At the beginning of time, ancient people were familiar with the benefits of trading with various commodities they were producing themselves. By exchanging them for something they could use but not produce, many of these ancient traders got rich in a short while.
With the rise of civilization, man perfected trading. First, bartering was swapped with money, and then banknotes and coins were replaced by plastic credit cards. Eventually, the 21st century ushered cryptocurrencies as the new ‘trading goods’. But, as we’ve come to see, they’ve become much more than that.
The Launch of Cryptocurrency
The brief history of cryptocurrency is associated with the name of a rather elusive character labeled as the inventor of the first decentralized cryptocurrency protocol – Satoshi Nakamoto.
While this moniker has been used to conceal the real identity of Bitcoin’s inventor, its etymology reveals that this person (or maybe a group of people) is strongly correlated with the foundation of a new, modern, and wisely conceptualized trading medium (Satoshi – “clear thinking, quick-witted, wise”; Naka – “medium, inside or relationship”; and Moto – “origin” or “foundation”).
By inventing a clever algorithm as a new trading medium, Nakamoto (be it a person or a group) became the founder of the first futuristic movement in the world of finance.
Unlike centralized currencies which are controlled by a single entity (usually the government of a country), the main idea behind the invention of the cryptocurrency system was for the users of assets to have more control and heightened protection over their finances. Namely, this unconventional and decentralized monetary system offers public, irreversible, and safer transactions that literally put all the control in the hands of the owner/user.
What Is Bitcoin?
Bitcoin (BTC) is the very first decentralized, peer-to-peer digital currency. More precisely, Bitcoin is a peer-to-peer electronic cash system software that allows for instant anonymous online transactions. It was launched by Satoshi Nakamoto in 2009, who published the Bitcoin whitepaper a year earlier where he elaborated on how cryptocurrency will function.
These virtual currencies are created by algorithms based on cryptography, hence the name ‘cryptocurrency’. Basically representing e-cash, bitcoins are digitally signed by the owner of the cryptocurrency and kept in digital cryptocurrency wallets.
The authenticity of a cryptocurrency transaction is confirmed by a private key, i.e. a piece of information known only by the owner of the cryptocurrency wallet. Since cryptocurrency is pseudonymous, having the key to your own cryptocurrency is the exclusive way of proving your ownership.
Prior to introducing Bitcoin to the digital cryptocurrency world, there were a couple of attempts to create digital currencies which were not fully developed. B-Money and Bit Gold are some of Bitcoin’s predecessors that were never launched as cryptocurrencies.
Unlike fiat currencies, these types of digital money exist only in the digital domain. Also, just like all digital files on the Internet, securing cryptocurrencies is a highly laborious task. Without the protective digital platforms and technologies used in the process of creating digital money, it would be even easier for cryptocurrencies to be replicated and shared.
Despite the fact that it’s not managed by any central bank, financial institution, or central authority, Bitcoin can be exchanged for fiat currencies without the need of a bank account or a bank as an intermediary.
How Many Cryptocurrencies Are There?
Just like we have many fiat currencies in the real world, i.e. government-issued currencies like USD, EUR, GBP, INR, and CHF, there are many types of digital currencies too.
Once Bitcoin had successfully proven its value, numerous other decentralized cryptocurrencies were created and released, such as Ethereum (ETH), Bitcoin Cash (BCH), Dash, Dogecoin (DOGE), Ripple (XRP), Monero (XMR), Litecoin (LTC), NEM, and NEO, for instance. Although the blockchain isn’t an open-source platform in technical terms, most of the platforms upon which these cryptocurrencies are built are open-source.
The second most popular (and second most valuable by market cap) after Bitcoin is Ether (ETH). It was created in 2015 and was designed to power both decentralized apps (Dapps), as well as the smart contracts on the Ethereum blockchain. Similar to Bitcoin, Ether has no centralized control and it doesn’t require a bank account to accept the payments.
All digital currencies modeled after Bitcoin are commonly known as altcoins.
What Are Cryptocurrency Tokens?
Cryptocurrency tokens are digital assets issued to the participants in Initial Coin Offerings (ICO) via blockchain-based smart contracts. Namely, by investing a certain sum of real money, the investor receives the respective share of the token supply issued via the ICO smart contract.
These tokens adopt the digital role of traditional stocks and are unlike bitcoins which have the role of a commodity, i.e. digital currency. There are numerous types of tokens that reside on their blockchain and can be issued for storing value, making purchases, or for investment purposes.
What Are Cryptocurrency Exchanges?
Cryptocurrency exchanges, also referred to as digital currency exchanges (DCE), are the most popular way of obtaining cryptocurrencies. These platforms enable trading with cryptocurrencies, as well as with any other type of cryptocurrency asset.
Some of the exchanges that enjoy a high reputation among cryptocurrency traders include Coinbase, Binance, Robinhood, and Cash App.
How Do You Create a Cryptocurrency?
So, after providing you with a general sense of what cryptocurrencies stand for, let’s get into the nitty-gritty of our topic.
Simply put, every cryptocurrency represents software created by the use of different coding processes, including cryptography, mining cryptocurrencies, blockchain technology, as well as similar digital operations and protocols. But, if there ever was a “skeleton” of cryptocurrency, it’d be blockchain.
What Is Blockchain Technology?
Blockchain technology is the underlying digital method of recording and distributing a digital asset. With the help of this technology, transaction data is coded as blocks. Except for the first block, each following block is chained to the previous one and follows a chronological timestamp.
The basic unit of the underlying cryptocurrency technology is a block of data contained in the blockchain that consists of four elements:
- Hashing algorithms;
- Transaction root value (Merkle root);
- Timestamp for block creation;
- NONCE.
Hashing Algorithms
The hashing algorithm used in blockchain technology converts the input of an alphanumeric string of data with variable length (it can be a single letter or an entire page of characters) into a fixed-length output, i.e. shortcode, which is referred to as a hash.
By being implemented in the coding of cryptocurrencies, the cryptographic function of the hashing algorithm provides swift, secure, and consistent data processing that cannot be easily edited or decrypted by an unauthorized entity. Hashing algorithms are also used for the safe storing of passwords, digital signatures, data authentication, management of both files and documents, etc.
All hashing algorithms follow strict mathematical rules that are not susceptible to amendments or adjustments. Their main function is to compress the input data into a uniform string with a predetermined length.
The user selects the most suitable type of hashing algorithm and, in the next step, they input the message into the computer that uses the chosen hashing algorithm. After this, the programmed system starts the hashing process.
By this process, the algorithm fragments the message into a series of equally sized blocks that are compressed in a chronological sequence. During the final step of the hashing, the hashed data is saved as a type of ‘message digest’ and can be sent to the intended recipient as a ‘hash’.
Once this operation is completed, it becomes irreversible, which adds to the safety of the encrypted data. At this point, we would like to bring your attention to the fact that hashing and encryption are terms that refer to different digital functions. While they can be used in the same context, they are not interchangeable.
Transaction Root Value (Merkle Root)
All information about the transactions of cryptocurrencies is hashed. Even the transaction hashes contained in a block can be hashed multiple times. This extremely complex process is labeled as the Merkle root, referring to the transaction root value.
In short, the Merkle root is the hash of all transaction hashes in the block, which is why it’s featured in the block header. By creating a Merkle root of all hashed transactions involving cryptocurrencies, the transaction accepted by the network can be securely verified by downloading only a tiny block of headers instead of the entire blockchain.
Timestamp for Block Creation
Every block in the blockchain consists of a system for describing a point in time. The so-called Unix time is a unique fingerprint for all content contained on the blockchain that prevents any kind of illegal manipulation with the data encrypted in a block. The process of timestamping the blocks enables a cryptographic digest that contains information about the time and date when the document has been included in the transaction.
This information is stored on the blockchain and provides secure keeping track of both the creation and modification time of a given document for the purpose of signing a contract or any other legal document, claiming contest winnings, e-commerce or scientific discoveries, and even in the event of designing a patent.
The blockchain content timestamp will change once any of the input elements of the block change. By having both the time and date of the data manipulation, it’s easy to track the changes and potential security breaches. This digital footprint also may serve as proof that a document once existed in the public ledger at the moment when the blockchain transaction was conducted. In addition, the timestamp of a created block can be valid evidence of the development or ownership of any other published data.
NONCE
NONCE is an acronym used in cryptographic communication that stands for a “number only used once” and has the practical use of a token in commercial applications. When this arbitrary number is encrypted in a block (or a hash) of the blockchain, blockchain miners solve it to receive crypto assets.
It’s a common practice for the NONCE to be used in the authentication protocol as insurance that the previous data will not be reused in fraudulent replay attacks of the digital network. Added to this, many of the NONCE numbers contain timestamps by which they provide an even higher degree of safety for the encrypted data.
Used in the HTTP digest access authentication protocol, these random numbers can be used only once to calculate the MD5 digest of the password. At the same time, they support the verification of passwords when entering a password-protected Internet page.
Blockchain Technology Components
There are several components that comprise blockchain technology:
- Cryptography;
- Distributed Ledger;
- Smart Contracts;
- Decentralization;
- Consensus Algorithms;
What Is Cryptography?
Cryptography is a digital method that allows for the creation of a sequence made up of smaller encrypted elements that are transmitted and stored over a network. The main aim of digital cryptography is to provide:
- Confidentiality – By encrypting the data, cryptography protects the information and makes it difficult to be understood by anyone, apart from the assigned programmer. Confidentiality protocols are used in order to prevent anyone from seeing data shared between two sites or clients. Both symmetric and asymmetric encryption algorithms are used to achieve this.
- Authentication – Authentication protocols are one of the most popular methods of data protection. With this cryptography method, it’s ensured that whoever tries to gain access to the data (person, entity, or program) is a verified user, not an intruder. At the same time, it allows for the safe transfer of authenticated data between two or more parties. The Password authentication protocol (PAP) and the Shiva password authentication protocol (SPAP) are the two most commonly used methods of data authentication.
- Integrity – In order to prevent manipulation of the data transferred between sites or clients, integrity protocols are implemented during the process of data encryption. These protocols ensure that no one modifies the encrypted information programmed on the blockchain. For this, hashing protocols of the MD5 or SHA(1,2) types are used.
- Non-repudiation – The non-repudiation protocol is used to ensure that neither of the clients in two-way communication can deny having sent or received data via the transaction. This is of especially great importance when it comes to email messaging. It provides evidence that the sender has provided particular data to the other party, while the recipient has undeniably received the data. This cryptography technique typically applies to formal contracts, communications, or data transfer.
What Is a Distributed Ledger?
Distributed Ledger Technology (DLT) refers to a distributed recording and sharing information system. It’s shared with a wider network of computers, i.e. nodes. Through these nodes, the database is enriched with new blocks on the blockchain that contain encrypted information of various transactions. This information is shared via the distributed ledger across the entire network, which is the main purpose of the DLT.
There are two broad categories of distributed ledger technology:
- A permissioned variant, and
- A permissionless variant.
In both of these categories, the nodes have the role of validators of the modification obtained via the predefined algorithm of the consensus mechanism.
What Are Smart Contracts?
The phrase smart contract refers to a computer protocol that supports making transactions without the need of a third party. This type of blockchain technology is able to provide digital verification and enforcement of a contract without an intermediary due to the decentralized character of blockchain technology.
Smart contacts facilitate transactions that focus on any sort of assets; be it money, stocks, property, or any other type of valuable commodity. Unlike traditional ones, smart contracts automatically enforce the obligations, rules, and penalties in the contract agreed between the parties.
What Are Consensus Algorithms?
Consensus algorithms are methods used to make a decision within a group that is considered as the primary root of blockchain technology. They back up the architecture of the blockchain network so that it can support millions of people who use the same platform.
There are many types of consensus algorithms, but the two most popular ones are Proof of Work (PoW) and Proof of Stake (PoS). These mechanisms help the group reach a consensus-based on several objectives, including agreement, equal rights, collaboration, cooperation, participation, and activity.
How Does Blockchain Technology Work?
Blockchain technology represents a contemporary digital model for database organization. It provides a better overview of the data arranged and stored in blocks. However, the blockchain itself does not provide decentralization. It’s obtained by the consensus algorithms.
Proof of Work (PoW) is the underlying consensus mechanism of blockchain technology. It’s utilized by cryptocurrency miners to confirm their transactions by creating a new block on the chain. When several miners are included in this process, they compete against each other for a priority to add a block with encrypted transaction data to the blockchain.
This type of activity on the blockchain is referred to as cryptocurrency mining. Basically, PoW is used to determine the way in which the blockchain validates the transactions without third-party support.
A Few Words Before You Go…
It’s worth noting that creating or mining cryptocurrencies require significant computing power, as well as that it is an extremely competitive undertaking. On the other hand, this limits the number of transactions that can be simultaneously processed, which raises the value of the digital currency.
Since the process of cryptocurrency mining utilizes difficult mathematical equations solvable only by the most powerful computers, once the encrypted equation is decoded, it cannot be repeated again. This is the highest authenticity PoW during the process of cryptocurrency creation.
Due to the fact that they hold a great value (often priced in U.S. dollars), cryptocurrencies are gaining more and more popularity. However, the crypto market is not as stable as the fiat currency one, which ultimately leads to the high volatility of digital money. Thus, the regulatory bodies and tax authorities worldwide are still trying to grapple with this modern monetary concept.