Digital currency, also known as cryptocurrency, has been growing in popularity in recent years but is a confusing concept for many people. However, it is essential to understand, as cryptocurrencies grow in popularity and prevalence.
People are drawn to cryptocurrencies because they are incredibly secure, and decentralized, protecting the currency from the influence or interference of a central authority such as government. Today, government influences its currency in many ways, including monetary policy, inflation, change in interest rates, subsidies, tariffs, regulations and more.
The call for cryptocurrency was the desire to avoid all that government influence on the value and distribution of currency. Bitcoin was the first successful cryptocurrency, first introduced in 2009. Since then, several other digital currencies have surfaced and gained popularity.
The foundation of any cryptocurrency is the blockchain, which allows for the decentralization and security associated with digital currencies. This article will explain the blockchain and its role in digital currencies today.
Before diving into the concept of blockchain, it’s important to understand cryptocurrencies. This section will provide a brief history and explanation of cryptocurrencies.
For decades, people have been interested in digital money, with attempts to establish a digital cash system dating back to the 1990s. One of the primary reasons for the interest in a digital currency was independence from government and banking authorities that can influence a currency’s value and distribution.
The first successful digital currency was created in 2009 by Satoshi Nakamoto, a person or group of people that remains unknown to this day. Satoshi Nakamoto penned a whitepaper in 2008 describing the development of a peer-to-peer electronic cash system called Bitcoin and released Bitcoin to the public in early 2009.
In a January 9, 2009, announcement, Satoshi described Bitcoin as “a new electronic cash system that uses a peer-to-peer network to prevent double spending. It’s completely decentralized with no server or central authority.”
The idea was that users could buy and sell bitcoins digitally, with no intermediary or third party involved. Each user is connected through a large network of computers. Transactions would be verified by the overall community and then permanently recorded in a public ledger, which all users have access to view.
The process of verifying a transaction is called “mining,” a complex mathematical process that ensures a transaction is accurate and valid. Users are incentivized to do this verification as they are rewarded with new bitcoins. This process allows for public accountability of every transaction and is how new bitcoins are issued. Through this process, bitcoin remains independent, transparent and decentralized.
As bitcoin grew in popularity, other cryptocurrencies were created, including Ripple, Ethereum, Litecoin, Dash, Monero and dozens more.
A blockchain is the foundation of any digital currency. According to Investopedia, a blockchain is a digitized, decentralized, public ledger. This ledger could record anything but is most commonly used for digital currencies.
Blockchain technology was initially developed by Satoshi Nakamoto as the accounting mechanism for Bitcoin. The blockchain was designed to capture and verify every Bitcoin transaction publicly, allowing for accountability and transparency among all Bitcoin users. Today, blockchains are used for many digital currencies as well as other applications.
A blockchain is a public ledger for a digital currency, essentially a list or database of every transaction recorded. For instance, the Bitcoin blockchain includes every bitcoin transaction since its inception, for complete accountability and transparency.
Transactions are added to the blockchain in chronological order, with the most recent transactions at the top, forming a chain. All records within that database are permanently stored and cannot be edited, though they are available for any participant to view at any time. In this way, a blockchain allows for public accountability without relying on a central authority or governing entity.
Chain and Block
Blockchains are aptly named because the two main components are the block and the chain. When a new transaction takes place, a record is created in a block. This block represents the most recent transactions recorded.
Transactions within a block are verified through the process of mining described earlier. Once authenticated, the block enters the blockchain as a permanent record, linking to the previous block in the chain.
The blockchain database stores the entire blockchain list, and blocks are continually added to the chain. Once verified by the community (mined) and added to the chain, blockchain data cannot be edited or deleted, making it tamper-proof and secure.
If you wanted to use a particular cryptocurrency, you’d need to start with a blockchain wallet, also known as a cryptocurrency wallet. A blockchain wallet is where you store and manage your online currency, similar to a bank account but without the bank.
An important distinction to understand is that your cryptocurrency itself is not actually stored in a wallet. The currency exists within its blockchain, while your wallet stores the amount of digital currency you currently possess. The wallet is encrypted using a private key (known only to the user) and a public key available to everyone. Your wallet stores those keys and allows you to send and receive coins.
There are many blockchain wallet options available, including software you install on your device, hardware wallets that connect to your computer, or online wallet applications.
Each wallet offers its own set of options and functionality related to storing and managing digital currencies. For instance, some wallets focus on only one currency, while others allow you to buy and sell multiple digital currencies, so it’s important to know which currencies you plan to use and manage.
Some wallet options are more appropriate for cryptocurrency beginners, and offer education and support in managing your online currency. Other wallets are designed for experts in the field, allowing for more control over their currency. Researching options and reading others’ reviews can help you identify the best wallet for your needs.
Above all, security is an utmost concern for any blockchain wallet, to ensure your digital currency is protected. Whichever type of wallet you choose, make sure it is a well-known and trusted provider.
Important Blockchain Terminology
We discussed most relevant blockchain terminology throughout the article, but this list may be helpful as a quick reference guide for all the confusing concepts and terms.
- Cryptocurrency is a digital currency secured by cryptography, independent from a central authority such as the government. Users can securely send and receive funds digitally, without a third-party intermediary, and all transactions are stored permanently in a decentralized database.
- Bitcoin was the first cryptocurrency, launched by Satoshi Nakamoto in 2009. Satoshi described it as “a new electronic cash system that uses a peer-to-peer network to prevent double spending. It’s completely decentralized with no server or central authority.” Dozens of new cryptocurrencies have been released since Bitcoin’s inception.
- A blockchain is the public ledger recording all transactions for a particular cryptocurrency. It exists across the network of all users with no central owner or administrator. Transactions (once verified) are permanently stored and unalterable, but available for any user to view.
- A blockchain is composed of blocks. Each block is a group of transactions, and once it is verified (mined), it gets added to the chain of previous blocks, creating a permanent record.
- Mining is the process of a user verifying transactions through a complex process and is also how new coins are issued for a digital currency.
- Distributed ledger technology, a key technology powering a blockchain, provides for a decentralized database spread among many users or entities, allowing all users to view.
- A blockchain wallet stores a record of a user’s amount of cryptocurrency and is secured by a private key available only to the user, and a public key that allows for transactions and transparency.
The Technology Behind Blockchain
Blockchains are powered by complex technologies. Blockchain ledger technology, which allows transactions to be digitally recorded across the network of participants, relies on a concept known as distributed ledger technology (DLT).
Simply put, a distributed ledger is a decentralized database that is spread across various sites or participants, which allows all participants to view all the records in the database. A blockchain is a type of distributed ledger, while distributed ledger technology can be applied to other scenarios as well.
To fully understand blockchain, it’s also important to discuss blockchain database technology. A traditional database is controlled by a central administrator, which can also grant access to other entities. Any user with appropriate access or permissions can edit the database, but control of the database remains with the central administrator, who can override or edit user contributions.
A blockchain database, on the other hand, is decentralized and shared among all participants in a network, without a central administrator. This is incredibly important for cryptocurrencies, as the main goal is decentralization and avoidance of government or other outside influence.
While any participant can enter a transaction, once it is verified by the larger community, it is permanently stored in the digital blockchain. This type of decentralization and reliance on community input ensures independence, accuracy, and security of the blockchain.