Today I’d like to talk a little about wallets, transactions and the blockchain, and a few of the other terms used in cryptocurrency. This article is aimed at beginners. I believe that education is key, not only to help people invest and trade in a safe and responsible manner, but also to promote adoption by the general public. While I certainly see the short term value of investing, holding and trading these currencies, I ultimately want to see the currencies being used for the purpose that suits them best.
What is “The Blockchain”?
All cryptocurrencies have some form of a blockchain, the blockchain is the backbone of the currency, and is essentially a ledger that contains and records all of the transactions within the system.
With paper money, we are able to (with some difficulty) forge it. We can sometimes use our credit cards to spend more money than we have available, a criminal can clone our credit cards, and that criminal could also use that cloned card to double spend the money in your account.
A blockchain (and I will use Bitcoin’s blockchain in this example) is a public ledger, which is widely distributed (in other words it is not controlled by one single organisation or person). In the case of Bitcoin, there are only 21 million Bitcoin that will ever exist. This number is hard coded, and cannot be changed.
Bitcoin is not printed or created by a centralised authority, it is mined, and I will explain how mining works in a future article. Today Bitcoin is mined by large businesses, groups or pools, but originally it could be mined by anyone with a laptop.
When a Bitcoin is mined or spent, it is recorded on the blockchain, and the blockchain is publicly available.
If I mine one Bitcoin, that Bitcoin is then linked on to me on the blockchain by my public and private key as well as a hash. Let’s think of my public key as my signature (easy to copy) and my private key as my thumb print (not easy to copy) and the hash as the serial number that’s printed on any bank note.
If I mined the original Bitcoin, and then wanted to send it to my friend Dave, I can do this electronically, by sending a note to Dave via the blockchain saying that I am giving Dave my Bitcoin, I sign this note, and send it out to the blockchain, which is made up of nodes. A node (lets think of a node as a very experienced fingerprint expert) analyses the hash that was created when I mined the coin, and then tells all the other nodes worldwide that this is definitely my coin, and I have not previously spent it. All the other nodes accept this as true, and the transaction is forever recorded, and is given a new and unique hash.
Now if I want to send the same coin to my other friend Julia, and I send a new note to her via the blockchain, and (the same, or another) a node gets it to verify the transaction. Since the last node sent out the information of my transaction to Dave to every other node, this new node already knows that I spent the Bitcoin, and then will not verify that the transaction to Julia is valid.
This new way of transacting essentially removes all trust from the equation, as we no longer need to trust that the person sending the funds has them, and that the funds are valid, because the
information is so widely distributed that it cannot be manipulated unless 51% of the nodes’ records are manipulated and changed, which would be extremely costly to the point that no individual or even government could realistically afford to do this. It removes trust from the whole equation, and replaces it with security.
What is a Wallet?
This one might scare some potential people away from cryptocurrencies, but I think its important to discuss it.
When someone uses the word wallet, what is the first image that pops into your head? It’s the image of a physical holder for money. With cryptocurrencies, you have two ways of storing your funds; in a wallet, or on an exchange.
With an exchange, you are entrusting your funds and its security to a company, and with a wallet, you are in total control of your funds.
Here’s the catch though: Your wallet contains no money.
Your wallet is simply an interface that allows you access to your funds. Your funds are on the network, and that’s where they stay. Your wallet is simply the interface that allows you to access your funds, by using your public and private keys. Think of your wallet as the key to your own personal vault at the bank. Except the bank is everywhere, and, unlike banks in history that have simply not honoured withdrawal requests in the past, this bank HAS to honour your requests if you have the keys. Much like a physical key, it can be copied and lost, and the lock that the key opens does not care who opens it, it only cares that the key fits.
No two currencies are created equal
The third concept I’d like to talk about is the question that I keep seeing pop up: “Why are there so many different currencies?”
There are many reasons why someone might want to create a currency. They could be simple, complex, honourable, practical, idealistic or malicious. The first thing I always advise before you invest in a currency, is to research it. Take at least 4-6 hours and read everything you can about the currency, the developers, the company and the implementation. Understand the idea behind the currency and then decide if it’s a good idea to you.
The first use case is small scale. I might own a laundromat that wants to create a loyalty program. Let’s say for every dollar you spend, I issue you with a LaundroCoin and once you have 100 coins, you can spend them with me on getting a load of washing done. Or, perhaps I, as the owner need to purchase a new machine which I don’t have the capital for. I could sell the coin at 90% of the value I allocate to the coin, and sell it in bulk to raise the funds faster, enabling me to purchase the new machine, which hopefully results in better profitability, and allows buyers of the coins to use them at my laundromat to do their washing over a period of time.
The second use case would be for a far larger audience, maybe I am the CEO of a fast food chain called Pizza King, and I want to implement a new rewards program. I might offer 1 PizzaCoin for every 10 dollars spent, and then allow customers to spend the coins back at our stores nationwide at a
percentage on the dollar. This is a handy way of trying to get customers to create brand loyalty and of course, to encourage them to buy more pizza in order to earn coins, to buy more pizza.
The third use case might be for mass adoption. This means that we can use a currency to purchase anything from a large amount of vendors and the coin is not restricted to one type of vendor or use. A good example of a currency that is actively pursuing this is DASH. DASH was previously known as DarkCoin and is a fork of Bitcoin. Their organisation has coined the phrase “DASH is Digital Cash”. While it is decentralised, it is also an organised group that actively funds marketing and innovation in order to achieve adoption. Their goal is to have DASH as easily spendable as actual cash, but on a global scale as opposed to being restricted to just one country or region.
The last example I’ll give is for an indexing currency. A few days ago I published the article “Analysing Charts Part 1: Ripple”. In the article I use the XRP to BTC chart as a way of measuring the value of Ripple’s XRP against Bitcoin. Personally I believe that Bitcoin is not really a practical currency anymore. The value as it stands is too high, and the fees are also astronomical compared to what they were a year ago. Now if I had a million Bitcoin last year, and the value increased as exponentially as it has, and I wanted to spend some of it, I might not mind a 30 dollar miners fee, but if I bought a few hundred dollars worth three months ago, I’d have a huge issue with spending 30 dollars on fees. This is why I feel Bitcoin in its current state is more useful as an index of value as opposed to a spendable currency. Unless of course, you’re buying something of an incredibly high value, like a car, or house, in which case 30 dollars isn’t a bad amount for a fee at all.
In the future we will use different coins for different transaction types, we might use Litecoin for everyday purchases like lunch or gas, DASH for monthly grocery shopping, and Bitcoin for a deposit on a house, or if you’re one of the fortunate few, perhaps a whole house.
This concludes our talk today, tomorrow we will look at some blockchain ideas that factor in both a currency and another application.
If you have any questions or comments, feel free to contact me on Twitter.