Cryptocurrencies, Bitcoin, Ethereum and Blockchain, understanding the basics.
This article is a guide to understanding the basics of Bitcoin, Cryptocurrencies, and Blockchain Technology in general.
Many people are using these words even if they do not know their meaning nor the concepts and stakes which are behind. Perhaps are you part of them?
This article aims at giving people some notions concerning cryptocurrencies, blockchain technology and bitcoin as well. Indeed this could help to demystify, not only, the fears we have when talking about a subject we do not master but also wrong beliefs one can have.
© Creative Commons / MichaelWuensch
In order to have a good comprehension of the concepts and stakes of Bitcoin, Cryptocurrencies and Blockchain Technologies, we will treat subsequently the following subjects:
– Brief history (who, when, why?)
– Technical aspects (What is Blockchain?)
– Main applications of Blockchains: cryptocurrencies (Bitcoin, Ethereum)
Before we start, it seems important to give some definition of the different words we use:
– Cryptocurrency: virtual currency or asset also called digital money based on computing and cryptographic sciences
– Bitcoin is a cryptocurrency based on Blockchain technology
– Blockchain: technology with which Bitcoin has been built. This technology relies on cryptology, and Internet (peer to peer networks)
Blockchain, who, when, why?
In 2008, following the world crisis, a certain Satoshi NAKAMOTO published a specification document concerning the creation of a digital money in order to replace the cash which is provided by central organizations in which we could not trust anymore. Satoshi NAKAMOTO was using this pseudonym and since this time, we have never known who he was.
In 2009, the Bitcoin was created referring to the specifications of Satoshi NAKAMOTO. It was based on a decentralized network working in a peer to peer architecture and secured by cryptographic software: the Blockchain was born.
Between 2009 and 2011, a few cryptocurrencies based on Bitcoin code were created. They were considered as alternative coins: « altcoins ». Among them: Namecoin, Litecoin…
In 2014, a new concept was created by the young Canadian: Vitalik BUTERIN. It was Ethereum, a Blockchain ecosystem with a cryptocurrency (Ether) giving the possibility to create sub-cryptocurrencies called tokens. With the concept of « token », was created the concept of smart-contract and distributed applications.
In 2016, we could see more and more project developing thanks to a new sort of fundraisings: the Initial Coin Offering.
In 2017, the ICOs were going on developing and we also saw new cryptocurrencies created from a fork of Bitcoin: Bitcoin Cash and Bitcoin Gold.
In 2018, summing coins like Bitcoin and tokens from ecosystems like Ethereum (NEM, NEO, TEZOS are other ecosystems…), we can count about 3000 cryptocurrencies in the global market.
2019 will probably be a decisive year for cryptocurrencies. Many of them are going to disappear when other relied on good economic models are going to be successful.
What is Blockchain?
The Blockchain technology allows the management of transactions with the guarantee to have: reliability, authentication, timestamping, security, traceability, historicity.
It relies on 3 principal functions and subjacent technologies:
- Peer-to-peer architecture
- Organization of the chain of blocks, thanks to a ledger and cryptographic functions
- The consensus which allows validating transactions
Distributed Architecture: peer-to-peer.
Blockchain is a technology which aims at allowing the storage of information and the management of transactions in a distributed architecture of computers.
Blockchain works at the opposite of a centralized architecture.
The distributed architecture is a peer-to-peer architecture, exactly as in Kazaa (https://en.wikipedia.org/wiki/Kazaa) or eDonkey (https://en.wikipedia.org/wiki/EDonkey_network).
In a centralized application, the relation between two members of the network is managed and controlled by a centralized server or organization. In a distributed network, there is no third party needed. Two members can make transactions directly without any third party except the blockchain software which validates and allow transactions.
A ledger, built with blocks
The Blockchain technology is based on a ledger.
A ledger is a kind of database which records and stores all the transactions that have been treated in the corresponding network.
The difference between a ledger and a database is that a database, generally speaking, organizes the information with tables containing fields whose contents can be created, modified and removed, while in the case of a ledger, a created content can be neither changed nor removed.
A transaction not only deals with money but can also concern information of all types: vote, certification, diploma, property titles, contract validation, signature etc…
The ledger is organized with blocks of transactions. Each block is generated every n second (600 seconds for Bitcoin, but the goal is having n < 1), and contains the last transactions (about 1500 transactions per block for Bitcoin).
When a block (a recording unit) has been generated, it can not be modified any longer.
A new block is linked to all the chain of blocks that have been previously created.
Thus, all the blocks have been linked the ones with the others through a digital signature (the hash of the Block) created thanks to cryptology. These Blocks linked together and associated to the cryptographic software, constitute the Blockchain itself.
A Blockchain manages also accounts and their corresponding balance. When a transaction occurs, the accounts are checked before validating it.
When the transaction has been validated, the accounts amounts are respectively increased and decreased.
When a block is complete, it has to be validated by all the nodes of the network. That is to say, all the nodes check if the transactions are regular, if the accounts are sufficiently creditworthy and if the balances of the accounts are in line with the transactions.
Besides, to validate a block, the nodes have to create a digital signature based on hash function (cryptographic function).
A hash function transforms a string of characters with any size, onto a new and unique string of characters with a fixed size. This signature can no be exploited to find the initial string that has been signed. If only one character is changed in a block, the signature will be completely different.
Each block contains the signature of the previous block which is also signed by the hash function. This makes the links between the blocks.
The figure below shows 2 consecutive blocks with the hash signature implemented in the following block.
This signature has to respect a certain format (starting with n « 0 »: 0000 etc…). To do this, the nodes have to make vary a string of characters in the block. This string is called the « nonce » and the node make its value change until it can validate the block with a signature that respects the requested format (starting with 4 « 0 » in our example above).
The node that finds the right string (the right value for the « nonce »), wins the challenge and is paid for this.
This work guarantees a certain level of difficulty to validate the blocks and consequently a difficulty to attack the blockchain.
The value of the nonce that allows obtaining a signature that respects the rules of the challenge defined by the blockchain software is called a proof of work. This proof of work makes very difficult for a pirate to break the security of the Blockchain. Indeed, to change the values of an account, the pirate should change all the blocks of the blockchain, recalculating all the proofs of work, and updating all the ledgers of all the members in the network. Not only does it seem to be impossible to do, but in case it would be possible, it would cost more than it would make earn.
When a node finally finds the right nonce for the new block, it shows it to the other nodes which check the operation, validate or not this block and attribute the gains to this first node. This operation is called « the consensus ».
Each type of Blockchain is associated to a cryptocurrency.
Cryptocurrencies are the first applications of Blockchains.
The principal cryptocurrencies of the market are Bitcoin and Ethereum. They represent together more than 70 percent of the market in terms of volume and value.
Bitcoin is the first application of Blockchain and the concept of Blockchain was created with Bitcoin.
Bitcoin is a virtual money and some people compare it to gold as being a safe haven. Bitcoin is symbolized by the following trigram: BTC.
Bitcoin is « open source », its code was published in Github. This means that everybody can have a look on the code, modify and correct the errors or weaknesses and create a new coin based on Bitcoin.
Bitcoins are stored in digital wallets. A digital wallet is like a physical wallet, we can store money (cryptocurrencies) on it and also send coins to another wallet or receive coins from another wallet.
The value of Bitcoin has reached $20 000 in December 2017. That means it has been multiplied by more than 20 million since its creation.
The value of Bitcoin is defined in the markets by the offer and demand.
The total amount of Bitcoin capitalization represents more than 50% of all the capitalizations of cryptocurrencies in the world.
The infographic below shows how a bitcoin transaction works:
Strengths of Bitcoin
Weaknesses of Bitcoin
The fees to treat transactions can be very high. Depending on the number of transactions to treat, the fees can climb and be very expensive (dozens of dollars). Indeed, the proof of work in a long and difficult process and the price to launch this process depends on the number of transactions needed. Besides, the more transactions there are and the longer time is needed to validate a block.
Bitcoin has been a victim of its success and has shown its limits in 2017 when the fees for a transaction have reached $35.
Bitcoin has not been designed to be scalable. When Visa Network is able to treat thousands of transactions every second, Bitcoin can only treat a maximum of 7 transactions per seconds. Besides these transactions are not validated in real time, a block needs 10 minutes to be created, that is to say, the transactions need a minimum of ten minutes to be validated. Once a transaction has been validated, we need a certain time to be sure there will not be a rollback. We commonly have to wait one-hour, corresponding to the execution of 6 blocks, to be sure our transaction has been definitely validated.
Ether and Ethereum
Ether is a cryptocurrency as Bitcoin is. Its trigram symbol is ETH.
The difference between the both is that the Bitcoin blockchain is only useful for Bitcoin and its working while Ether relies on a Blockchain that is not only working for Ether but constitutes a whole ecosystem. This ecosystem is called Ethereum.
Ethereum is a complete environment that allows creating some sub-cryptocurrencies called « tokens ». These tokens can be stored in wallets and can be exchanged, sold, received and transferred exactly like the other cryptocurrencies. Nevertheless, to allow a transaction of tokens, it is necessary to pay a contribution. This contribution is paid with the main cryptocurrency of the Ecosystem where the token has been created. For example, when making a transfer of token « T » from member A to member B in Ethereum ecosystem, I will have to pay some fees, these fees are called « gas ». This gas is paid in Ether. Thus, before completing a transaction of tokens « T » I need to get some Ether (ETH). The same as in real life, before to go from point A to point B with my car, I need to buy petrol.
The cryptocurrency Ether and the ecosystem Ethereum have been both created by Vitalik BUTERIN, a young Russo-Canadian passionate by Bitcoin who decided to develop the concept of Blockchain.
Ethereum has become the first cryptocurrencies plant since it is very easy to build one’s own token through the Ethereum platform and it framework.
How do Ether transactions work?
In an Ether transaction, 3 elements are treated:
- from: transaction origin account
- to: transaction destination account
- value: amount to transfer
Ether is used for native transactions in Ether value and also when gas is needed to allow transactions of tokens. In this case, the account that initiates the transaction defines the maximum amount of gas he is able to spend in order to process the transaction.
The nodes (the computers that have the Blockchain software and make it work) of the Blockchain can accept or not a given value proposition for gas. This creates a market for this gas.
The chart below shows the evolution of price gas in Ethereum ecosystem.
Thanks to the gas concept, we avoid unuseful transactions because people pay only for real and useful transactions.
Smart Contracts are programs that define the conditions of the execution of a transaction. In the program, there are some conditions that are checked: « if … then … ». When these conditions are verified then the transactions can be executed.
When creating a token, there is a smart contract that is linked to it. This smart contract is executed in the network when a transaction is invoked. That is to say, all nodes in the Blockchain execute the program and validate or not the corresponding transaction.
All transactions in Ethereum platform consist in executing a smart contract.
Thanks to Blockchain and smart contracts we can avoid many intermediaries.
The concept of smart contract has been invented in the ’90s by a cryptology and computer specialist: Nick SZABO.
Many people think that Nick SZABO is the real identity of Satoshi NAKAMOTO.
The infographic below shows how smart contract work.
Descentralized Applications (dApps)
DApps are applications executed in a peer-2-peer network. Every node of the network execute the code of the dApp. These dApps have been designed to be independent from any organization.
Ethereum is a platform that allows decentralized applications. Smart Contracts are an example of very simple decentralized applications. But in principle, we could develop much more complex and complete dApps.
Strengths of Ethereum
- Ethereum has changed the paradigm in the Blockchain revolution
- Very known, with a big community
- Ether is the second cryptocurrency in the market after Bitcoin
- Most of the tokens have been created in Ethereum platform
- Ethereum foundation is active and able to propose evolutions to the community
Weaknesses of Ethereum
- Ethereum is based on Proof of Work, like Bitcoin and needs a lot of energy to treat transactions
- Ethereum is not very scalable (only 21 transactions per second) while decentralized applications need the possibility to treat thousands of transactions per seconds
- Technical difficulty to make the network scalable.
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