Cryptocurrencies have been the latest craze for some time. Bitcoin and many other blockchain currencies have exploded in growth over the past few years. They are here to stay long term.
But what is a cryptocurrency and how does it work?
Any complex subject can always be broken down to an analogy. In this case, I will be using treasure maps. Like the ones in Pirates of the Carribean.
Let’s say you are a treasure hunter. You scour the seas looking for booty. You have a treasure map in your hands, and you tail the high winds looking for that island where “X” is marked.
You find the “X” marked designation. Grabbing your shovel, you reveal a chest with a giant lock on it.
Taking your key, you insert it into the chest, opening it up. Inside there’s jewels and gold that you could use for food, staff, ship equipment, etc.
Inspecting the treasure chest itself, it has another map to another treasure chest.
So what is a cryptocurrency and blockchain technology?
A treasurechest is a block. Many linked treasure chests is a blockchain. Here is the analogy:
- It looks like a treasurechest – This is like a public key, its an identifier to the block in the blockchain
- It has a lock – This is a private key, only unlockable if you have the right key.
- It is marked by an “X” on a treasure map – This is the address of the block
- It has goodies inside – Money associated with the block, only unlockable if you have the private key
- It has another treasure map on outside of chest – This continues the cycle of the blockchain. This is how all the blocks or treasuremaps are linked to each other. Its what makes everything work
Now imagine these treasure hunters all had access to the internet. And that they could see the chain or treasuremaps linking to each chest. This is what we call the public ledger. Its how we know that every chest is located.
In this public ledger, we get to see what each chest looks like. And what the keyholes look like, etc and how these maps are all linked to each other.
These treasurehunters who all have access to the same resource, cannot access the contents of those chests. Unless of course they own them. With a key.
How does one get a key for that chest? There’s a few ways
- That treasure hunter built the chest, and therefore knows how the keylock works. This is like owning your own bitcoin wallet in the cloud, accessed only by a privatekey/ password.
- Keys are stolen. This is like when you put a spare housekey outside your home, and someone sees you do this / breaks into your home with it.
But you might be asking what is coinbase, and all of these other exchanges?
Imagine instead of having your chest located in the middle of nowhere, people put their chests inside a centralized building. This makes it easier to access the contents, link it up to other services (e.g. selling off the loot and buying things).
But where does the loot even come from? Where did this treasure originate from?
In cryptocurrencies we have something called “solving the block”. When a block is solved, whoever solved it gets the equivalent of 1 cryptocurrency.
Imagine these treasure chests are created filled with loot when something is solved. Whoever solved it gets a private key to it.
But what is “solving the block”? This is cryptography, and the below example explains more
What’s cryptography, and how is money being generated?
Let’s go back to the treasure chest with gold inside of it example.
That gold had to come from somewhere right?
Someone had to use a pickaxe and mine it in a shaft. Instead of people, this is generally associated with electricity use in “solving a block” instead.
When that miner ends up hitting a gold node, they “solve the block” essentially and get rewarded with that gold.
Just pretend that gold immediately gets wrapped inside of a box with a key they have accessed too.
How do cryptocurrencys get valued?
Back to the treasurehunter example again.
Imagine the gold in these chests start becoming less valuable. This could be a number of reasons – people might find silver as a better form of currency (maybe its easier to produce, or transport, etc).
Or too much gold is found making it less valuable overall. Because of supply and demand.
In any case, these are the reasons
- Too much hype – People jumped on the gold mine bandwagon only to find it isn’t worth as much as people say it is
- Hard to use – This is when you go to mcdonalds to pay for you BigMac in bitcoin, only to find it takes 30 minutes to process
- No faith in currency – This is when someone forges a master key and unlocks several hundred chests, some even that you own, and you lose your money inside.
- What everyone else uses – If everyone uses gold, its convenient to trade in gold. Silver won’t be as used even if its comparable in value.
Whats a cryptocurrency contract?
Let’s look at the miners mining the gold for the treasure chest.
They have families to feed. Somedays at the gold mine they might find enough gold to pay for the day. Other times they might find absolutely nothing.
This presents a problem since there’s no guarantee that the work they put in will make them ends meet.
So they come up with an idea. A union for sharing all the gold that’s mined out, based on how much work each person puts in
That’s a cryptocurrency contract. You share resources so everyone benefits equally when a gold node is uncovered.
What’s bitcoin vs other cryptocurrencies (Ethererum, etc)
Imagine now that the gold mine has taken off, and everyone wants a piece of the action. Like the california gold rush in 1949.
Now imagine this gold mine is just loaded with nodes. The government finds its not efficienct for too many people to be in the gold mine at the same time. They also found a method for discovering where gold nodes are in the mine.
Then say only 50 people can be allotted into the mine at a time.
This is kind of how other cryptocurrencies works. A lot of work is wasted in bitcoin crytocurrency creation.
A few other cryptocurrencies have similar yet different models. They all differ in how these gold mines are “managed”
Here are the most important physical analogies
- Treausre chests are like blocks
- Gold miners are like bitcoin miners
- Treasure hunters are the end users
Here are important things about blockchains in general
- Public ledger – all the treasurehunters have smartphones and can see what each treasurechest looks like and how they are linked to each other
- Only if you have the (private) key to the chest can you open its contents
Here are all the abstract analogies:
- Maps > treasure chests > Maps created the blockchain network
- Private key is the key to the chest