The world is moving fast, and our financial system is joining this bandwagon. Among several other things, the origin of crypto has introduced a new arc in the global economy.
Many people are getting hooked on the crypto craze. They consider it a way to diversify their portfolio, as the cryptocurrencies can make some wild swings. However, this part relates to the outer world of crypto. So we want to dig deeper into what's going on inside?
By inside, we mean what's the technology that has created the frantic world of crypto. This guide will talk about the technology behind cryptocurrencies and how it affects our financial system.
But first, what are cryptocurrencies?
Before diving into the technology behind cryptocurrency, let's first define what the term cryptocurrency means. Cryptocurrencies are tokens or coins in the form of virtual or digital money. The vast majority of cryptocurrencies remain intangible despite some entering the world through credit cards and other ventures.
As the name implies, crypto refers to the sophisticated process of encrypting data so that digital currency can create and process, as well as their transactions, over a decentralized network. These currencies all share a decentralization commitment, which is what makes them "crypto" in nature.
Since their inception, cryptocurrencies have taken the world by storm. Some consider it a hedge against inflation, some consider it a lucrative investment, and some consider it a bubble. But whatever the views, cryptocurrencies are creating a buzz. So, that's why you need to understand the technology behind it.
Ok, let's move to the tech behind cryptocurrencies.
Although you've certainly heard of Bitcoin, Ethereum, and other cryptocurrencies recently, many financial experts believe it's the technology underlying them that you should focus on.
The primary technology that most cryptocurrencies depend on is blockchain. Yes, blockchain is the tech that's driving the world of crypto. You probably are thinking, blockchain seems complex. Well, on paper, it is, but we'll present a simple explanation so you can easily understand it.
Blockchain explained
A blockchain records all peer-to-peer transactions in a centralized ledger. It does not require a central clearing authority to confirm transactions using this technology. The use of cryptocurrencies is possible for funding transfers, trade settlements, voting, and other issues.
For a better perception of blockchain technology, use a Google Doc as a comparison. Instead of being destroyed or duplicated, it disseminates documents whenever they are produced and shared with a large group of people. In this way, everyone has simultaneous access to the document because the distribution network is decentralized.
It logs all changes to the document in real-time, so it locks nobody out while awaiting the other party's input. Even though blockchain is more complicated than Google Docs, this comparison is useful since it emphasizes three key points.
Probably your head is wobbling with all the geeky info, so let's break it down for you.
What's a block?
On the blockchain, blocks hold data, and it's up to whoever creates the blockchain to decide what sort of data they store. Because of the limited storage of each block, it adds a ledger regularly, forming a chain.
A cryptographic hash identifies each block individually. In addition to identifying a previous block, the hash protects its data from those who do not have the code by protecting its position in the chain.
A blockchain's genesis block, or the initial block, includes all the above information. However, because it is the first block, it has no preceding blocks; therefore, the genesis block theoretically only has two elements: data and its hash.
However, because the prior hash has no value, the value of the previous hash is automatically changed to 0 when you program the genesis block.
What's a chain?
Assume I've just created a new blockchain: the first block will be there, bright and fresh but lonely. The second block would then appear and declare. The block in front of me is the first block. The following block would state, the block before I am the second block, and so on, forming a chain (of blocks).
Every new block is formed in a chain after compiling a newly added block into its block and adding to it once it fills. Then, it assigns every block in the chain a timestamp.
What are the different types of blockchain?
As we mentioned earlier, blockchain is a bit complex, and here come its types. But don't worry, as we'll simply explain this.
Public Blockchains
Anyone may utilize open public blockchains decentralized networks of computers to request or confirm a transaction (check for accuracy). Miners (those who verify transactions) get rewarded.
In public blockchains, proof-of-work or proof-of-stake consensus mechanisms act (we'll discuss this later). Bitcoin (BTC) and Ethereum (ETH) are two well-known examples of public blockchains.
Private Blockchains
Private blockchains aren't open to the general public, and access is limited. Anyone who wishes to join must first obtain authorization from the system administrator. They are generally centralized and controlled by a single organization. Hyper ledger, for example, is permission, private blockchain.
Consortium blockchains
A consortium blockchain, also known as a permissioned blockchain, may be thought of as a cross between public blockchains' low-trust model and private blockchains' one highly-trusted entity model.
Instead of letting every user participate in the transaction verification processor, on the other hand, enabling a single business to have complete control, a consortium blockchain allows just a few predefined parties to participate. Only a handful of people are permitted to participate in the consensus process.
Consider a ten-bank group or a network, each of which is linked to the blockchain network. In this case, we may assume that seven out of 10 banks must agree for a block to be legitimate.
Although this structure has substantial centralization, operators can allow access to read and write to other users. As a result, consortium blockchains are designed to be somewhat decentralized. Consortia blockchains, like private blockchains, maintain data privacy while without concentrating authority within a single organization.
How does the blockchain function?
Consensus mechanisms, or the method of confirming deals without a third party such as a bank, are the main component of blockchain.
PoW and PoS are the primary sources of this concept. While their objective remains the same—to achieve a consensus that a transaction is valid—how they get there differs.
What Is PoW?
Proof of work (PoW) is a decentralized consensus mechanism that requires network members to spend time-solving an infinite mathematical puzzle to protect the system from being hacked.
In cryptocurrency mining, experts frequently use PoW for validating transactions and mining new tokens.
What is PoS?
The proof of stake concept was created as an alternative to solve the basic shortcomings of the proof of work (PoW) concept. Cryptocurrencies are presently the only ones that employ the proof of stake concept. When a transaction begins, the data is summarized into a big block and repeated across many computers or network nodes.
What exactly are nodes?
One of the most important ideas of blockchain technology is decentralization. A single device or entity cannot control the chain. Instead, a distributed ledger is formed by the nodes that connect to the chain. A node is any electrical equipment that stores copies of the blockchain and keeps the system operating.
Every node has its ledger model, and the network must algorithmically allow each newly mined block for the chain to be updated, recognized, and verified. Because blockchains are understandable, any action on the ledger can be easily reviewed and seen. In addition, it gives each user a unique identification number that they can use to record their transactions.
The mining
In Blockchain technology, mining refers to adding transactional information to the current digital/public ledger. Though the term links with Bitcoin, it may also refer to other Blockchain technologies. Mining is the process of producing a difficult-to-forge hash of a block transaction to keep the whole blockchain secure without needing a central mechanism.
Miners use specialized software to tackle the extremely tough mathematical problem of creating a valid hash from a nonce. Because the nonce is only 32 bits large and the hash is 256 bits large, there are around four billion nonce-hash keys to search through before finding the right one.
When this happens, many think miners have found the golden nonce, and their block adds to the chain.
Any modification to a block beginning in the chain involves re-mining that block and all future blocks. That's the reason why it is so difficult to manipulate blockchain technology. Because classifying golden nonces takes a great time and many computing resources, think of it as safety in math.
How does blockchain perform transactions?
Users can also use blockchain to perform user transactions without the involvement of third-party middlemen. To perform transactions, all that is necessary is the possession of a wallet.
A Blockchain wallet is a software that lets you spend cryptocurrencies like Bitcoin, Ethereum, and others. Such wallets protect themselves by cryptographic methods (public and private keys), which allow users to monitor and manage their transactions.
When a user starts a purchase on the Blockchain network, the block initially represents a transaction. Then, the intended transaction goes via a peer-to-peer network, which comprises computers known as nodes, who then validate it.
A verified transaction might include cryptocurrency, contracts, papers, or any other essential data. Following the validation of a transaction, it is coupled with other blocks to produce a new data block for the blockchain.
Who Invented Blockchain?
In 1982, cryptographer David Chaum devised the first blockchain-like technology. Stuart Haber and W. Scott Stornetta later published a paper on consortiums in 1991.
After deploying the world's first digital currency, Bitcoin, Satoshi Nakamoto designed and deployed the first blockchain network.
What blockchain offers for the crypto world?
Blockchain offers a lot for cryptocurrencies, so here's a breakdown of some of the things blockchain brings to the table:
Adding accuracy
On the blockchain network, a network of thousands of computers validates a transaction. As a result, it almost eliminates human assistance in the affirmation process, resulting in less human failure and a more detailed data record.
Even if one of the machines in the network made a computational error, only one copy of the blockchain would be affected. That flaw would have to be made by at least 51 percent of the system's computers to propagate to the rest of the blockchain, which is almost unlikely in a large and developing network.
Reducing the costs
When you go to a bank, you usually have to pay to verify a transaction, a notary for signing a paper. The blockchain does away with the necessity for third-party verification, as well as the associated fees.
Businesses that accept credit card payments, for example, must pay a small fee to banks and payment processing organizations for the transactions to be processed. BTC and others, on the flip side, have no central authority and minimal transaction fees.
Its decentralized nature
None of the data on the blockchain saves in a single location. Instead, the blockchain is reproduced and disseminated by a network of computers. To reflect a new block to the blockchain, each computer in the chain updates its blockchain.
By distributing data throughout a network somewhat than saving it in a single primary database, blockchain makes it more challenging to tamper with it. For example, only a private copy of the data can compromise if a hacker acquires a copy of the blockchain rather than the whole network.
Smooth and efficient transactions
Transactions processed by a central authority may take several days to settle. If you deposit a check on Friday, for example, you may not receive cash until Monday. Financial organizations work during business hours, five days a week, whereas blockchain runs 24/7 round the clock.
It can complete the transactions in as little as 10 minutes, and they are considered secure after only a few hours. It is particularly useful for cross-border transactions, which take much longer due to time zone variations and the necessity for all parties to confirm payment processing.
Secure transactions
Once it records a transaction, the blockchain network must check its legitimacy—thousands of computers on the blockchain race to verify that the data in the purchase is correct.
After a machine has approved the transaction, it adds to the blockchain block. The hash of every block on the blockchain is different, as is the preceding block's hash. When the data on a block is modified, the hash-code of the block before it switches; nevertheless, the hash-code of the block after it does not. Because of this distinction, it is extremely difficult to change information on the blockchain without being noticed.
It is open-sourced
The vast majority of blockchains are built solely out of open-source software. It means that anyone with an internet connection may examine the code. It enables auditors to assess the safety of cryptocurrencies such as Bitcoin. However, this suggests no real administration over who controls crypto code or how it is modified.
As a consequence, anybody can suggest changes or enhancements to the system. If most system users feel that the new form of the code with the update is solid and useful, you can update it.
The limits of blockchain technology
Although the blockchain has several benefits, it, like anything else, has flaws. The first is that the blockchain may slow down if there are too many users on the network. Second, because of its consensus-based work approach, it's also more difficult to grow.
Another limitation is that blockchain data is irreversible; it cannot alter once you code a block. As a result, some may perceive it as a rip-off that demands self-maintenance, indicating that users must maintain control over their wallets or risk losing access.
The reason that blockchain tech is still in its early stages is a major stumbling hurdle. It's also incompatible with other blockchains and financial systems, and integrating it into existing systems is challenging.
How can you join the bandwagon?
Blockchain technology is being tested and used by businesses and governments worldwide, but nothing will happen soon. For example, it will be long before we reach a point where government money is decentralized, and medical records are on a blockchain.
Meanwhile, you may put your money behind a blockchain by purchasing a blockchain-based cryptocurrency such as Bitcoin, albeit this isn't the only option. You may also alter ordinary investments to make them blockchain-ready. For example, check to see whether any of your ETFs or mutual funds invest in companies developing or adopting blockchain technology in their business operations.
Final thoughts
So there you have it; now you know what the driving force behind cryptocurrencies is. Blockchain technology promises a lot for the crypto world. Smooth and safe transactions, their decentralized nature, and cost reduction are having and will have an impact on our financial system.
In the meantime, you can catch the trend of investing in blockchain networks. But you have to remain calm and focused, or you can see your dollars go by from your account.
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