Cryptography is defined as the study of secure communications techniques that allow only the sender and intended recipient of a message to view its contents. The term originated from the Greek word kryptos, meaning “hidden.”
In 2008, Satoshi Nakamoto wrote and published a paper titled Bitcoin: A Peer-to-Peer Electronic Cash System. In this piece, Nakamoto outlines the first cryptocurrency, Bitcoin, describing it as “an electronic payment system based on cryptographic proof instead of trust.” As we define, discuss, and provide examples of cryptocurrencies, diving specifically into NFTs, keep in mind Nakamoto’s principles for Bitcoin and the hidden origins of these investments.
To understand cryptocurrency, let’s compare this medium of exchange to one that we know well: the U.S. dollar. The U.S. dollar is managed by a central authority, the Federal Reserve, that maintains and determines the currency’s value. The U.S. dollar is a physical entity, a green bill, that can be transferred between anyone, any number of times. On the other hand, cryptocurrency is digital, encrypted, and decentralized. You cannot hold a bitcoin in the palm of your hand, and control of the currency is distributed among the currency’s many users over the Internet. Most of all, cryptocurrency is exchanged using cryptographic proof which comes in the form of payments that are verified and recorded on a blockchain.
A blockchain is a chain of blocks that contains information. The technology was originally created by researchers in 1991 who wanted to use the blockchain to timestamp digital documents and avoid backdating or changing the date these documents were signed. However, it was not until Nakamoto in 2009 that blockchain technology was used to create Bitcoin. In the context of cryptocurrency, a blockchain is a distributed ledger that is open to anyone. This is like a checkbook that everyone can gain access to. Inside this checkbook are the recorded transactions of every user, and you can record your own transactions here too for other users to verify. Each “block,” or transaction, contains three pieces of information: data, hash, and the previous transaction’s hash. On a blockchain for Bitcoin, the data in the block would state the sender, receiver, and the amount of coins passed between the two individuals. Every block also has a hash, or a code, associated with the data stored, as well as the code of the transaction before it. Just like every human being has a unique fingerprint, every block has a unique hash.
For example, let’s say Samantha sent two bitcoins to Ashley. This transaction would be added to the blockchain as a block, and the block would include the data that Samantha was the sender, Ashley was the receiver, and two bitcoins were passed between the two women. The block would also contain a hash, perhaps the code “3456,” that would distinguish it from all other blocks on the chain. Before Samantha and Ashley made their transaction, Carl gave John three bitcoins, and the hash of their transaction was “1234.” Now, Samantha and Ashley’s block will contain both their own hash and the hash of Carl and John’s transaction.
Why does a block contain all of this information? Because the security of the block ensures that none of the transactions can be tampered with. If someone wanted to change a block, the block’s hash would be changed, causing the blocks after to become invalid, as they contain the previous block’s hashes. The block that has changed and every block afterward would need to be assigned a new hash.
However, with the speed of today’s computers, hashes can be changed in seconds, which could allow someone to tamper with the entire blockchain. To avoid this, there are two different validation techniques used to verify transactions before they are added to the blockchain: proof-of-work and proof-of-stake. Proof-of-work verifies transactions by providing a mathematical problem that computers race to solve. Each computer, which is referred to as a “miner,” works to solve the problem, and when a solution is found to the puzzle, transactions are added to the blockchain. The first computer to solve the problem is rewarded with a small amount of cryptocurrency, which oftentimes is just the right amount to cover the cost of power and electricity spent to solve the puzzle. Proof-of-stake, which is more efficient than proof-of-work, is when the number of transactions that a person can verify is limited to the amount of cryptocurrency they are willing to risk, or “stake,” to take part in the process. The more cryptocurrency you stake, the more chance that you’ll be selected to verify transactions.
Why do these verification methods exist? To create consensus. Proof-of-work and proof-of-stake ensure that the majority of members are verifying new transactions and approving them to be added to the blockchain. Hence, if someone wanted to hack the blockchain, they would need more than half of the individuals participating in the blockchain to approve their transaction, making fraud highly unlikely and almost impossible.
Now you know what cryptocurrency is and how it’s stored. Next up, we’ll be diving into how to earn, or “mine,” cryptocurrency, and how to invest in this encrypted medium of exchange.
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