Cryptocurrency and Bitcoin - How does it work? Why is bitcoin so popular?

What is Cryptocurrency and Bitcoin?

Before starting with Cryptocurrency, let's first understand what is a Currency?A Currency is a medium of exchange for goods and services. In the modern world, a currency is money in the form of paper or coins that is issued by the Government and serves as a method of payment for goods and services.

A Currency in a nation is controlled by a central authority, for example in India, it is the Reserve Bank Of India. This central authority has complete control over the currency of a nation, it decides how much money has to be printed or circulated in the nation, it ensures the stability of the currency and supervises the banks and many more.

Although there are many upsides to this system, there are also downsides:For example, when we deposit our money in banks, they use our money to give out loans to their customers at high interest rates, whereas the interest gathered by the money in our account is very low. We put our full trust on banks to secure our money. But banks sometimes misuse our money, they give out huge loans to big companies or industrialists using our money without performing a thorough check and sometimes these loans become bad debts and when some of these companies go bankrupt and can't pay back their loans, it is the small depositors who become victims.

We also have limited control over our own money. We are allowed to make a withdrawal within a certain limit and if our money in our account is below a certain limit we have to pay a fine. So you see banks make sure that we must play by their rules, even though it is our own hard earned money.

What is Cryptocurrency?

When Cryptocurrencies was introduced, they had one thing in mind and that was, to eliminate this central authority and let the owner stake complete control of their own money. Cryptocurrency comes from two words, Cryptography and Currency. We have already seen what is Currency, whereas Cryptography in the context of Cryptocurrencies is the use of complex mathematical calculations to secure the transactions made without trusting a third party member such as bank.

A Cryptocurrency is a decentralized digital currency that is designed to work as a medium of exchange that is not reliant on a central authority such as banks or government. The first Cryptocurrency that came into existence was Bitcoin when it was introduced in 2009.

Bitcoin is a digital currency which is decentralized and can be sent from one user to another through a peer to peer network. Anybody who wants to send or receive bitcoins must communicate with each other through this network. And Bitcoin runs on blockchain technology.

Now, if you want to own a bitcoin, you must thoroughly understand what it is and what is actually happening inside the computers when we send or receive a bitcoin.

Now let us go into the details about bitcoin.What is bitcoin?

Bitcoin is actually just a spreadsheetthat records all of the transactions made by the users and this spreadsheet is called a ledger

This ledger is public and anyone can add their transactions. Now, if it is public and anyone can add their own transactions, what if a user wants to add a transaction which is not legitimate. Bitcoin solves this problem by the use of a Public-Private Key pair and a digital signature. Anybody who wants to send or receive bitcoins must be issued a Public-Private key pair.

Now what is this public-private key pair? You can think of the public key as your bank account number and the private key as your ATM PIN, or signature that provides control over your account.

Let’s understand it this way, the public key is like your email address and the private key is the same as the password. Using your email address, anyone can send you an email but only you can read it using your password. Just like an email address, the public key can be shared but like a password, a private key must be kept private at all times.  So, in Bitcoin technology, a Public key is actually the address to send bitcoins so if you want to receive a bitcoin you must provide your Public key to the sender similarly if you want to send bitcoins to others you must get their Public key to send to. This also leads to becoming anonymous on the network, where you don’t have to share your personal details but just your Public key. Whereas a Private key is necessary to release the bitcoins from the user. So if a user wants to send bitcoins the user must provide the Private key to verify that they actually have enough bitcoins to send. But that would mean they would have to share their Private key in order to prove that they own the bitcoins.

To solve this problem digital signatures are introduced. Digital signature is 256 bit long and it is impossible to crack it and the only way to crack it is by random guessing which would probably take millions of years. This signature is generated by signing the transactional data with the Private key, Sign(Data, Private Key) = Digital signature. The signature is then attached along with the transaction data.

Now, this signature is verified by the Miners to prove that the one who signs the signature with the Private key is the owner. So, in this way, a Private key ensures
a safe and secure transaction.

Now, the next part is where is this ledger kept? If this ledger is kept at a single location then it is similar to a central authority controlling the currency. As we know, bitcoin is a decentralized digital currency which means there is no single authority controlling bitcoins. Therefore the ledger is stored on computers across the bitcoin's network and those computers are called nodes. There are thousands of nodes on the network and each node records every new transaction on a blockchain.

Now, coming to Blockchain, it is a way of storing information where the information on the blockchain cannot be changed, manipulated or tampered. The information is stored in blocks that are linked to one another, where if you tampered with one block, it would render the entire blockchain to be invalid and the tampering will be rejected. The Bitcoin ledger is stored on this blockchain.

Now, let’s discuss another concept in bitcoin, called Mining. Mining is the process by which new blocks are created and these blocks are broadcast to every node on the network to be added to the blockchain. New blocks are created approximately in every 10 minutes. The creators of these blocks are called Miners and are rewarded for every block they create.

Before the creation of these blocks, Miners must verify that the transactions and digital signatures are legitimate. This way they help secure bitcoin's network against any fraudulent activities and maintain the integrity of the currency.

A Bitcoin is not generated like a normal currency by printing notes. It is generated through mining in a similar way our natural resources are mined. The way natural resources are limited, in the same way bitcoins are also a finite number, so we mine them. In the banking system, they have a centralized system to control transactions, but there is no centralized system in bitcoin, instead it allows millions of people to verify transactions and ensure the Bitcoin network remains secure through blockchain, making the whole system decentralized.  

Miners are also rewarded for every block they help create by getting some amount of bitcoins. This system of rewarding the miners with bitcoin is how bitcoins are generated and which is why they are called Miners. Now, the miners don’t need to do any calculation to mine a bitcoin. He just needs a computer, which can participate in the network. You just need to install the system and leave it, it has an automatic algorithm. So, the miners are those who run the automatic lgorithms in their computer. The faster your computer works, the faster you can generate bitcoin.

Miners are rewarded by a set of rules set by its creator. The original reward was 50 bitcoins per block when it started in 2009 and after every 210,000 blocks which is approximately after 4 years, the reward is cut to halve. Now with the original reward of 50 bitcoins per block, currently we are at 6.25 bitcoins per block. The reward for mining Bitcoin has been decreasing as the amount of unmined Bitcoin is declining. There exist only a finite number of bitcoins, which is exactly 21 million bitcoins. Around 19 million bitcoins have been mined so far and only 2 million will be mine in the future and it is predicted by experts that the last bitcoin will be mine in the year 2140. From that point onward, Bitcoin miners will earn profit only from transaction fees.

There are millions of Miners around the world and they create their own blocks, now another challenge is, how do every node on the network decide which block should be added to the blockchain so that the blocks in the blockchain are in the same order on every node. This is addressed by another concept called Proof of Work. Proof of Work(PoW) is the consensus algorithm in a blockchain network. In simple words, it is nothing but a form of cryptographic proof where a miner proves to other nodes in the network that certain computational effort has been expended to solve a computational puzzle.

In this process, bitcoin software actually creates a challenge or a computational puzzle and all miners compete against each other to solve the challenges, and this challenge will take approximately 10 minutes to be completed. The winning miner receives the reward only after the other nodes in the network verify that the solution is correct and valid.The process of proof-of-work algorithms is not there to prove that certain work was carried out but to prevent anybody from gaming the system and manipulating the transaction records.  

Because proof of work requires expensive equipment, it makes it increasingly less likely that someone will seek to manipulate a transaction. So, the process ensures adequate security but this system requires a large amount of electricity for solving the challenges and thus, this process has always been criticized by many environmentalists for their energy consumption.  

Why is bitcoin so popular?

Well, the first reason is because it was the first cryptocurrency that came into existence. Currently, there are many Cryptocurrencies available. But since bitcoin was introduced a little earlier its value has also significantly gone up compared to the others. And because it is decentralized, more power is given to the people and that’s why, people are investing in bitcoin.Also, bitcoin is quite secured considering there are millions of Miners around the world mining for bitcoin and protecting the integrity of the Currency.

How is Cryptocurrency different from Digital currency?

Let’s first define what is a digital currency? A digital currency is a currency or money that is stored, managed and exchanged on computers over the internet. We already know Cryptocurrencies are run on computers as well so, they are also a digital currency, but what sets them apart from other digital currency are that they are decentralized where no single person or authority has complete control over the Currency unlike other digital currencies that are completely controlled by the Government.

With Cryptocurrencies, there is hardly any involvement of paperwork which is very convenient unlike other digital currency. We don't need any trust with Cryptocurrency since they are secured by Cryptography whereas with digital currencies, we need to put our full trust with the banks. Cryptocurrencies will continue to grow in the future and their possibilities are endless. Currently, the value of 1 bitcoin is about Rs 30 Lakhs. Now that’s a huge amount and this shows the potential of Cryptocurrencies.