Today cryptocurrencies have become a global phenomenon known by most people but understood by few. In 2018 you would have a hard time finding a major bank, accounting firm, software company or government that hasn’t researched crypto currencies or started a blockchain project beyond the noise in the press releases.
Many people often fail to understand the basic concepts about cryptocurrencies and DeFi. So let’s walk through the whole story:
What are crypto currencies?
Invention of Bitcoin
Satoshi Nakamoto and his team of developers invented Bitcoin in 2008 as a peer-to-peer electronic cash system to realize digital cash. You need a payment network with accounts balances and transactions—that’s easy to understand. One major problem every payment network has to solve is to prevent double spending, that is to prevent one entity from spending the same amount twice.
How Record Keeping is Done on a Blockchain
Usually this is done by a central server that keeps records of all the balances in a decentralized network. You don’t have this server so you need every single entity of the network to do this job—every peer in the network needs to have a full list with all the transactions to check if future transactions are valid or an attempt to double spend.
But how can these entities keep their consensus about these records if the peers on the network disagree about one single minor balance. Everything breaks. They need absolute consensus; nobody knew how to achieve that until Satoshi proved it was possible.
How Cryptocurrency Transactions Are Processed on a Network
Cryptocurrencies are a key part of the solution; to illustrate this we will look at the transactions on the network. The transaction is a file that says Bob gives X Bitcoin to Alice and signed digitally by Bob. Once signed, the transaction is broadcasted to the network sent from one peer to every other peer. This is standard p2p technology, nothing special happening. Here after a specific amount of time the transaction gets confirmed.
Cryptocurrency Transaction Confirmation
Only miners can confirm transactions. This is their job in a cryptocurrency network— they take transactions, stamp them as legitimate and spread them in the network. After a transaction is confirmed by a miner every node has to add it to its database. It has to become part of the blockchain.
For this job the miners are rewarded with a portion of cryptocurrency. For example, for Bitcoins anybody can be a miner. They just need to use some of their computer’s power to qualify for the task. Every miner competes to solve a cryptographic puzzle, after finding a solution a miner can confirm the transaction and add it to the blockchain. As an incentive to do this they then receive a payment from the network in the form of a cryptocurrency.
Maintaining Independence of a Blockchain Network
In this way a network of independent actors are economically incentivized to maintain the legitimacy of the transaction history. So that’s the gist of it. Cryptocurrencies are the key to the complex digital cash problem that Satoshi solved; how to maintain integrity and consensus across independent and potentially malicious actors.
Cryptocurrencies are essentially the monetary incentive offered to anyone willing to keep the network secure.