantity and address to which the bitcoins have been transferred.

What is interesting about this mechanic is that the creator of Bitcoin “Satoshi Nakamoto” actually used the power of computers to mimic the ancient method touched on at the beginning of this post. As mentioned, the ancient barter system that everyone has heard about was not a direct exchange of good. Instead, there was a local trusted ledger managed by a 3rd party that the community used to record transactions to keep account of who owed what to who. The blockchain is simply an evolution of this ancient idea on a global scale that is not controlled by any 3rd party entity and therefore cannot be corrupted.

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