A Beginner’s Guide to Cryptocurrency

Hey gents, a few people have asked me about cryptocurrency lately. As it’s something I’ve spent a couple of hundred hours studying I think I can offer some insights. I’m no Vitalik or Satoshi and I cannot read code but maybe that’s a good thing, it means I’ll keep things nice and simple. For this first article I’m going to lay the groundwork for understanding crypto. To that end I’ve chosen five words / ideas / whatevers that you will come across in the cryptosphere again and again. If you can wrap your head around these you’ll have a much better idea what the hell everyone is talking about.

1. Mining

If you’ve heard about Bitcoin you’ve heard about mining. Bitmain, the largest Bitcoin mining company in the world, just opened an office in Silicon Valley and they’re looking to go public at some insane evaluation that’s probably billions more than they’re worth… But what is mining?

In the simplest terms mining secures a cryptocurrency, it’s what prevents hackers from stealing funds or otherwise screwing up the network. The basic idea is that a bunch of different people (or, as it has worked out in practice, a small group of very powerful wealthy people) devote an obscene number of computer processors (ASICs) to doing complex math problems. These miners, ostensibly the “good guys”, secure the network. If a hacker wanted to steal some Bitcoin he would need to control more than half of the computer processors doing this math. Given that there are literally dozens of football sized warehouses filled from floor to ceiling with processors, that would be prohibitively expensive.

If you’ve heard about miners getting paid it’s because they do. Their reward for buying all these processors and paying for electricity is a steady stream of sweet, sweet coin. The largest miners make tens of millions of dollars a month. In the early days of Bitcoin the average guy with a computer could mine but that’s the case no longer.

2 – Proof of Work / Proof of Stake

Proof of Stake, POS, is a newer system that doesn’t require miners. Instead of doing a bunch of pointless math and burning rainforests to generate electricity, a person “stakes” their coin and earns a reward. If a bad actor attempts to make a fraudulent transaction, they lose the coins they’ve staked. Let’s simplify it with an example.

Five people are playing a game and each person puts in $1,000. As long as they play by the rules, they get $5 every hour they play. It’s not a bad deal and people are incentived to play. However, in our example player three decides to cheat. He wants to influence the game so that he gets $25 and everyone else gets nothing. Well, the other players are pretty smart and they catch player three and he gets kicked out of the game and doesn’t get his $1,000 back. Damn. So that’s proof of stake, everyone puts up some coin and if someone tries to cheat the network they lose their investment. It’s an environmentally friendly solution to Proof of Work (POW). Transactions are validated by coin in an escrow account, instead of by electricity and pointless math.

3 – Node

I have to be honest, trying to pin down a good definition of a node is difficult for me. Maybe I don’t understand it backwards and front but let’s have a shot anyways. A node is a computer which carries a full copy of the blockchain. Depending on the blockchain this could be smallish or largish. Bitcoin’s blockchain is 173 GB and Monero’s is 57 GB. Why would anyone want to “spin-up” a node? A couple of reasons. The first is that it helps to decentralize the network. Bitcoin is resilient because a copy of the ledger (the blockchain) is stored on thousands of (five-thousand something at present) computers all around the world. No country can shut it down just as it’s impossible to eradicate those pesky torrents.

Another advantage of running a node is that, depending on the coin, you may get some kind of voting rights (big caveat that running a node is often not enough to get voting rights, you also have to own a (significant) amount of coin). And finally, if you run a node you can self-validate a transaction. However, this isn’t a big deal for about 99% of people and by the time you understand the advantage of running a full node you won’t be reading this article. For now, you can think of a node as a water cooler in the office. It’s a place to take in and give out information, the social hub of a blockchain network.

4 – Permissioned / Permissionless Blockchain

There are two types of blockchains, one that anyone can participate in and another which is a closed environment. Ethereum, Monero and Bitcoin are permissionless blockchains (among many others). Anybody can run a full node and anybody can mine, they are as decentralized as a blockchain can be. On the other hand, you have cryptocurrencies like NEO and XRP. These are permissioned blockchains where only approved computers / servers can run a full node. Security, that’s why any of this matters and it comes in two forms.

  1. Security – State actor (government) shutting down a blockchain.
  2. Security – Bad actor (hacker / huckster / fraudulent dudes) trying to defraud others.

XRP and NEO* (and any other permissioned blockchain) can, theoretically, be shut down (point #1). They have a limited number of nodes and if you take those offline the blockchain dies (whereas Bitcoin, Ethereum and any other cryptocurrency with thousands of nodes across the world are virtually impossible to shut down). So why have a permissioned blockchain if it can be shut down?

A couple of advantages, the first is speed. If you select the nodes that can participate on the network then you don’t have to worry so much about security (point #2). If you don’t have to worry about security then you can speed everything up. The fewer nodes, the more trusted they are, the easier it is for them to vote to approve transactions. Thus you see XRP confirming transaction in a matter of seconds and NEO claiming 10,000 TPS (Transaction Per Second). Bitcoin can do 4 to 7 TPS and it takes 10 or 20 or 30 minutes to confirm a transaction. Permissioned blockchains are way, way faster and way, way more susceptible to being shut down.

*NEO and XRP are two cryptocurrencies which seek government approval and regulatory conformity. In other words, the opposite of Bitcoin. They are not worried about government intervention because they work with regulators.

5 – Confirmations

In the last section I mentioned confirmations, let’s have a look at that. A confirmation is proof that a transaction is valid. On the Bitcoin network a confirmation happens every ten minutes and most websites / exchanges / merchants require several confirmations before they credit funds to your account. In a nutshell, once you have a couple of confirmations everybody knows that you’re not a scammer, your funds are valid and you actually have the coin that you claim to. Figuring out how long it takes to confirm your funds is easy. Just look at the number of required transactions multiplied by the time to confirm a block. In the Bitcoin network a block is confirmed every 10 minutes and most websites require 2 to 4 confirmations. That means you’ll wait about 20 to 40 minutes before you can access your funds.

Some coins like Bitcoin Cash (more about them in another post) urge merchants to accept 0 confirmation transactions for small orders like coffee or dinner (not Lambos). If a merchant chooses to accepts 0 confirmations, a payment will settle within several seconds (although there is a small risk of fraud, again, discussed in a later post).

Still, no matter how you look at it, 0 confirmations with a risk of fraud or 2 to 4 transactions with waiting thirty minutes is not as good as a blockchain like XRP which fully settles with no chance of fraud within 3 to 10 seconds. So why the hell doesn’t everyone just use a permissioned blockchain? That’s a question for another post (we obviously have quite a few posts coming). Suffice to say for now, people claim permissioned blockchains are the devil’s minions and stand for everything that crypto hopes to defeat. Today though, we’ll stick with the basics. Hopefully you now have a better idea of some key terms in crypto. If you have any questions please feel free to leave a comment below, I’ll answer it!