Understanding how cryptocurrencies work

Understanding how cryptocurrencies work

In 2010, sitting with more Bitcoin than he knew what to do with, a computer programmer spent 10 000 coins to have someone deliver two large pizzas to his house in Florida. No big deal then, when it was valued at less than half a US cent a piece. Today? Those 10 000 Bitcoins are worth approximately $ 39 million. Expensive pizzas by any standard.

Bitcoin and numerous other virtual currencies have all but exploded into the mainstream in recent months. In fact, at the end of last year, one Bitcoin worked out to roughly R 4 500. More recently, the exchange rate is sitting close to R 65 000.

And while the story of Bitcoin itself is quite fascinating, let’s dig deeper around the technology that is essentially powering cryptocurrencies. Whether it is Bitcoin, Ethereum, Ripple, Litecoin, take your pick – understanding the blockchain will help you get to grips with the cryptocurrency movement

 

Defining the blockchain

Wikipedia defines a blockchain as a distributed database that maintains a continuously growing list of records, called blocks, secured from tampering and revision. Each block contains a time-stamp and a link to a previous block. By design, blockchains are inherently resistant to modification of the data – once recorded, the data in a block cannot be altered retroactively.

Okay, in slightly more general terms a blockchain is an open, distributed ledger that can record transactions between two parties efficiently and in a verifiable and permanent way.

Enter cryptocurrencies. Bitcoin is the first and one of the most widespread blockchain protocols and provides people (and companies) with a secure and efficient way to buy and sell products and services without ever needing to use a financial institution. Payments could be either peer to peer or remittances between two countries. Bitcoin is also an alternative asset, often called ‘digital gold’, since it is digital, limited in supply and there is a global demand and understanding of the asset.

 

Why is it important?

Earlier this year, IBM wrote about how the convergence of the Internet of Things (think connected devices such as smart watches, fridges and cars) and the blockchain could provide businesses with a vital tool to build trust with customers, reduce costs, and accelerate transactions.

It argues that because the blockchain makes it easier to create more efficient business networks where anything of value can be tracked and traded, the organisation itself can take over the trust role from a third party or intermediary. And by empowering users to operate independently as a group, the blockchain can reduce costs by cutting out the middle men.

Finally, transactions can be accelerated through blockchain technology and by using an appropriate consensus algorithm for a group that agrees to work together. This algorithm sees transactions being processed faster while reducing costs and continually engendering trust in one another by working together as a collective.

 

Going digital

Over the past several months, you might have noticed the buzz phrase of the moment being ‘digital transformation’. This is essentially how businesses are implementing technology throughout the organisation to improve their bottom line but also to make our dealings with them appreciably easier.

As the Harvard Business Review writes, many of the fundamental elements of the running of a company (think contracts, transactions and records) need to stay in tune with economic digital transformation.

The publication argues that the blockchain enables these contracts and bureaucratic elements to be embedded in digital code and stored in transparent, shared databases where they are protected from deletion, tampering and revision.

 

A brave new world

Of course, this does not necessarily make blockchain the perfect solution for investing thousands of rands or embarking on nefarious deeds. As with any new technology, there might be a temptation to adopt it en masse without giving due consideration to its long-term potential.

We have seen this even with music and video streaming services. Initially, there might be a healthy scepticism around what it enables us to do. And yet, the likes of DStv and others have all but accepted video streaming as a core part of their growth into the future. The same could potentially apply to cryptocurrencies.

Sceptics argue that we are living in a Bitcoin bubble that could burst at any moment. While nothing is impossible, many of those same critics believed the same of many of the modern innovations we are benefiting from daily – from apps to cloud storage

Ultimately, having a secure and compliant networked approach between different business and consumer partners means a company can do things more efficiently and faster than was previously possible. It changes collaboration methodologies and integrates technology into all spheres of business and, by implication, into our lives.

It should be noted that Bitcoin could have an impact on online payments, physical payments, payments for the unbanked, and cross-border payments. And many people are interested in Bitcoin because of the decentralised way of storing an alternative asset with limited supply. Many believe it will become a more efficient (even stable) store of value over time.

But even when Bitcoin and other cryptocurrencies are embraced, people should not expect them to be an overnight success.

As the Gartner Trend Insight Report on Practical Blockchain explains: “We may all jump on board with cryptocurrencies and other blockchain-enabled services, or we could have a backlash. Governments could step in and try to exercise some control. More likely, there will be a kind of ‘arctic slide’ where people will become used to one application of the technology and become increasingly comfortable with it … blockchain is going to fundamentally change the society in which we live. Not tomorrow, but within our lifetime.”

 

Tips for the newbie Bitcoin investor and how to get started:

Bitcoin and Alt (alternative) coins are extremely volatile, so it is important not to get excited or let your emotion cloud your better judgement when buying in. It doesn’t matter what the price of Bitcoin is at the time you want to purchase; what does matter is where it sits in the cycle. Be sure to note if it is due for a correction or if it is likely to go up. Has it had a correction or has it had a huge jump up? If you buy in at the top of the curve then you are likely to see an immediate decline in your investment, which may lead you to panic-sell and lose value. The best thing to do is get set up, then watch the market and learn it for a week or so. Do research and watch daily YouTube videos and tutorials. Make sure you buy on the exchange, and at the lowest possible price available so that you can enjoy watching your investment turning into profit. Don’t rush and don’t panic – be strategic and informed.

 

YouTube daily market insight feeds to subscribe to:

  • CryptoBud
  • Crypto Bobby
  • Coin Mastery
  • DataDash
  • Chris Dunn
  • Tone Vays

 

Exchanges to use:

 

Monitoring the market and own analysis:

 

Daily news feeds and best way to stay informed:

 

Ashton Gardner – newbie Bitcoin investor on the ‘Up’


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