What is Cryptocurrency? [What is Cryptocurrency Mining!]

The concept of digital currency gained considerable traction in the 90s tech boom. Multiple organisations and programmers ventured to create a parallel line of currency that would be out of any central authority’s reach. However, ironically, the companies that tried to create this digital currency themselves assumed the authority of verifying and facilitating transactions.

It not only defeated the purpose but founded the venture as well. Moreover, the digital currencies back then were riddled with frauds and other financial challenges. For a long time since then, this idea of digital currency was considered a lost cause. This idea was falsified when Satoshi Nakamoto – a programmer or a group of programmers – introduced Bitcoin in 2009, the first-ever cryptocurrency.

What is Cryptocurrency?

It is a purely virtual line of currency that runs on the system of cryptography. It functions as a decentralized medium of exchange where cryptography is used to verify and facilitate each transaction. Cryptography also underlines the creation of units of different cryptocurrencies.

This mode of exchange primarily runs on the blockchain technology – that which lends cryptocurrencies the decentralized status. It is a shared public ledger that contains all the transactions that have ever taken place within a network. Therefore, everyone on the network can see each transaction that takes place and also view others balances.

The Blockchain technology addresses one of the primary concerns with digital payment platforms, i.e. double-spending while ensuring there is no monopoly of authority. That is because, in blockchain technology, parties to a transaction themselves verify and facilitate every such activity.

Types of Cryptocurrencies

When it comes to the variants of cryptocurrencies, most are forks of Bitcoin, while others were built from scratch. However, there are only 3 broad types of cryptocurrencies currently in existence. These are –

  • Bitcoin

It is the first cryptocurrency that was ever introduced and is considered the “digital gold”. It currently holds a market capitalisation of $172.76 billion, the largest of any other variant of cryptocurrency. A unit of Bitcoin can be broken down into Satoshis, which is equivalent to the relationship of rupees and paise.

Furthermore, the Bitcoin network is so designed that it can only have 21 million units of Bitcoin circulation at any point in time. This limited availability is a primary component that drives its market price. Currently, the market supply of Bitcoin is 18.39 million.

  • Altcoins

This category primarily involves forks and alternate versions of Bitcoin, thus, the name. However, some Altcoins are exponentially different from Bitcoin and use varying algorithms. For instance, Ethereum, which is an altcoin, is not a currency but a platform where entities can make their apps based on blockchain.

Currently, there are more than a thousand altcoins. Some of the notable altcoins are Ethereum, Factom, Litecoin, NEO, etc.

  • Tokens

These are products of altcoins like Ethereum and NEO. These cryptocurrencies do not have a separate blockchain but instead run on the decentralised apps created via such altcoins. However, tokens carry supremely low value compared to the other two types mentioned above, because it can only be used to purchase items from such decentralised apps or dApps.

How does Cryptocurrency Work?

According to Satoshi Nakamoto, the founding father of Bitcoin, it is a peer-to-peer electronic cash system. In that, it is much similar to peer-to-peer file transactions, where there is no involvement of any central authority or regulator.

Ergo, cryptocurrencies are mere transactions or entries in a shared ledger that can only be changed upon meeting certain prerequisites. Typically, in a blockchain technology like the Bitcoin network, each transaction consists of the involved parties’ – sender and receiver – wallet addresses or public keys and the amount of such transaction.

What attributes the safety net in such a network to avoid fraud is that the sender needs to confirm a transaction with their private key. After confirmation, the transaction is reflected in the shared ledger or database.

However, only miners are authorised to confirm transactions within a cryptocurrency network. They need to solve cryptographic puzzles to confirm any specific transaction. In exchange for their service, they receive a transaction fee in that particular type of cryptocurrency and a reward.

Once miners confirm a transaction, they spread it to the network, and every node in that automatically updates its ledger accordingly. Furthermore, once a miner confirms a particular transaction, it becomes irreversible and non-modifiable.

However, there is a crucial catch in mining. It is that as a particular type of cryptocurrency gains popularity and more and more miners join the bandwagon, the miners’ fees and reward per transaction go down. For instance, initially, miners could get 50 bitcoins (BTC) as a reward for mining; however, due to the recent halving in May 2020, miners’ rewards have gone down to 6.25 BTC.

What is the Use of Cryptocurrency?

It is worth wondering if the popularity that cryptocurrency has garnered over the years is hollow or not. However, even though it is still nowhere near to replacing institutionalised cash, cryptocurrency, especially Bitcoin, has found wide acceptance across the world.

  • As a mode of payment

Initially, Bitcoin had little value as a mode of payment to merchants. However, with time, several merchants worldwide like restaurants, flights, jewellers, and apps have come to accept it as a viable payment medium.

One of the most notable acceptors of cryptocurrency as a viable medium of payment is Apple Inc. It allows 10 types of cryptocurrencies for carrying out transactions in the App Store.

However, India, as an economy is still to explore cryptocurrency as a viable payment mode extensively. Nevertheless, with big companies like Apple and Facebook hoisting its cause, it is expected that cryptocurrency will gain traction in India soon.

  • Investment

Cryptocurrencies, especially Bitcoin, is one of the most lucrative investment options currently present. Its value appreciation is supremely dynamic and can prove to be an excellent avenue for capital expansion.

However, individuals must also note the volatility of this investment avenue. Bitcoin, the most popular cryptocurrency with the largest market share, has experienced some of the most erratic price changes as an asset. For instance, in December 2017, Bitcoin’s value plunged from $19000 per BTC to $7000 per BTC.

Since cryptocurrency is not rooted in any material change but a change in popularity and fad, such price fluctuation is natural.

Cryptocurrency Price List

The following table illustrates the top 10 cryptocurrency list currently trading and their market prices as of 28th May 2020.

Name Price (in $)
Bitcoin9395.43
Ethereum210.96
Tether1.01
XRP0.197996
Bitcoin cash235.39
Bitcoin SV189.01
Litecoin44.36
Binance Coin16.62
EOSA2.58
Tezos2.74

How to Buy Cryptocurrency?

Compared to other variants of cryptocurrency, units of Bitcoin can be purchased more conveniently owing to a large number of options. Individuals can choose to purchase it from cryptocurrency exchanges, using gift cards, via investment trusts.

How to Store Cryptocurrency?

Entities can hold units of cryptocurrencies in wallets – offline and online. Each such wallet holds a public key, i.e. the wallet address and a private key (used to sign off payments). In any case, it is not exactly the units of cryptocurrency that one holds but the private key.

Nevertheless, entities can select from a wide range of crypto wallets, each catering to a different purpose. Online wallets largely serve the purpose of regular transactions. Apple, as well as J.P. Morgan Chase, Visa, and Facebook, have introduced online crypto-wallets. Conversely, offline or cold wallets are stored in a person’s hard drive and serve the purpose of the security of cryptocurrency.

What Is Cryptocurrency Mining?

Cryptocurrency mining is the process in which transactions between users are verified and added to the blockchain public ledger. The process of mining is also responsible for introducing new coins into the existing circulating supply and is one of the key elements that allow cryptocurrencies to work as a peer-to-peer decentralized network, without the need for a third party central authority. 

Bitcoin is the most popular and well-established example of a mineable cryptocurrency, but it is worth noting that not all cryptocurrencies are mineable. Bitcoin mining is based on a consensus algorithm called Proof of Work.

How does it work?

A miner is a node in the network that collects transactions and organizes them into blocks. Whenever transactions are made, all network nodes receive them and verify their validity. Then, miner nodes gather these transactions from the memory pool and begin assembling them into a block (candidate block). 

The first step of mining a block is to individually hash each transaction taken from the memory pool, but before starting the process, the miner node adds a transaction where they send themselves the mining reward (block reward). This transaction is referred to as the coinbase transaction, which is a transaction where coins get created ‘out of thin air’ and, in most cases, is the first transaction to be recorded in a new block.

After every transaction is hashed, the hashes are then organized into something called a Merkle Tree (or a hash tree) – which is formed by organizing the various transaction hashes into pairs and then hashing them. The outputs are then organized into pairs and hashed once again, and the process is repeated until “the top of the tree” is reached. The top of the tree is also called a root hash (or Merkle root) and is basically a single hash that represents all the previous hashes that were used to generate it.

The root hash – along with the hash of the previous block and a random number called nonce – is then placed into the block’s header. The block header is then hashed producing an output based on those elements (root hash, previous block’s hash, and nonce) plus a few other parameters. The resulting output is the block hash and will serve as the identifier of the newly generated block (candidate block). 

In order to be considered valid, the output (block hash) must be less than a certain target value that is determined by the protocol. In other words, the block hash must start with a certain number of zeros.

The target value – also known as the hashing difficulty – is regularly adjusted by the protocol, ensuring that the rate at which new blocks are created remains constant and proportional to the amount of hashing power devoted to the network.

Therefore, every time new miners join the network and competition increases, the hashing difficulty will raise, preventing the average block time from decreasing.  In contrast, if miners decide to leave the network, the hashing difficulty will go down, keeping the block time constant even though there is less computational power dedicated to the network.

The process of mining requires miners to keep hashing the block header over and over again, by iterating through the nonce until one in the network miner eventually produces a valid block hash. When a valid hash is found, the founder node will broadcast the block to the network. All other nodes will check if the hash is valid and, if so, add the block into their copy of the blockchain and move on to mining the next block.

However, it sometimes happens that two miners broadcast a valid block at the same time and the network ends up with two competing blocks. Miners start to mine the next block based on the block they received first. The competition between these blocks will continue until the next block is mined based on either one of the competing blocks. The block that gets abandoned is called an orphan block or a stale block. The miners of this block will switch back to mining the chain of the winner block.

Mining pools

While the block reward is granted to the miner who discovers the valid hash first, the probability of finding the hash is equal to the portion of the total mining power on the network. Miners with a small percentage of the mining power stand a very small chance of discovering the next block on their own. Mining pools are created to solve this problem. It means pooling of resources by miners, who share their processing power over a network, to split the reward equally among everyone in the pool, according to the amount of work they contribute to the probability of finding a block.

Stay tuned for more content and don’t forget to check our other videos at Binance Academy!

Leave a Comment