Bitcoin was created in 2009 and was the first decentralized or distributed cryptocurrency, but what does that mean?
For the sake of keeping this easy to understand, we’re just going to call any cryptocurrency a coin in the discussions which follow. Let’s get started…
What does “decentralized” or “distributed” mean?
- Both of these terms essentially mean that rather than a single computer system being in “control”, hundreds or thousands of computers all over the internet work together to keep track of the movement of coins from one entity (person, company, government) to another. Those computers are owned by lots of different people, companies, and even some governments.
- The way those computers keep track of the movement of coins is through a ledger which is just a sequence of coin movements using the date and time to keep them in proper order and show where a coin was sent. Rather than keep this information on paper or in a spreadsheet, it is stored using Blockchain technology.
- An important aspect of this is that the computers aren’t controlled by any one government or central bank.
So what’s a Blockchain?
- Remember the coin movements we mentioned above being kept in a ledger? Well, to break up the work load and make all of this secure, the coin movements are broken into groups based on a size limit. Each group (block) of coin movements is reviewed by the decentralized computers and when enough of them agree on which coin movements are to be part of the next block, that block gets locked (so it can’t ever be changed!). The new block is added to the end of the sequence of previous blocks, forming a chain. Hence, Blockchain.
How are coins secure?
- That’s a pretty deep subject so we’ll try to keep it simple. First, all the data that makes up the block chain is kept secure. That’s accomplished as each block is added to the chain and by the nature of the decentralized computers. Remember, they all have to agree on what goes into a block, but they are also responsible for making sure that no data in any block is ever changed after a block is locked. They do that by taking all of the data in the new block, plus “a piece of data from the previous block”, scrambling it all together into what is called a hash. A hash is just a long bunch of seemingly random numbers and letters, but the cool thing about a hash is that if you take the same data you put into it again and create a new hash of that, you always get the same hash string out. Equally important, you can’t undo a hash or reverse engineer it to get to the original information. The hash becomes part of the block and is the “piece of data from the previous block” that we just mentioned. Hashes are pretty special and important in the cryptography world and are used a lot.
- The second way that coins are secure is by controlling how the sender and receiver of a coin movement are identified to make certain that the sender and receiver can’t be forged (we’ve already seen how the Blockchain makes sure that a coin movement can’t be tampered with later). That’s done by encrypting the identities of the sender and receiver using Public Key Cryptography. That sounds pretty complicated but it’s really not. Ok, it is pretty complicated but here is a simple explanation. There are two pieces of information used to protect the sender and receiver information. There is one part of that which is public (all the decentralized computers have this piece) and another which is private (only the computer that initiates the coin movement knows this piece). Together they are used to create a digital signature that can’t be forged or tampered with as long as the secret piece stays secret!
How are coins stored or kept?
- Just like money! Well, kind of. You keep dollars, or yen, or pounds in a wallet. Same concept. Remember the two pieces of public & private information (keys) used to keep coins secure? Well, like hashes, they are just a really long sequence of numbers and letters. Those can be printed out (Danger!!! If someone were to find your private key on a piece of paper then they have the same access to your coins as you do!) or stored on a computer or hardware device.
- There are different kinds of wallets.
- An online wallet is a program or web service with one or more private keys assigned to or created by you. It could be a web site up in The Cloud, or could be a program you run on your computer, laptop, tablet, or mobile phone.
- A cold wallet (or cold storage) is a wallet that is not connected to the internet. This could be a computer which isn’t on a wired or wireless network but is usually a special kind of USB device that knows about private keys.
- A paper wallet just means that you print out your secret key on paper (DANGER!!!) and store that information somewhere very very secure.
How do I get coins sent to me?
- Once you’ve got a wallet, either on your computer or online on a web site, it will give you a public key which you can share with whomever needs to send you coins. Your public key is just another really long sequence of numbers and letters.
- After you give the other party your public key and they tell their wallet to send you coins, that information gets sent out to all of those distributed computers to be added to a block and appended to the Blockchain. That process can take anywhere from 15 minutes to an hour or even more. Remember, those distributed computers have to agree on where in the sequence to put your coin movement, create the hashes, etc. That takes a lot of computer power and a bit of time.
What is mining?
- All of those distributed computers which create the blocks, agree to what’s in a block, compute hashes, etc aren’t doing all of this work just for the fun of it. Well, it may be fun for the computers, if computers could feel fun. But the owners of those computers aren’t buying all them just out of the goodness of their hearts. They want to earn money. All of that complicated stuff that those computers do is referred to as mining. If one of your computers is the first one to figure out all the computations that go into all putting a bunch of new coin movements into a block and the other distributed computers agree with what your computer did you get rewarded a coin!
- The other way the owners of these distributed computers make money is through transaction fees or “gas”. If you want to go somewhere in your car, you have to buy gasoline right? Same concept here. If you want to move coins, you have to pay a fee. Those fees are shared by all the owners of the distributed computers.
Are coins really moved around anonymously?
- Yes, but no.
- Coins within a wallet aren’t tied to people. They are tied to the private and public keys we talked about above. So, coins move around based on pseudonyms rather than anonymously. Coin owners aren’t identifiable, but all coin movements are publicly visible in the Blockchain.
- Most coin exchanges (online websites where people buy and sell coins) are often required by law to collect the personal information of their users.