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How Cryptocurrency Works: Ultimate Bitcoin 101 Guide

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14th May

I constantly get asked about Bitcoin, and my thoughts and break down of what Bitcoin and other cryptos are.  In the following, I take a deep dive into some of the top cryptos and what we offer on the iTrust platform. Following, we will jump right into Bitcoin and discuss everything you ever wanted (and didn’t want) to know:

What is Bitcoin?

Bitcoin is a new kind of digital currency that, unlike other forms of payment, is designed for the modern world to which we are all digitally connected. Other forms of payment, like cash and credit cards, have their place, and probably won’t be going anywhere soon, but they aren’t really suited to the way we are going to be living in five or fifty years. Bitcoin is.

In fact, if you have a bank account or if you use credit cards or PayPal, then you’re already using digital currency. If you own or trade stocks, you are using digital money. Most of the movement of money between these banks and businesses is nothing more than numbers on balance sheets. The difference is that unless you are using fiat currency, anything you do with your money has to go through the banks, brokers, or the credit card companies. And, as you know, many charge fees and have all sorts of conditions and penalties.

With Bitcoin, no one is in control but you, unless you decide otherwise.

The story of how Bitcoin got started is that an unknown person or group using the name Satoshi Nakamoto created Bitcoin and released it in January of 2009. Satoshi set up a system that would create digital tokens and also put controls on them so that Bitcoin could be treated in some ways like gold and in some ways like cash.

created Bitcoin and released it in January of 2009. Satoshi set up a system that would create digital tokens and also put controls on them so that Bitcoin could be treated in some ways like gold and in some ways like cash.

Let’s take a look at some of the properties of Bitcoin:

How Bitcoin is like gold:

They have to be mined.

What “mining” in this case means is that work has to be done in order to get them. With gold, that means picks, shovels, pans, and a lot of physical effort. With bitcoins, it means that computers have to solve math equations providing a “proof of work” that the miner has earned a payoff of a certain amount of bitcoins.

The reason that Satoshi set it up this way is that if all the bitcoins possible were released all at once, then he would own them all and there would be no reason for anyone to want them. However, since he made it a challenge to get them, for the early adopters it became a competition to see who could get them, it spread them out more evenly, and made people willing to exchange them. One early adopter in 2010 famously bought a pizza for 10,000 bitcoins. Those same coins now would be worth a fortune, but if nobody had spent them early on, then they wouldn’t be worth anything. When people saw them a way to buy or sell things, they began to have value.

Just like gold, there is also a limited supply. Unlike gold, we know exactly how many bitcoins there will eventually be: 21 million. This is to keep Bitcoin from becoming inflationary and to keep them valuable. Rather than there being an infinite number of bitcoins, bitcoins are divisible to 8 decimal points, which gold is not. If one bitcoin becomes worth too much, the decimal can be moved to the right. The number of bitcoins is capped at 21 million, and that cannot be changed, but the number of places the decimal can be moved to the left can. Currently, each bitcoin can be divided into one-hundred-million smaller coins, called “satoshis,” after the inventor. That’s a very small amount, but if the need ever arose to make even smaller divisions, it could be done.

One should note that this makes Bitcoin an inherently deflationary currency. Because the number of coins is limited and released to a set schedule, over time, the value of each coin will tend to rise. This is a very good thing for people. Salaries and savings will increase just by virtue of remaining the same. On the other hand, one tool governments use to overspend is to increase the money supply, devaluing the value of money (inflation).

Currently, almost no individuals mines bitcoins. The system is set up to make it more difficult to solve the math producing the bitcoins. This is to keep them from being produced too fast, and again, having too many of them end up in the hands of too few people. Now mining is really only done by professionals who buy and maintain special and expensive equipment. Because of the rising difficulty, the cost of new equipment, the cost of electricity, etc., some believe it’s very difficult to make mining pay.

So, again, why is Bitcoin like gold? Because it takes work to get them and because they are scarce, they are seen as valuable. And since you can’t just make more of them when you want, their price is likely to rise over time–for sure, Bitcoin is highly volatile and we are going to see huge spikes and crashes, but keep an eye on the trend of the charts and you will notice that they always trend up.

How Bitcoin is not like gold:

Unlike gold, there is nothing to hold in your hand.  Its digital.

Unlike gold, it is almost infinitely divisible. If you have an ounce of gold and want to buy a cup of coffee, just exactly how do you get your change?

Unlike gold, you can store all the bitcoins in the world on a single thumb drive or in a notebook (if you wanted to take the trouble of handwriting all those numbers and letters). With gold, you have to have a vault, guards, etc.

Unlike gold, you can’t make anything with it if it loses its monetary value. Well, this isn’t exactly true. You can’t make a pair of earrings, say, but there are a number of uses for the blockchain, the public ledger that records everything that happens to every bitcoin that may revolutionize how we notarize documents, set up wills, conclude contracts, finalize large purchases of smart devices, etc. The businesses that will become the next Amazon based on the non-monetary uses of Bitcoin’s blockchain are just being built now.

How Bitcoin is valuable:

One of the chief arguments against Bitcoin is that it has no inherent value.

But this is also true of just about any type of currency you can name. What makes a currency valuable is that people believe that it is valuable and trust that it will be valuable tomorrow; a trust in the government who creates them. Based on that trust, I can hand over a dollar and get a cup of coffee. The coffee shop can then pay their employees and buy more beans. That dollar shifts from hand to hand to enable a flow of goods and services in the other direction.

But paper money isn’t valuable in-and-of itself. Money used to be made of precious metals, and at that time an argument could have been made for inherent value. But in 1971 the US was taken off the gold standard with the Bretton Woods Act, meaning that money only has value on the government’s say so. Meanwhile, the government has the ability and the right to print money out of thin air to pay its debts. They also create more dollars to the tune of 60 Billion or so a month. As mentioned before, this is an inflationary tactic that benefits the government, but hurts everyone else.

How Bitcoin is like cash:

In a lot of ways, Bitcoin is more like a commodity, like gold, than it is cash, but in certain ways, it is just like cash.

The most important way Bitcoin is like cash: You can spend it.

Because Bitcoin is digital and divisible into really small units, when you want to buy something, you can use a computer or smartphone, take a picture of a QR code or paste in a bitcoin address, enter the amount you want to give the other person, and hit send. Simple.

This is especially good for situations when you are shopping online or would otherwise be using a credit card. For merchants, its good too since the fees to accept Bitcoin are a lot less than Visa fees, thus is saves the seller money.

How Bitcoin is not like cash:

It is impossible to fake or forge: If I pay for something with cash, there may be concerns that the bills are forged. If you pass over a large denomination, they may check it with a security pen or light, but little more is done. The blockchain nature of Bitcoin means that there is no possibility of it being forged.

On the other hand, like credit cards, there is an acceptance process before the person being paid can be certain the transaction has taken place.

It works like this: The math problems discussed as being a way to mine bitcoins also are collecting records of the transactions that have been taking place and weave them into the math of that problem. When that problem, or block, is solved, then the transaction is written into the math history of Bitcoin and cannot be reversed.

But it is not just one computer trying to solve this problem, there are thousands or millions of computers chugging away at this and communicating back and forth on the blockchain. They start sending out confirmations that this transaction is valid and has been recorded. One confirmation is usually enough, but multiple confirmations do take place, which is truly secure and protects the payee from something called a double spend.

It should take about ten minutes to mine one block according to the schedule set up by Satoshi. That means that to get six confirmations, it might take an hour. In fact, the number of ten minutes is only an average, so it could take less or more time.

How Bitcoin is secure:

Even if the system as a whole is secure, each Bitcoin user needs to be careful with how the get, spend and store their bitcoins. The need to be careful is no different in being sensible in how you need to be careful with cash or with your banking information. Keeping them on hard wallets or cold storage is most likely the safest, while keeping them on an exchange is more dangerous.

That was a lot to digest.  And that was just Bitcoin. Now, let’s look into the next cryptocurrency, Ethereum.  Maybe you need to take a break and/or get some coffee before continuing on.

Now that you have, let us continue on:

What is Ethereum?

Ethereum is an open-source software platform based on blockchain technology. This platform enables developers to build and deploy decentralized applications (or dapps) like Status or Celsius on it. All of this is possible because of a breakthrough in blockchain technology (as popularized by Bitcoin), and then Ethereum came along with some new ideas.

As the two biggest cryptocurrencies (by market cap), Bitcoin and Ethereum often get mentioned in the same sentence. For the uninitiated, understanding what Ethereum is and how it differs from Bitcoin can be difficult. On the official website under the tagline “build unstoppable applications”, you will find the following description of Ethereum:

A decentralized platform that runs smart contracts: applications that run exactly as programmed without any possibility of downtime, censorship, fraud or third-party interference.

Another common description of Ethereum is that it’s intended to become a “world computer”.

If none of the above makes complete sense to you, don’t worry, that’s why this is being limited to just a top level discussion. Think of this as basic Ethereum 101. As a starting point, think of Ethereum as Bitcoin’s multi-talented, more versatile younger sibling.

Ethereum started with one person, and that person is Vitalik Buterin. Unlike Bitcoin, Ethereum has a real name attached to it, a leader if you will. Buterin is a Russian-Canadian programmer and writer primarily known for his work with Ethereum and as a co-founder of Bitcoin Magazine.  He came up with the idea of Ethereum at the age of 19!!

 In 2013, while working on Bitcoin, he noticed that it lacked its own scripting language for application development. He argued that this was a huge opportunity that needed some action; when he failed to receive broad support for this idea, he began writing his own whitepaper. Late in 2013, he released the Ethereum whitepaper outlines his vision to “provide a blockchain with a built-in fully fledged Turing-complete programming language that can be used to create “contracts”. These contracts he was referring to are the “smart contracts” that Ethereum has become famous for. A smart contract is simply a self-executing contract written into code that is stored on the blockchain. They render transactions “traceable, transparent, and irreversible”. As credence was given to Ethereum, a nonprofit foundation, the Ethereum Foundation (Stiftung Ethereum), was created to guide development. This development was funded by a crowdsale that kicked off in July 2014. This was the first initial coin offering (ICO).

Every time someone wants to send ether to another person or execute a smart contract, this entire decentralized ledger must record and confirm the accuracy of the event. This critical task is not carried out by people or a company, but by thousands of computers all over the world that are connected to the Ethereum network. These computers are usually what people are referring to when they say “miners”. The name itself is actually quite misleading; a more accurate term might be “transaction processors”. To make sure that transactions are securely and properly recorded requires computers to use a huge amount of computing power to solve complex algorithmic problems, and do so as quickly as possible to get a reward (paid in ETH). This is called Proof-of-Work (PoW) and it ensures the integrity and vitality of the network as a whole.

In the context of Ethereum, the blockchain acts as a public ledger that lists everything that goes on in the network in real-time. It’s the thing that everything possible. Some of the same fundamental blockchain technology that allows Bitcoin to function allows Ethereum to function. The structure of the Ethereum blockchain is very similar to Bitcoin, in that when a transaction goes through, a copy of it is distributed through the whole network. Every node (Ethereum software running on a computer) on the network stores a copy of this history. This distributed ledger of information can be easily synced across a large decentralized network. This is what makes Ethereum accessible to anybody with internet access, regardless of location. Within the Ethereum network, there are blocks of data that consist of transactions and smart contracts. These blocks are chained together and are the complete record of Ethereum’s history going back to its first block. These blocks are created or mined by users and distributed to other users who validate them or make sure they are “right”. Every blockchain has some type of algorithm for reaching consensus. The network uses these algorithms to agree upon the single value of a data point across the entire system.

Smart Contracts:

When you start learning about Ethereum, it becomes clear that the special sauce is its ability to power smart contracts. Smart contracts carry out if-then statements. For example, imagine if a smart contract was used to operate a vending machine. The if-then statement could be: “If someone puts a dollar into the vending machine, the vending machine will release a can of Coke for them.” Ethereum provides a base for these contracts because it is “software that can host other software”. This offers a level of functionality that many other cryptocurrencies simply don’t have. Ethereum is projected to have the ability to deal with things like identity systems, insurance payments, and management of permissions (to name a few). All of these are possible due to the smart contracts which sit on the Ethereum blockchain. They effectively stand in for a transaction or contract in an all-digital environment.

ERC20 Tokens:

ERC20 is simply the name for the standard requirements for anyone wishing to introduce a new token onto the Ethereum blockchain. ERC stands for Ethereum Request for Comments. To paraphrase Coindesk, the primary reason that ERC20 exists is to ensure that Ethereum-based tokens perform in a predictable way throughout the ecosystem, such that decentralized applications and smart contracts are interoperable across the platform, and that all tokens follow a fixed standard of security. In layman’s terms, it’s so that new things work with everything else in the system.

Ether and “Gas”:

The ether token is the currency that makes the Ethereum ecosystem run. The Ethereum website explains it this way:

“ether is a necessary element — a fuel — for operating the distributed application platform Ethereum. It is a form of payment made by the clients of the platform to the machines executing the requested operations.”

The cost of this fuel is determined by the degree of computation for an action the network performs — basically, everything costs a bit of gas, but some things more than others. This means that no one works for free and it disincentivizes inefficient code. Who needs ether? Any developer wanting to build something on Ethereum or anyone wishing to access an Ethereum-based smart contract should have ether. It can also be used as a currency. As the Bitcoin network slowed and transaction fees rose toward the end of 2017, some people turned to ether as a medium of exchange.

Alright, now onto the next.   We will move on to Litecoin, or as many like to call it, Bitcoin’s little sibling.

What is Litecoin:

Litecoin is an open-source, fully decentralized digital asset. It is attractive to users because it allows instant, near-zero cost payments all over the world. The Litecoin blockchain is an open source, fully decentralized project, developed by volunteers with plans to add full-time programmers to expand and improve the experiences of users and investors.

Litecoin is among the top offerings in most online exchanges. Exchanging Litecoin for Bitcoin is easy. Litecoin is liquid i.e., it is also relatively easy to buy and sell Litecoin for cash. The popularity of the coin is so far-reaching that there are Litecoin debit cards available along with Bitcoin debit cards. Litecoin is a suitable way to diversify crypto asset positions and mitigate the risk of fluctuations in other top crypto assets – Ethereum and Dash.

Litecoin is a non-inflationary coin. The algorithm would never allow creation of more than 84 million Litecoin, ensuring demand and the ability to store value, just like precious metals. This is Litecoin’s promise to serve as “digital silver”.

A computer scientist, Former Engineering Director of Coinbase and Google employee Charlie Lee released Litecoin via an open source client on Github on 7th October 2011, later the Litecoin network went live on 13th October 2011. One important thing about Litecoin is, it is not a hard fork nor soft fork of bitcoin. To classify as a soft or hard fork it should share some of the related chains from the genesis block. Litecoin has a completely different chain right from the beginning. That is why it is considered as a source code fork. The total amount of Litecoin will be 84 million, which is about 4x the amount of Bitcoin that will ever be created.

Litecoin is able to transfer funds in minutes at any location, any distance also without using high-priced wire transfer. The transaction speed of Litecoin is about 2.5 minutes where bitcoin takes almost 10, so its 4x as fast. Litecoin blockchain technology is one of the best in all digital currencies. Like every single transaction that happens in their currency network. All the information about that transaction is recorded in a block. All those blocks are attached to the blockchain. But the users always remain anonymous.

It is fast and got a huge amount of volume but another nice thing about Litecoin is its algorithm. Unlike bitcoin’s SHA-256 hashing algorithm, Litecoin uses a script hashing algorithm. Both algorithms are powerful but SHA-256 is old and more complex for miners. Litecoin’s script hashing algorithm is easier for miners.

The future of Litecoin is considered stable due to the dedicated technological community and regular updates that increase speed and decrease cost. The Google+ following on the Litecoin project has more than 5,000 followers dedicated to maintaining the stability of the Litecoin network and expanding the Litecoin ecosystem. A newly released Litecoin Roadmap for 2017 cited 14 developers assigned to various tasks to improve the service powers of the Litecoin blockchain. Another area of focus is the release of an improved Android wallet. There has been fundraising and plans to hire full-time developers for the Litecoin Core project as well.

Users and investors may also expect the Litecoin Network project, tracking and gathering information about the blockchain to happen in one place. The site would keep a record of development, network economics, mining information and historical data.

The most notable innovation for Litecoin would be the possibility for smart contracts or conditional payments between parties. Smart contracts would make Litecoin similar in technology to Ethereum.

Litecoin vs Bitcoin

Price

It is difficult to ignore the difference in price of the two assets as Litecoin is priced multiples apart. However, that shouldn’t make any difference since we can buy any multiple we want of both coins.  A lot of people believe since it runs on a 4x quicker version of Bitcoin, it should be about ¼ price of BTC.

Mining

The key difference for end-users being the 2.5 minutes time to generate a block, as opposed to bitcoin’s 10 minutes.

Transaction

The main difference is that Litecoin can confirm transactions much faster than bitcoin. The implications of that are as follows:

  • Litecoin can handle a higher volume of transactions as it has a faster block generation capacity. If bitcoin were to try to match this, it would require significant updates to the code that everyone on the bitcoin network is currently running.
  • The faster block time of Litecoin reduces the risk of double spending attacks — this is theoretical in a situation where both networks have the same hashing power.
  • A merchant who waited for a minimum of two confirmations would only need to wait five minutes, whereas they would have to wait 10 minutes for just one confirmation with bitcoin.
  • The maximum number of coins is, consequently, four times higher than the maximum number of Bitcoin.

Litecoin in its own ways adds value to the world of crypto assets with a market cap of more than $4.6 billion of the total markets. It would be interesting to further observe the change in prices as an altcoin as this asset sees widespread adoption.

You’ve made it this far!  Wow, impressive!

Hope you took some breaks to stretch and maybe watch some Game of Thrones.

Now for the last one, the home stretch!

Bitcoin Cash:

Bitcoin cash is a hard fork from Bitcoin that occurred on 8/1/2017 at 12:20 UTC.

What caused the Bitcoin community to fork?

Creating Bitcoin and making transactions with it all happens in a shared network within a larger system. The software relies on a blockchain, a ledger of “blocks” that represents the ongoing continuity of operations, and each block is limited to 1 megabyte in size.

This inherently restricts the amount of transactions that the network can handle. In average, seven transactions per second is the limit in the main BC system, which in turn makes for a significant congestion given the sheer number of users and operations constantly going on.

A debate sparked among two factions of the community long ago: one that has urged others to preserve the current integrity of the Bitcoin system and another that proposed making simple changes that could bring tangible results. The latter banded together to support and push the creation of Bitcoin Cash (BCH).

Bitcoin Cash went live on August 1 with a standard block size of 7 megabytes, which effectively gave its network seven times the capacity of the original Bitcoin ledger and pushed its initial value to the third highest place among cryptocurrencies worldwide.

Final Words:

So you have now taken a dive into some of the top currencies in Crypto.  We appreciate you learning, as that is one of the core objectives here at iTrust.

We will be releasing many more educational pieces, so please subscribe to our blogs, Medium, and YouTube channels.  Remember, the more you learn, the more informed you will be about any and all decisions you make.

If you have any questions please feel free to reach out to us at info@itrustcapital.com  or call us at (866) 30-Trust (866-308-7878)

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