“Bitcoin soars, “Cryptocurrency Ethereum on the Rise,” “Bitcoin rises 9.8%..” It has become nearly impossible to avoid such headlines. I am sure that the person reading this is already aware of the ‘craze.’ But you may not be aware of where it came from, who is running it, and, most importantly, what is it? Throughout the article, we shall talk about bitcoin as it is the most renowned cryptocurrency. But the workings we’ll apply to all types with a few caveats here and there.
Bitcoin is the first of its kind. It is an intangible and decentralized currency that is entirely digital. The preceding definition essentially consists of two major parts: decentralized and digital hence ethereal. A Lot of the intrigue surrounding bitcoin comes from the decentralized part, which means that there is no central authority (e.g., the Bank) regulating anything. To fully understand it, we should take a look at our dealings with ‘normal’ money.
Let’s say that you want to send some money to your friend. You pick up your phone, open up your Bank’s website and send 5000 Rupees to her account. Soon after, you will probably receive a thank-you message from your friend. What has happened is that the specified number has been deducted from your balance at your Bank. The opposite has happened at her end; 5000 is added to her balance at whatever Bank she is affiliated with. It is understood that the Bank is of crucial importance here. But what if you use cryptocurrency instead? On the front end, everything will seem quite familiar. You pick up your phone, open up your bitcoin wallet and send crypto coins or cryptocurrency or any other coin to your friend. Hidden behind all the technology, the transaction itself happens, and this is where things drastically change. Crypto coins or cryptocurrency are deducted from your wallet and added to her Wallet. In the absence of a central authority, who does this? You and your friend yourselves! And in another case, if your coins are on the exchange, then the exchange will work as a bank, and they also have their transaction fees during this process.
If there is no central authority that has a ledger storing all transactions and balances, there has to be an alternative to avoid fraud and the risk of loss. If there is no such feature, anyone could say that their friend gave them while their friend is unaware of this. A method to prevent this is what provides a currency its value.
Without a central authority, how are you to trust anyone’s claims regarding their balance? The answer is simple. You don’t have to. The need for trust is entirely sidestepped by providing every bitcoin owner with an independent record of all past transactions that have ever happened. A user cannot add or edit the information unless authorized by all other users. This is called ‘blockchain technology,’ which is what all cryptocurrencies are based on.
When a transaction goes through, the computer sends out a signal containing information about the transaction to every bitcoin wallet. This also happened when you sent the cryptocurrency to your friend. Your phone sent a signal containing this exact information into the bitcoin network. Every transaction made is eventually added to a block which is then added to the blockchain. We’ll discuss this in more detail later.
Due to the nature of the information being sent, its security is critical. To ensure as such, one can digitally sign their message. Digital signatures, similar to handwritten signatures, offer proof that you approve of what has been signed. A digital signature relies on asymmetric encryption. This is a method to encrypt or decrypt your data using a pair of keys. The private key is only known by the owner, while the public key is available to everyone.
The outcome is what is known as a digital signature. Without your private key, a third ‘friend’ cannot just send out the message that you paid him 10 bitcoins, thus officially reducing bitcoins from your wallet and adding them to his. To further intensify the security, even if the message is slightly altered, the digital signature completely changes. This prevents anyone from copying your signature and adding it to another letter. If anyone wants to verify a message, they can apply the owner’s public key to tell whether its matching private key produced the digital signature.
But digital signatures are not the only type of cryptography used. An idea central to bitcoin and its functionality is a cryptographic hash function. A hash function is basically a mathematical function that converts an input message into a collection of bits. This is done according to a set of rules that make up the function. More specifically, a cryptographic hash function creates an output that is nearly impossible to reverse engineer into the original message.
We are still to address the significant problem that may arise in all of this. How can we trust that the message we received has been received by everyone else? Or that the block of transactions we have does not conflict with other blocks? This is where data miners step in and earn their due.
When you make a bitcoin transaction, you pay a small fee, usually a reward for the miner to validate your transaction. When a block is filled with transactions, it is verified by millions of computers owned by miners on the network. Miners are the people with computers that add transactions to a new block. But to do so, they have to solve an extremely complex mathematical problem. A miner aims to find a number to add to a block, leading to the hash address of that block. In a blockchain, a block contains the hash of the previous block, the transaction details, a 32-bit number called a nonce (the number the miner has to figure out), and the hash of the block itself. Due to this, solving the problem gets increasingly difficult as the blockchain grows.
This process needs a lot of computational power as computers usually guess the number rather than reaching it by solving the problem. When a lucky miner guesses the correct number, their block is added to the chain, gaining some bitcoins. This ingenious solution of data mining or ‘proof of work’ was suggested in the original paper of 2008 that initiated bitcoin. Many cryptocurrencies use another method known as ‘proof of stake,’ which doesn’t require any mining, saving energy, and computational power. Similar to this change, new cryptocurrencies are innovating and integrating consistently, whether they’re catering to specific niches or being more general-purpose. Whatever opinion anyone holds of this phenomenon, there is no denying that we are all excited and curious to see where this leads us economically and technologically.
Shoaib Shahid is a high school student doing his A-levels from Beaconhouse Margalla Islamabad. He is a great admirer of Physics and aspires to become a theoretical physicist himself. He started writing narratives in his childhood and has since ventured into non-fiction.