What are cryptocurrencies?

Cryptocurrencies

Cryptocurrencies are basically peer-to-peer networks in which participants are able to send each other units of value. Therefore it is possible to transfer value without the necessity to rely on any form of intermediary like banks or payment processors. The first operating cryptocurrency, called Bitcoin, was launched in January of 2009. It was initiated by an anonymous group or person operating under the pseudonym Satoshi Nakamoto.

Blockchain

Nakamotos important invention that made Bitcoin possible is called Blockchain. It is nothing else than a decentralized database that is stored and secured by every participant in the network. Every transaction that ever happened gets recorded to the Blockchain.

Scope

Cryptocurrencies (or lets say Blockchain based projects) fulfill a wide variety of tasks. It is important to differentiate between monetary projects like Bitcoin, Litecoin or Dash and non monetary projects like Ethereum, NEO or IOTA. Monetary projects are meant for payments in both online shops and physical stores. Non monetary projects are using their coins/token to compensate network participants. In the case of Ethereum for example they execute Smart Contracts that make it possible to automate numerous digital processes.

Survey of Blockchain Projects

You can find a graphic survey of the most relevant projects in the blockchain ecosystem at TechCrunch.

Follow this link if you want to read the article >>

Why do cryptocurrencies exist?

The financial crisis of 2007 made it obvious to many people, how unstable our monetary system is. In the media only the symptoms are being discussed, but almost never the actual causes. One main cause is, to simplify, the possibility of arbitrarily raising the amount of money in circulation. For the central banks this is a medium to operate an active monetary policy. As a result of this policy decision the money is losing its purchasing power. In cases of imminent governmental bankruptcy the state even has the power to freeze the bank accounts of its citizens like it happened in Greece. Cryptocurrencies are non-governmental money and therefore an alternative to the old financial system.

Most cryptocurrencies share the following characteristics:

  • protection from inflation
  • independence
  • decentralized management

We recommend to study the educational material by the German Bundesbank to get a more in-depth knowledge about the fiat monetary system.

Statement

The creation of Bitcoin in 2009 was not only a technological breakthrough but also a political statement: Satoshi Nakamoto was criticizing the old monetary system when he wrote into the first Bitcoin-Block, the so called “Genesis-Block”, a headline from “The Times” dated 3. January 2009. The headline was: “Chancellor on brink of second bailout for banks”.

Inflation-Proof

Because the inflation rate of cryptocurrencies is definitely stated in the beginning it is not possible to create money out of thin air which protects the consumer from arbitrary inflation. This characteristic is extremely important for economically destabilized countries with a high rate of inflation but it is also a significant benefit for people who want to save money.

It is therefore not possible to use cryptocurrencies as book money that is created out of thin air and brought into circulation through credit. The disproportionate issuing of credit called “Fractional Reserve Banking” is not compatible with cryptocurrencies.

Independence

Cryptocurrency transactions are facilitated without the help of banks or other intermediaries. Through the decentralized nature of the infrastructure no centralized organization has the ability to get access to the nodes or balances.

Access

One half of humanity is so poor that banks have no interest in working with them. There are no ATMs or physical banks in these areas. Cryptocurrencies have a lower barrier of entry because all you need is an internet connection. It is therefore possible to discover markets for financial transactions that were previously left behind by the global financial system.

How does a cryptocurrency function?

You need a Wallet to use a cryptocurrency. This is a piece of software that you have to install on one of your devices like your smartphone. The Wallet manages your public and private keys that are used for transaction and is therefore like a physical wallet.

  • digital wallets to store your money
  • they manage your transaction keys
  • they have public and private keys

There are many variations of Wallets with different features and security options. You have to choose which one to use based on the use case. Mobile Wallets for smartphones are very popular because they can scan QR-Codes for transactions with the camera. For high amounts of coins it is recommended to store them safely in a Hardware Wallet.

Wallet

The wallet is a software application where you keep your coins. All private and public keys as well as the transaction history are stored in the Wallet. To secure the Wallet it is very important that you encrypt it with a long password. If somebody gets access to the Wallet he can steal all your money.

 

Public Key

The public key is your address on the network. If somebody wants to send you money he has to use this key. Because a Wallet can manage an infinite amount of keys it is recommended to not use the same public key for each payment. Otherwise everybody would be able to see exactly how much money is stored in your Wallet.

Private Key

It is very important that the private key remains unknown to everybody but you because it allows someone to send your coins. Normally only the owner should have the right to send his coins. For every public key there is a private key that signs the transaction. This way the owner can prove that he owns the coins and wants to use them for a transaction. If you lose your private keys your money is no longer accessible.

HD Wallet

HD means “hierarchical determinism” and it makes Wallets much more secure. In the beginning of cryptocurrencies it was only possible to protect your Wallet through Backups. But with HD-Wallets it is possible to recover your private keys through a Recovery Seed. If your Wallet has generated such a “seed” it can “flourish” again after using it. The only things that are needed to store such a seed are a piece of paper and a pencil, no DVD and no USB device. You could even store the seed to your crypto wealth in your own mind although that is not recommended.

What is a Blockchain?

Most cryptocurrencies are based on Blockchain technology. First of all a Blockchain is just a database. The name already suggests that the database is composed of blocks forming a chain. All transactions are recorded in these blocks. They are permanently stored because Blockchains are irreversible unlike other databases. All transactions are kept while new ones are added at the end of the chain into a new block. You can think of the Blockchain as a cash book where every 2,5 minutes (the block time of Dash) a new page is added.

The Blockchain technology is considered to be:

  • tamper-resistant
  • disruptive
Network

The Dash network is run by miners and Masternodes. Miners confirm transactions, concentrate them into one block and add this block to the Blockchain. The Masternodes store the Blockchain while performing additional features like InstantSend and PrivateSend. A public Blockchain like Dash leaves participation open for everyone with the technical knowledge and qualifications. While not everyone can run a Masternode certainly everyone can run a Bitcoin-like Fullnode. Fullnodes are Nodes without the additional features of Masternodes. They only store the Blockchain and communicate with other Nodes about transactions. There are more Masternodes than Fullnodes on the Dash network because Masternodes are incentivized.

Security

Blockchain technology is known to be very secure because since 2009 all attacks and attempts to manipulate have been fended off.

Numerous nodes secure a real-time copy to protect the Blockchain from manipulation. Only a majority of Nodes can change the Blockchain and the more Nodes exist the harder it gets to secure a majority for malicious attempts. The same is true for Miners: more Miners and more processing power are securing the network. This makes a 51% attack that could manipulate individual blocks almost impossible.

Both Masternodes and Miners are financially incentivized because they are paid for performing their services through block-rewards. The future of the network is very important for them because maintaining the network means profit for them. The needs of the Blockchain are fulfilled because all elements of its infrastructure have an incentive to participate.

Transparency

All transactions that ever happened are visible. The sending address as well as the receiving address are irreversibly saved. Manipulations are impossible due to this transparency.

Features & Scalability

The biggest strength of the Blockchain is at the same time its biggest weakness: the decentralized nature can slow transactions down. There is no central authority (VISA, Mastercard) with a centralized server where all transaction can be confirmed in seconds. Every transaction on a Blockchain has to be confirmed and validated by the whole network because the network is based on a global consensus. Only what the majority of the network consents to is seen as valid.

The most important elements for a high-capacity network are block-size and block-time. Bitcoin for example uses the following parameters:

  • a new block is created every 10 minutes
  • one block can only store 1 MB of transactions

This results in 7 transactions per second which means that it is at the moment no competitor to traditional payment systems that can process up to 4000 transactions per second.

There are various solutions to this problem that try to solve it off-chain while the Blockchain is not used. This doesn’t solve the underlying problem and only moves the point where it has to be solved into the future.

The Dash Team follows a well thought-out road-map for global scaling on the Blockchain. The founder of Dash, Evan Duffield, has offered a detail plan on how to surpass VISA and Mastercards high-capacity while remaining secure, independent and censor-resistant. Dash tries to scale “on-chain” which means that blocks have to reach a size of 400 MB to achieve 4096 transactions per second. Dashs block-time is 2,5 minutes and therefore shorter than that of Bitcoin.

How does a Blockchain function?

A Blockchain consists of data blocks which contain all transactions of the network. The creation of those blocks is called mining. This process gets performed by the so called miners. Everybody can, at least in theory, become a miner if he has energy, internet, hardware, software and the necessary knowledge.

Miner are constantly in competition with each other about who can solve the task that the algorithm of the Blockchain has defined. As soon as a miner has found the solution to the task all other miner have to confirm it. If the solution was correct he gets paid the block-rewards. The block-reward consists of newly created coins and the transaction fees.

The Blockchain is stored on Nodes and Fullnodes that own a copy of the Blockchain. For this reason the data is always available in the form that the majority of the network has agreed on.

Mining

The miners are in competition with each other when they are solving mathematical puzzles with high-capacity processing power. In the case of Dash one mathematical puzzle is solved every 2,5 minutes and the miner who solved the puzzle gets the block-rewards paid out. The miner also has the privilege to create a new block. Besides the block-rewards the miner also gets all transaction fees resulting from the transactions in his block. Therefore he is financially incentivized to prioritize transactions that involve a higher fee.

You can find more information about mining at: https://www.dash.org/de/mining/

Nodes

Nodes are the accountants of a Blockchain network and the central part of its infrastructure. They can be called accountants because they store and continue the entire Blockchain. They verify and store every new block of the Blockchain. Bitcoins Fullnodes are not incentivized while Dashs Masternodes get 45% of the block-rewards for offering their service to the network.

They also communicate with the network about transactions or other important messages (like InstantSend and PrivateSend requests). The viability of a network depends on its nodes.

Blocks

The blockchain is a chain of blocks that could go on forever. Every block has an individual hash and a number for identification. The hash of the next block depends on the hash of the last block. The name blockchain is explained by the fact that every block is linked to its predecessor. Every valid transaction that took place since the last block was mined gets stored in the next block.

Mempool

All transactions that are accepted by the network but not yet written into a block get stored in the Memory-Pool (the combined RAM of all Nodes of the network). It is theoretical possible to send coins with “0 confirmations” (0-Conf) to another address although only one transaction would ultimately been seen as valid. In the ideal case the Mempool would be nearly empty most of the time but in some cases the amount of 0-Conf transactions could create a backlog. In this case a transaction could take longer than the normal block-time to get its first confirmation. This happened to Bitcoin where it took sometimes days to confirm a transaction instead of 10 minutes. This problem is related to Bitcoins limited block-size of 1 MB.

Difficulty

The mining difficulty indicates how complex it is to find the nonce of the next block. The difficulty increases together with the hashrate and therefore with the number of miners that are participating in the network. If the hashrate would increase without the difficulty than the block-time would decrease over time. Therefore hashrate and difficulty are linked together.