What is this Cryptocurrency stuff ?
I've heard about Bitcoin , Ethereum , Litecoin and some others .. What are they and should I be investing in them ?
This is a question I have asked myself recently and after a lot of research have pieced together an understanding that may not be 100% technically correct but it serves my purposes in understanding these new cryptocurrency things.
Heres my attempt at explaining and I hope it helps someone else.
Firstly crypto coins don't exist as a physical or even a single data entity any where and the concept of me "having" coins only exists in a ledger which changes as I recieve or send coins to others. In essence a cryptocoin is just a number associated with a cryptocurrency address which tracks how much of the currency the address "has".
Cryptocurrencies are typically acquired in exchange for goods and services or they can be purchased using other forms of currency whether it be another crypto or a fiat currency such as USD.
When ever a transaction is executed a permanent unchangeable record of the transaction is stored in a distributed ledger called a blockchain and it is from this information that the cryptocoin "balance" for a crypto address can be derived.
The distributed ledger exists on nodes around the network which each keep a copy and must reach consensus that the transaction is valid before it is added to the ledger. Once consensus is reached and the transaction is added to the ledger it cannot be removed.
Up to this point it all seems fairly simple and makes sense to me but it gets a little sketchy for me going forward.
In many cryptocurrencies including Bitcoin the "book keeping" for the distributed ledger is performed by "miners" who run the nodes , reach consensus, and add transactions to the ledger. This in essence isn't a terribly difficult task which it seems to me shouldn't require a lot of effort if it weren't for the fact that it has been made artificially more difficult by adding the requirement for the "miner" to solve a cryptographic "puzzle" before they can add a block of transactions to the ledger , in return for solving this puzzle the miner is rewarded with an amount of currency for solving the puzzle first.
With some of the most popular coins my understanding is that this puzzle is made more or less difficult in order to ensure that it always takes around the same time to add a new block of transactions to the ledger.
The way I see it this has resulted in an escalation that goes something like the following:
- A few Miners started off mining on relatively low spec hardware and because there wasn't much processing power being applied the "puzzle" was kept fairly easy to solve.
- Miners worked out that if they had better spec computing hardware they could solve the puzzle quicker than other miners and earn more currency.
- Miners who didn't increase spec of mining hardware werent able to earn as much currency so they soon upgraded their mining rigs.
- Meanwhile word got out that there was coin to be earned and more miners started mining.
- With all the extra processing power being thrown at mining the time to solve the puzzle started reducing so the puzzle is made arbritarily more difficult.
- Miners start upgrading their equipment to allow them to solve the now more difficult puzzle in the same time they could previously
- goto 1.
Do you see where this goes ? Basically we are now at the point where huge amounts of specialised processing power, electricity , and money are being thrown at "mining" a currency which is gaining value against traditional fiat currencies because it has to .. If it didn't it wouldn't be worth anyones while to be a "miner".
My view is that this approach is extremely wasteful and needs to change for currencies to have a long term future but I also think the people who have invested huge amounts of money building massive mining operations will do everything they can to ensure they continue recieving their rewards.
There are other mining systems that are far less processing intensive which can be used and if successful I think will act as a breaker for this escalation.
Please note that I am expressing an opinion above and as always do your own research (DYOR).