I “discovered” Bitcoin in 2013, and like most regular folk couldn’t readily get my head around the concept of a decentralised digital currency and cryptocurrency mining. I am not a techie, a coder or a quant, and while I’ve been involved with a variety of consumer technologies for over a decade, this was a whole new level of head scratching for me. In this series I will attempt to decode in everyman language myth from fact, bubbles from bloats, coins from tokens, bullshit from banter.
The purpose of this series is to assist noobs (newcomers) to better understand the wild world of crypto. I do not claim to be an expert by any measure — in fact if you ask the experts they will tell you there is no such thing as a crypto expert — and I know enough to concur. This is such a nascent technology that nobody has any real idea how crypto-assets will pan out over the next year, let alone the next decade.
My objective is to bridge the gulf between most mainstream media coverage of cryptos — appallingly under-researched, widely misunderstood, overly simplistic and almost entirely focused on price volatility — and the hard-nosed world of geek speak, being largely unintelligible to the uninitiated.
What is blockchain technology?
In simple terms, a blockchain is a database ledger. Yes, it really is that simple. Where a blockchain differs from a traditional database is that batches of data (which can be data packets of any sort such as financial transactions) are combined into blocks based on block size (e.g. a 1 megabyte block can consist of hundreds or thousands of segments of data, each representing a dataset) which are then cryptographically locked. Each block is added to the previous block on a continuous timestamp basis creating an immutable record.
There are two primary types, public and private. Private (also known as sovereign) blockchains are centralised and have multiple uses across many industries — for instance the giant shipping logistics firm Maersk joint-ventured with IBM to build a bespoke blockchain to manage their extremely complex data systems much more efficiently and robustly than traditional databases can. But of interest in the crypto world are public blockchains — fundamentally different in that these are distributed ledgers, or decentralised. Although the two terms are often used interchangeably, there are important technical differences between distributed and decentralised, but that’s a subject for a later edition.
A public blockchain is an ever-growing database of certain types of data (blockchain dependent) that have remarkable properties:
Public blockchains are open source protocols. Anyone can download the source code and add their own code on top of it to create a fork off the original chain. More importantly, the code and the transactions are visible to anyone who chooses to view them, or verify them. (There are exceptions to this, called dark coins, but again, for a later edition.)
Once data is stored on the blockchain, it can never be modified or deleted. Every record is cryptographically locked and remains a permanent record for eternity.
Being decentralised, no single individual or organisation maintains the database. Rather, thousands of individuals do, most of whom aggregate their computing resources into what are called mining pools, and every computer or node on the network has a live, up to date copy of the database.
Each dataset entered on the chain must be verified by at least 51% of the nodes, which are synchronised. As an illustrative example, verification consists of nodes confirming that party A has sufficient funds in their wallet to pay party B what they have undertaken to pay. The identity of the parties remains unknown: the only information visible is a user’s public key — which is like a bank account number — and that there are sufficient funds in the account to cover the transaction. All the nodes do is verify that A has sufficient funds to pay B the amount stipulated. Once it is verified it is added to the current block and both balances are simultaneously updated.
Whenever a block is full it is locked and distributed to the network for mining, to which I will return.
In other words, a public blockchain does precisely what your bank does when you swipe your card at a merchant. The merchant sends an encrypted message to their bank requesting authorisation of the funds, which in turn sends a message to your bank to confirm you have sufficient money to complete the transaction. Your bank confirms to the merchant’s bank which confirms to the merchant, and in a matter of seconds you’re walking away with the goods.
The difference is that your bank, plus the merchant’s bank, plus your credit/debit card company and any intermediaries are all centralised entities that may track and store your data. In a blockchain transaction the only record is the transaction itself, while the network of computers does the approval of a transfer of value from party A to party B, both of which remain anonymous.
Which is precisely why Bitcoin earned the unkind reputation of being the currency for criminals. The reality is that criminals are always on the cutting edge of risk and regulatory avoidance, so they are by nature amongst the first adopters of detection avoidance. In truth, based on the value of crypto to fiat transactions, illegal transactions via crypto likely represent less than 1% of those in banknotes.
What is mining?
“Genuine” cryptocurrencies (as opposed to cryptotokens) are mined by the application of massive amounts of computing power used to crack each cryptographically locked block. For simplicity’s sake I’ll use Bitcoin to illustrate the point. The Bitcoin protocol was developed by the pseudonymous Satoshi Nakamoto (Google is your friend here). His/her/their 2008 white paper is widely regarded as genius, as groundbreaking as the birth of the internet. It is a work of art — the art of simplifying the complex and distilling it into a mere 8 pages. Bitcoin remains the benchmark of crypto assets not only because it was the first, but also because it’s proven to be the most robust. It’s literally un-hackable. The protocol isn’t static, but very much dynamic, and it’s maintained by around 400 coders from all over the planet who contribute their skills freely. It is, by many accounts, the most perfect example of distributed autonomy. The network is managed by a voting system by those with skin in the game — being developers and miners. As an investor in Bitcoin you have zero influence over protocol decisions such as forks and scaling debates. Owning Bitcoin doesn’t entitle you to anything other than the ability to hold it or trade it.
Satoshi determined that there would only ever be a finite quantity of Bitcoin — 21 million to be precise. Miners are rewarded for their work in cracking a cryptographic challenge that encrypts the block and adds it to the chain which is locked in place for eternity. In the early years it was easy to mine Bitcoin. The value of the asset was nominal, very few people knew of its existence, let alone understood its objective, and it was largely a coder’s hobby in figuring out if this peer to peer electronic cash ecosystem could actually work. The now infamous first real world transaction was made between a pizzeria and a customer, who paid 10,000 Bitcoin for two pizzas, placing the value of each coin in 2009 at $0,0000001. At today’s price a mere 8 years later that’s a staggering $44 million per pizza. Wrap your mozzarella and pepperoni around that.
Satoshi calculated, very accurately, that the rate of difficulty in mining Bitcoins would increase exponentially, so the block reward (mining reward) halves every 210,000 blocks, about every four years. The initial block reward was 25 Bitcoins. It’s presently 12,5 and the next halving is expected around May 2020 when it will drop to 6,25. Early miners earned a lot of Bitcoins, and those who held on to them, or at least a good chunk of them, are now billionaires. There are at present 17 million in circulation (having been mined), which means that a mere 4 million remained unmined. It’s difficult to say when, or even if, the last coins will be mined — like with deep level gold mining it may become commercially unsustainable to extract the last remaining ounces 4km beneath the earth’s crust.
For an alternative take this post by Nik Custodio from 2013 is still a go-to reference. For a non-technical introduction in a 5 minute video, check out this YouTube link.
In the next edition, I explore more on the purpose of Bitcoin’s existence, what it may or may not mean for the world of finance, economics, governments and social structures.
Disclaimer: This article is not intended as investment advice nor will the author be responsible for any investment decisions that are made on the basis of this article. Cryptotokens are speculative investments that are not for the risk averse.
Photo by Andre Francois on Unsplash