CRYPTOCURRENCY

Module - 2
Topics to be Covered
2.1 Cryptocurrency
1. Bitcoin, Altcoin, Tokens (Utility & Security)
2. Cryptocurrency Wallets (Hot & Cold Wallets)
3. Cryptocurrency Usage
4. Transactions in Blockchain, UTXO and Double Spending Problem

2.2 Bitcoin Blockchain

1. Consensus in Bitcoin
2. PoW, PoB, PoS, PoET
3. Life of a Miner, Mining Difficulty
4. Mining Pool & its Methods
 Generated, Stored and Refers to all CRYPTOCURRENCY
Transferred Electronically. encrypted
decentralized
digital currencies
CONCEALED System or Type of Money

● Cryptocurrencies are digital currencies designed to be

Faster, cheaper, and more reliable than money.

● It is an OPEN SOURCE ENCRYPTED LEDGER of transactions The first cryptocurrency

built on Blockchain Technology was Bitcoin, which was first
released as open-source
● Cryptocurrency is still in its Infancy, and considered more software in 2009.
as an INVESTMENT OR COMMODITY rather than a
currency

ETHER, LITECOIN, TETHER are some popular cryptocurrencies other than Bitcoin
 Money vs Currency
Money is anything which is Currency is the physical or
generally accepted as a tangible representation of money
medium of exchange, Always in the form of paper notes & coins
seen in numbers
 WHAT IS CRYPTOCURRENCY
1. Cryptocurrency is a digital asset that is used as a medium of exchange on the Blockchain
2. The most popular cryptocurrency is BITCOIN, followed by Ether of Ethereum and XRP
tokens of Ripples
3. Since the creation of Bitcoin, thousands of alternative digital currencies, referred to as
ALTCOINS or COINS and TOKENS

Used for Buying or Selling Used as a Utility or Security

products or services

4. Cryptocurrency & Blockchain projects all have open-source code to foster trust & safety.
 CRYPTOCURRENCY
● Developers can copy the open-source software & modify it to build compatible
applications. E.g. Building Wallets on existing blockchain or build a completely new
cryptocurrency network like LITECOIN
● The process of duplication from an existing blockchain is called FORKING.
● A fork creates an alternative versions of Blockchain.
● Forking is usually done to apply UPGRADES OR NEW GOVERNANCE RULES to a
network.
 BLOCKCHAIN FORKS

● A fork is a change to the blockchain protocol. It is essentially a divergence from the

previous version of blockchain.
● Forking is a technical phenomenon that occurs when a blockchain splits into two separate
branches.
● These two branches share their transaction history up until the point of the split. From there
on, they each go independently each in their own direction.
 BLOCKCHAIN FORKS
Creating new tokens from scratch is the most common method.
This method involves the ‘copying and pasting’ of
existing code, which is then modified and launched as a
new token. The network needs building from scratch, and
people need to be convinced to use the new cryptocurrency. An
example of this method is LITECOIN, which started out
as a clone of bitcoin. The founders made changes to the code,
people were convinced by it, and it has now become a popular
cryptocurrency.
The alternative method is to fork the existing
blockchain. With this method, changes are made to the
existing blockchain rather than starting from scratch. In this
case, two versions of the blockchain are created as the network
splits. An example of this can be seen with the creation of
bitcoin cash. Differing opinions around the future of bitcoin led
to the creation of a new cryptocurrency (bitcoin cash) from the
original cryptocurrency (bitcoin).
 Forked Blockchain
FORKS IN BLOCKCHAIN
Both can
coexist at
the same
time.
Original Blockchain

The genesis block is the very first block from which the blockchain starts.
The divergence block is the block from which a new fork has been created with updated rules.
Prior to the divergence block, all blocks share a common history.
FORKS IN BLOCKCHAIN
Forking in blockchain occurs due to several reasons, such as:
1. Change in protocols
2. Multiple miners simultaneously mining the same block
3. A lack of consensus between stakeholders (users)
4. Adding new functionalities FORKS
5. Fixing security issues
6. Reversing transactions

Accidental forks Intentional forks

1. Such forks occur when multiple miners mine a block As their name suggests,
at the same time. intentional forks occur by
2. As their name suggests, accidental forks occur by intention.
accident. The users are aware of the action
3. No change in protocols or instructions causes these and approve it, that is why it is
forks. called an intentional fork.
FORKS IN BLOCKCHAIN
FORKS

Accidental forks Intentional forks

Hard forks Soft forks

A hard fork is a fork that introduces new rules and A soft fork does not require nodes to be
requires the nodes in the network to upgrade their upgraded. They can keep running the old
software. software version and still participate in the
upgraded network as validators of
transactions.
HARD FORKS IN BLOCKCHAIN
• A hard fork refers to a radical change to the protocol of a blockchain network that
effectively results in two branches, one that follows the previous protocol and one that
follows the new version.
• A hard fork implies a change to a software protocol that makes older and newer versions
incompatible.
• When hard forks occur, new currency comes into existence. An equivalent quantity of
currency is distributed to the full nodes that choose to upgrade their software so that no
material loss occurs.
• When a hard fork occurs, the community members (users and miners) must make a
decision. They can either update their node and switch to the newly-forked chain, or they
can keep running the old software.
• Blockchain forks occur quite often. In fact, they are one of the ways of creating new
cryptocurrencies. Some popular currencies are products of hard forks.
HARD FORKS IN BLOCKCHAIN - Examples
Bitcoin Cash, which forked from Bitcoin in August 2017. The Bitcoin
Cash fork changed the block size limit from 1 to 8 MB and later to 32
MB.

Another example of a hard fork is Ethereum Classic. This was created in October
2016, when a group of developers rejected new rules that were implemented with
a hard fork. Instead, they opted to keep using the old Ethereum blockchain, which
was later renamed Ethereum Classic.
SOFT FORKS IN BLOCKCHAIN
• When there is a change in the software that runs on full nodes to function as a network
participant, new blocks are mined based on new rules in the blockchain protocol and are
also considered valid by the old version of the software. This feature is also called
backward compatibility.
• Blocks created by the latest software version will be accepted by old version nodes, but
not the other way round. The newer software will reject old blocks, thus forcing users to
upgrade. This is a snowballing process.
• As more miners switch to the newer version, the longer their chain becomes, encouraging
the other miners to update the software and join the mainstream.
Soft fork examples:
Block size limit. Initially, Bitcoin did not have a block size limit, the restriction to 1MB was
introduced through a soft fork.
 CHARCTERISTICS OF CRYPTOCURRENCY
DECENTRALIZED:
Fiat currencies are issued by government and regulated by the Central Bank. Thus, government – issued policies &
control of supply can affect the value of the currency. But, Cryptocurrency is not backed or controlled by any bank
or central authority. This feature means that NO CENTRAL BODY can control or influence the value of the
cryptocurrency.

FORM OF EXISTENCE:
Fiat currencies can exist in both physical and digital forms that allow electronic transfer of money whereas
Cryptocurrency can only exist in DIGITAL FORM. They are not tangible & are developed by software code and
Cryptographic algorithms
LIMITED SUPPLY:
The supply of cryptocurrency is limited. The maximum supply of cryptos that can ever be generated or mined is
defined when the genesis block is created

GLOBAL ACCESS
Due to decentralized nature of blockchain anyone can access & transact in cryptocurrency irrespective of their
geographical location. There are no cross-border restrictions & their use is not limited to only those having access to
banks. This allows very low transaction fees as Third Party intervention is removed
 CHARCTERISTICS OF CRYPTOCURRENCY
ANONYMITY & TRANSPARENCY:
In cryptocurrency, a transaction is linked to person’s cryptocurrency address and not the
person’s name, or any other personal details. Thus, anonymity is maintained. At the same time,
every transaction record is stored in blockchain ledger as a list of open, yet encrypted records
making it transparent, verifiable and honest

IMPOSSIBLE TO DUPLICATE
Cryptographic encryption and consensus protocol make counterfeiting cryptocurrency
impossible

IRREVERSIBLE
Cryptocurrency transactions are irreversible. This feature has its pros & cons. Once a
transaction is recorded & verified, it is irreversible & impossible to change.
This foster Trust, Integrity and Auditability BUT if a cryptocurrency is sent to the wring address,
the coin is lost forever.
Hence, users must be vigilant to fall for cryptocurrency scams or frauds.
 Cryptocurrency Wallets (Taken in Module 1)
Hot wallet Cold wallet

These are usually free, and some pay These require the purchase of an
Price
interest on stored crypto. external device, around $50 to $250.

Hot wallets are convenient to access and Cold wallets are better suited for long-
Better for
use for trading. term storage.
Maximum
Hot wallets can store anywhere from one to Cold wallets store anywhere from
number of
tens of thousands of cryptocurrencies. 1,000 to tens of thousands.
cryptos

Excellent. They can’t be accessed

Average. Because they are connected to the
online, but they require security
Cybersecurity internet, they could potentially be vulnerable
measures to keep them from getting
to hacking.
damaged, lost or stolen.
 Cryptocurrency Wallets (Taken in Module 1)
Hot wallet Cold wallet

Average. Most have recovery

Good. Most have recovery and backup options and backup options for a lost
Loss protection
and can be accessed from multiple devices. password, but not for a lost
device.

Average. Cold wallets require an

Ease of transfer Excellent. Hot wallets are easily accessible as the
extra step to connect online
to exchanges wallet is already internet-connected.
through USB, Wi-Fi or QR code
 Types of Cryptocurrency

BITCOIN ALTCOIN TOKEN

Derived from Derived from

Original Original
BITCOIN Blockchain
E.g. Litecoin, Dogecoin E.g. Ether, NXT
Types of Cryptocurrency BITCOIN
✓ Bitcoin was introduced to the public in 2009 by an anonymous developer or group of
developers using the name Satoshi Nakamoto.
✓ Bitcoin (BTC) is a cryptocurrency, a virtual currency designed to act as money and a
form of payment outside the control of any one person, group, or entity, thus removing
the need for third-party involvement in financial transactions.
✓ It is rewarded to blockchain miners for the work done to verify transactions and can be
purchased on several exchanges.
✓ Unlike fiat currency, Bitcoin is created, distributed, traded, and stored using a
decentralized ledger system known as a blockchain.
✓ Bitcoin and its ledger are secured by proof-of-work (PoW) consensus, which is also the
"mining" process that introduces new bitcoins into the system.
Types of Cryptocurrency ALTCOIN

✓ "Altcoin" is a combination of the two words "alternative" and "coin." It is generally

used to include all cryptocurrencies and tokens that are not Bitcoin. Altcoins belong
to the blockchains they were explicitly designed for. The first altcoins launched in
2011, and, by now, there are thousands of them
✓ Many of the Altcoins come from a fork of famous and durable cryptocurrencies like
Bitcoin, Litecoin and Ethereum.
✓ These forks generally have more than one reason for occurring. Most of the time, a
group of developers disagree with others and leave to make their own coin.
Types of Cryptocurrency ALTCOIN

✓ Many altcoins are used within their respective blockchains to accomplish something, such as
ether, which is used in Ethereum to pay transaction fees
✓ Some developers have created forks of Bitcoin and re-emerged as an attempt to compete with
Bitcoin as a payment method, such as Bitcoin Cash.
✓ Others fork and advertise themselves as a way to raise funds for specific projects. For example,
the token Bananacoin forked from Ethereum and emerged in 2017 as a way to raise funds for a
banana plantation in Laos that claimed to grow organic bananas.

Altcoins attempt to improve upon the perceived limitations of whichever cryptocurrency

and blockchain they are forked from or competing with. The first altcoin was Litecoin,
forked from the Bitcoin blockchain in 2011. Litecoin uses a different proof-of-work (PoW)
consensus mechanism than Bitcoin, called Scrypt, which is less energy-intensive and quicker
than Bitcoin's SHA-256 PoW consensus mechanism.
Types of Cryptocurrency ALTCOIN

FEATURES THAT ARE COMMON TO ALL ALTCOINS

1. They are peer – to – peer digital currencies that involve a mining process

2. They possess their independent Blockchain

3. They possess the characteristics of money i.e. they are fungible, divisible and

have limited supply, and typically meant to operate only as a means of

payment.
 Types of Cryptocurrency TOKEN
✓ Tokens are another category of cryptocurrency that resides on top of existing
blockchain.
✓ Unlike coins that needs to be built from scratch, tokens are created using standard
templates from Blockchain Platforms like Ethereum
✓ The Basic Principle is that running several applications on a shared sturdy blockchain
is more practical and business savvy than executing a single application on a
blockchain that needs years to build up its network & reputation
✓ Tokens and their underlying applications benefit from the technology and security of
Native Blockchain, as they can leverage their existing mining strength and inherent
resistant to attacks.
 EXAMPLE TO UNDERSTAND TOKEN

✓ Ethereum is a blockchain, and this blockchain's native cryptocurrency is called Ether.

Since Ether has its own blockchain, it's considered a crypto coin.
✓ One of the things that made Ethereum special is that it was the first programmable
blockchain. Because it's programmable, developers can use it to launch their own
cryptocurrencies. These cryptocurrencies operate on Ethereum's blockchain instead of their
own, which makes them crypto tokens (the official term for tokens built on Ethereum are
ERC-20 tokens).
DeFi tokens like Chainlink and Aave run on top of, or leverage, an
existing blockchain, most commonly Ethereum’s.
How do Crypto Tokens Work? TOKEN
As cryptocurrencies, crypto tokens are assets with value. They can typically be transferred,
traded, bought, and sold, and they're stored in blockchain wallets.
Transactions with a crypto token are processed on the blockchain that it uses.
For example, if it's an ERC-20 token built on Ethereum, then the Ethereum blockchain will
handle all transactions for that token. In addition to their role as a currency, crypto tokens can
serve many other purposes. Here are a few of the most common uses for crypto tokens:
• Governance tokens: A governance token is a crypto token that gives the
holder voting rights in a cryptocurrency project. Token holders are able to
make and vote on proposals that help determine the future of that specific
cryptocurrency. The more tokens you hold, the more voting power you have.
How do Crypto Tokens Work? TOKEN
• Decentralized finance: Decentralized finance (DeFi) refers to alternative
financial systems built on blockchain technology. For example, instead of getting
a loan from a lender, you could put up crypto tokens as collateral and get one
from a DeFi platform. Each DeFi platform has its own token that it uses as its
official currency.

• Crypto rewards: The previously mentioned DeFi platforms rely on investors

who lend their own cryptocurrency funds. In return, investors receive crypto
rewards as an incentive. These rewards are usually paid out as crypto tokens.

• Non-fungible tokens: A non-fungible token (NFT) is a crypto token that

denotes ownership of a digital asset. The ownership information is stored in the
cryptocurrency token. NFTs can be used to show who owns a unique digital
image, a GIF, or a character in an online game.
 How are Tokens differ from Altcoin
1. They are digital assets that are built to perform a specific function within the project
ecosystem and not operational as a typical cryptocurrency.
2. They do not have purchasing power i.e. Tokens can be bought with coins, but coins
cannot be bought with tokens
3. They are built to interact with Decentralized Applications (Dapps) that sit on an existing
blockchain network like Ethereum, NEO. Hence, they are easier to create than coins ,
that need new coding or code modifications, thus saving the application developer time
and resources.
Tokens are created and distributed to the Public through Crowd Funding method called Initial
Coin Offering (ICO), where tokens are issued in exchange for funding a potential blockchain
project.
 Types of Tokens
Based on the function of the token, they are typically divided into 2 types:
UTILITY TOKENS SECURITY TOKENS
Utility tokens offer the holder the right or license Security tokens, also referred to as Equity Tokens,
to use a product or service e.g. ETH issued entitle the holder to a share or equity in the company
during an ICO, these tokens can, in the future, or startup
be redeemed to access the product or service
of the company or project.

They are considered free of regulatory Security tokens are issued during STO or Security
restrictions as they are not built to function as Token Offering, which is a variation of ICO with more
an investment instrument, but to facilitate the regulatory and due diligence controls fostering
funding of ICOs. investor confidence.

The token holder may have some voting rights They are seen as an Investment Opportunity. As the
within the ecosystem. However, they do not tokens represent percentage ownership of the
have any decisioning power in the direction that company, including voting rights & decision making
the company or project can move power, they are subject to regulatory restrictions
 Types of Tokens - EXAMPLES
UTILITY TOKEN: - CVC token used by Civic, an identity management application that
keeps track of encrypted identities on the Ethereum Blockchain

SECURITY TOKEN: - BCap of Blockchain Capital, Spice VC are example of security

token

SEC classifies tokens as securities if they pass all the following criteria set by the ‘Howey
Test’ to classify the security as an investment contract:
1. There is an investment of money or assets
2. There is an expectation of profits from investments
3. The investment is in a common enterprise
4. The expectation of profit is solely from the efforts of a promoter or third party
Cryptocurrency Usage: A blockchain is only as strong as its community
Ecosystem Crypto Airdrop Token or Investing & Cryptocurrency
Players mining Coin Burning Trading Safety
Programmers Solo Benefits of Airdrop 1. To reward Investing in 1. Best Practises
Or Mining Investors Cryptocurrency in Using
Developers Exchanges
Miners Pool 1. Marketing & Hype 2. To destroy Trading in 2. Storing
Mining Unsold ICO Cryptocurrency Cryptocurrency
Tokens
Users 2. Rewarding loyalty 3. To 3. Transaction
supporters & Investors decentralize Safety
Mining
Opportunity
Merchants 3.Wider & Even 4. Enable
Distribution of Tokens Security
Measures
Traders 4. Lead Database
Generation
Cryptocurrency Usage:
Ecosystem Players
Programmers Or Developers: The success of the blockchain project is established by a strong team of
blockchain programmers or developers. Blockchain programmers develop and maintain the blockchain protocols,
applications and interfaces. They design different levels of functionality of the blockchain such as protocols,
architecture, consensus design etc. Developers continue to monitor & maintain the blockchain technology as per
needs & requirements
Miners: Validate new transactions & record them on the blockchain. They contribute their effort & computing
power for solving the cryptographic problem & are rewarded with block reward or transaction fees. In PoS, they are
referred as FORGERS.
Users: A blockchain user is a consumer who uses the blockchain or cryptocurrency for the purpose it was
designed for E.g. Doctors & Patients use Veris Foundation Blockchain. Users are represented as nodes that have
a copy of the ledger related to their needs for initiating, reading or creating transactions
Merchants: Are retail or other business entities that accept cryptocurrency as a form of payment for their
good or services
Traders: Speculate and Buy/sell cryptos based on the price movements via a decentralized exchange. Traders
sometimes use Brokers to help them in getting the best market rate & minimal slippage for long term profitability.
Cryptocurrency Usage
Cryptomining: Miners generate wealth through mining. For this, a miner needs to have some level of
technical knowledge & expertise in setting up computing software & equipment. In Bitcoin a successful
miner gets a Block reward of 3.125 BTC while for Ethereum it is 2ETH + Additional fees per block.
Solo Mining: Miner works independently to find the block. They have large mining equipment & do not
rely on Third party. The miner connects to the network via their wallet. Once the block is added to the
chain, the miner is credited with FULL BLOCK REWARD. Disadvantage: It may take a long time to
find a block
Pool Mining: This is when a group of miners join their collective computational resources over the
network towards faster processing of the hash function. The miners submit the block hashes into the
pool. If any of the hashes are successful in creating the block, then the mining pool distributes the
reward between all the miners, proportional to their contributed processing power or as per the terms
agreed. Higher success rate & consumes fewer resources making it economically viable.
Disadvantage: Rewards are divided.

There are different types of mining based on processors or equipments used by the miner:
CPU Mining, GPU Mining, ASIC Mining, Cloud Mining
Cryptocurrency Usage:
Airdrop: Is promotional activity aimed at spreading awareness among the blockchain
community. It is a distribution event where blockchain project distributes free coins or
tokens to wallet address to create a market for the project & buzz among investors
Benefits of Airdrop
1. Marketing & Hype: Dropping free coins in a wallet can lead to free advertising for the blockchain project
through word of mouth, websites etc.
2. Rewarding loyalty supporters & Investors: If users keeps substantial tokens of the company in their
wallet, the company rewards them with free tokens. Also, tokens are given for providing loyalty services like
promoting the cryptocurrency on social media, writing reviews, etc.
3.Wider & Even Distribution of Tokens: Airdrops are an effective method of achieving wide & even
distribution , especially for utility token projects. It helps these projects gain new users & contributors, & at
the same time retain existing users which leads to high level of engagement within the community

4. Lead Database Generation: Airdrops are great mechanism adopted by companies for lead generation.
Users are requested to fill online forms to claim their free coins/tokens. This valuable user information can
be used by companies to develop targeted marketing campaigns & strategies.
Cryptocurrency Usage
TYPES OF AIRDROP:

1. SURPRISE AIRDROP

2. PLANNED AIRDROP
Cryptocurrency Usage
TOKEN or COIN BURNING
✓ Is a process of permanently removing coins out of circulation to reduce the total supply.
✓ The primary aim of Token Burn is to reduce the existing supply of coins/tokens & thereby to
increase their value
✓ A coin is said to be burned when it is sent to an unspendable public address, known as
EATER ADDRESS, which does not have any operable private key associated with it.
✓ The transaction is transparent on the blockchain for anyone to confirm that the coin(s) were
sent to the address, but at the same time, the address does not belong to anyone & has no
practical value .
✓ This is referred as Proof of Burn, wherein anyone can check & verify that the coins were
legally destroyed or burn. i.e., in effect put out of circulation
Cryptocurrency Usage
Coin Burn is initiated when the user calls a burn() function with the
amount of coins one wants to burn.

✓ A smart contract then verifies whether the user has the stated amount
or not. If available, the coins are sent to the eater address, and the burn
is completed.

The KEY PURPOSE of burning coins is to increase the value of the

remaining coins that are in circulation.

Reasons for COIN BURNING

1. To reward Investors
2. To destroy Unsold ICO Tokens
3. To Decentralize Mining Opportunity
Cryptocurrency Usage
INVESTING & TRADING

✓ This is perhaps the easiest way for the public to generate wealth through
CRYPTOCURRENCY.
✓ The common principle if “BUY LOW, SELL HIGH”
✓ Investors are in it for LONG-TERM PROFITS, whereas TRADERS are focussed on
SHORT-TERM GOALS.
✓ Compared to the stock market, the cryptocurrency market is extremely volatile, with
upward & downward market trends occurring in very short periods. Hence there are
equal chances of making HUGE PROFITS or INCURRING HIGH LOSS
Cryptocurrency Usage
INVESTING IN CRYPTOCURRENNCY TRADING IN CRYPTOCURRENCY
Traders are speculators & have a higher risk
Investors are generally risk-averse, & they
appetite than investors
take a stance that cryptocurrency is still in its
infancy. They aim to buy low and sell high within short
periods. The trader is also willing to drop coins if
Investors study the inherent value of the the market trend looks bad or does not seem to
company by evaluating the financial pick up, even if it means a small loss.
statements, research reports & other
Since cryptocurrency is volatile market, traders
economic factors.
tend to make huge profits if they do it right

Investors keep an eye out for potential ICOs, Traders are not interested in the intrinsic value of
HARD forks & airdrops for investments their assets but on the potential for percentage
gains. They base their decisions by analysing
hourly price movements as well as historical price
data
Cryptocurrency Usage
CRYPTOCURRENCY SAFETY
✓ Currency is only as safe as the CUSTODIAN.
✓ In Cryptocurrency World, you are the sole owner of the money. Transactions once executed,
cannot be reversed.
✓ Verification is done with private keys, and if the private keys are compromised or money is
sent to the wrong address, then it is lost forever.
Following SAFETY MEASURES must be followed while storing &
transacting in cryptocurrencies.
1. Best Practise in Using Exchanges
2. Storing Cryptocurrency
3. Transactions Safety
4. Enable Security Measures
 UTXO
Unspent Transaction Outputs, or UTXOs, represent specific amounts of Bitcoin
that you have received but not yet spent. Each UTXO is like an individual bill in
your wallet, each with a unique value.

For example, a balance of 0.52 BTC in your wallet may consist of several UTXOs
like 0.2, 0.15, and 0.17 BTC.

Each UTXO is distinct and can hold any amount of bitcoin. They are the pieces of
bitcoin you haven’t spent yet, and you use them to make new payments.
UTXO - Unspent Transaction Output
An Unspent Transaction Output (UTXO) is the technical
term for the amount of digital currency that remains after a
cryptocurrency transaction.

The easiest analogy for UTXOs is physical fiat currency. Just like how coins or notes cannot
be split into smaller denominations, a UTXO cannot be divided either.

One can think of a UTXO as a discrete (indivisible and unique) chunk of its corresponding
token controlled by the private key of its owner.

The collection of all existing UTXOs at any given point is called the UTXO set.

Any transaction performed on the blockchain can be viewed as a modification of the UTXO set.

The UTXO model is used by projects such as Bitcoin (BTC), Bitcoin Cash (BCH), Litecoin (LTC),
 How is a UTXO created?
1. UTXOs are created through the consumption of existing UTXOs.
2. Every Bitcoin transaction is composed of inputs and outputs.
3. Inputs consume an existing UTXO, while outputs create a new UTXO.

UTXO Model
1. The UTXO model does not incorporate wallets at the protocol level. It is based on
individual transactions that are grouped in blocks.
2. Cryptocurrencies that use the UTXO model do not use accounts or balances. Instead,
UTXOs are transferred between users much like physical cash.
3. Each transaction in the UTXO model can transition the system to a new state, but
transitioning to a new state with each transaction is infeasible.
4. The network participants must stay in sync with the current state.
 UTXO vs Accounting Model

UTXO Model Accounting Model

The transaction requires more storage The transaction requires less storage
space. space.

The state is saved in transactions. The state is saved on the nodes.

The transactions are computationally The transactions utilize complex

simpler. calculations.

Bulk transactions are less efficient. Bulk transactions are more efficient.
 EXAMPLE

OUTPUT 2 BTC to Alice

5 BTC
INPUT

OUTPUT 3 BTC to Himself

Example - Continued
Transfer 2 BTC to
ALICE

Available : 2BTC

TOM ALICE
Unlock Inputs
2 BTC INPUT

0.5 BTC INPUT INPUT

SET OF 2 BTC 2 BTC OUTPUT
0.5 BTC INPUT UNSPENT
TRANSACTIONS STXO UTXO
UTXO
1 BTC INPUT

1 BTC INPUT
Example - Continued
Available : 1.2 BTC

CAR PRICE: 0.6 BTC

TOM
TOM CAR

0.1 BTC INPUT

0.7 BTC INPUT 0.6 BTC OUTPUT
Unlock Inputs
0.7 BTC INPUT STXO UTXO
0.4 BTC INPUT
0.1 BTC OUTPUT
SET OF UNSPENT UTXO
TRANSACTIONS
UTXO
Topics to be Covered
2.1 Cryptocurrency
1. Bitcoin, Altcoin, Tokens (Utility & Security)
2. Cryptocurrency Wallets (Hot & Cold Wallets)
3. Cryptocurrency Usage
4. Transactions in Blockchain, UTXO and Double Spending Problem

2.2 Bitcoin Blockchain

1. Consensus in Bitcoin
2. PoW, PoB, PoS, PoET
3. Life of a Miner, Mining Difficulty
4. Mining Pool & its Methods
 Proof of Work: PoW
PoW is a blockchain consensus mechanism in which computing power is
used to verify cryptocurrency transactions & add them to the blockchain.

The algorithm is used to verify the transaction and create a new block in the
blockchain.

The idea for Proof of Work(PoW) was first published in 1993 by Cynthia
Dwork and Moni Naor and was later applied by Satoshi Nakamoto in the
Bitcoin paper in 2008.
 Proof of Work: PoW
● In order to decide whether to add a new block or not, Proof-of-Work
(PoW), a consensus mechanism, is used.

● The blockchain network has an arbitrary “Difficulty” setting managed by

the protocol that changes how hard it is to mine a block. Mining here
means adding a new block. Miners design new blocks in the chain.

● Miners receive rewards in proportion to their share of the computing

power they spend mining a new block. The miner proves the work done
by mining a valid block.
 Proof of Work: PoW – How does it work?

• The incentive for mining transactions lies in economic payoffs, where

competing miners are rewarded with 3.125 bitcoins and a small
transaction fee.
• This reward will get reduced by HALF ITS CURRENT VALUE WITH TIME.
• The miner who manages to solve the problem gets the bitcoin reward
and adds the block to the blockchain by broadcasting that the block has
been mined.
 Example of Proof of Work
• Proof of work requires a computer to randomly engage in hashing functions until it arrives
at an output with the correct minimum amount of leading zeroes.

• For example, the hash for block #775,771, mined on Feb. 9, 2023, is:
00000000000000000003aa2696b1b7248db53a5a7f72d1fd98916c761e954354

• The block reward for that successful hash was 6.25 BTC & 0.1360 BTC in fees.

The nonce was 2,881,347,934, there were 1,519 transactions in the block,
and the total value of the block was 1,665.9645 BTC.

Remembering that a hash is generated and the nonce starts at zero, this
block was hashed by a miner 2.8 billion times before reaching a number less
than the target
 Challenges With PoW
● The 51% risk: If a controlling entity owns 51% or more than 51% of nodes in the network, the
entity can corrupt the blockchain by gaining the majority of the network.

● Time-consuming: Miners have to check over many nonce values to find the right solution to
the puzzle that must be solved to mine the block, which is a time-consuming process.

● Resource consumption: Miners consume high amounts of computing power in order to find
the solution to the hard mathematical puzzle. It leads to a waste of precious resources(money,
energy, space, hardware). It is expected that 0.3% of the world’s electricity will be spent to
verify transactions by the end of 2028.

● Not instantaneous transaction: Transaction confirmation takes about 10–60 minutes. So, it is
not an instantaneous transaction; because it takes some time to mine the transaction and add it
to the blockchain thus committing the transaction.
 Proof of Stake: PoS
● Proof of Stake (PoS) is an algorithm aiming to achieve
distributed consensus in the blockchain.

● This way of achieving consensus was first proposed here by

Quantum Mechanic and later written up by Sunny King and
his colleagues.

● Proof-of-stake reduces the amount of computational work

needed to verify blocks and transactions.
 Proof of Stake: PoS – How does it work?
Nodes on a network stake an amount of cryptocurrency to become
candidates to validate the new block and earn the fee from it. Then, an
algorithm chooses from the pool of candidates the node which will validate
the new block.

This selection algorithm combines

• The quantity of stake (amount of cryptocurrency)
• With other factors (like coin-age based selection, randomization
process) to make the selection fair to everyone on the network.
 Proof of Stake: PoS – Workflow
With proof of stake, participants referred to as “validators” lock up set
amounts of cryptocurrency or crypto tokens—their stake, as it were—in a
smart contract on the blockchain.

In exchange, they get a chance to validate new transactions and earn a

reward. But if they improperly validate bad or fraudulent data, they may lose
some or all of their stake as a penalty.

Staking is when people agree to lock up an amount of cryptocurrency in exchange for the chance to
validate new blocks of data to be added to a blockchain. These validators, or “stakers,” put their crypto
into a smart contract that’s held on the blockchain.
 Proof of Burn - PoB
Proof of burn is one of the several consensus mechanism algorithms
implemented by a blockchain network to ensure that all participating nodes come
to an agreement about the true and valid state of the blockchain network.

This algorithm is implemented to avoid the possibility of any cryptocurrency coin

double-spending.

Proof of burn follows the principle of “burning” the coins held by the miners that
grant them mining rights. By BURNING COINS, validators earn a privilege to mine
on the system based on a random selection process.

The more coins validators burn, the better are their chances of being selected to
mine the next block. Coin burning refers to the process of intentionally removing a certain
number of coins or tokens from circulation. Also known as burning tokens,
this is irreversible and typically achieved by sending the coins to a public
wallet address where they cannot be retrieved or spent.
 Proof of Burn – How does it work??
● In PoB virtual currency is burned. The more the currencies are burned by miners the more
they have the power to create blocks. When the coin is burnt its availability decreases
leading to a potential increase in the value of the coin.

● By destroying the currency, the consumer is displaying a big commitment to the currency
by foregoing a narrow profit in exchange for a long-term profit.

● To avoid any undue advantages for early adopters, The power of burnt coins “decays” or
reduces partially each time a new block is mined. This promotes regular activity by the
miners, instead of a one-time, early investment.

● To maintain a competitive edge, miners may also need to periodically invest in better
equipment as technology advances.
 Proof of Elapsed Time: PoET
● PoET is a consensus algorithm used in a permissioned blockchain network to decide
mining rights and next block miner. A permissioned blockchain network requires
participants to prove their identity, whether they are allowed to join. Hence, it needs
permission (or invitation) to join the decentralized network as a new participant ( or
node).

The PoET algorithm was developed by Intel Corporation, in early 2016.

PoET Mechanism assigns an amount of time to each node in the

network randomly. The node must sleep or do another task for that
random wait time. Whichever node gets the shortest waiting time
wakes up and add their block to the network. Later, the new update
information floods among other network participants
 Mining
1. Mining is a process by which new blocks are added to the blockchain.
2. Blocks contain transactions that are validated via the mining process by
mining nodes on the Bitcoin network.
3. This process is resource – intensive due to requirements of PoW, where
miners compete to find a number less than the difficulty target of the network
Life / Task of a Miner
Life / Task of a Miner
Mining Reward
 Mining Difficulty
1. It is defined as a measure of how difficult it is to find a hash below a given target.
A bitcoin network has global block difficulty. This difficulty changes every 2016
blocks
2. The desired rate is that one block should be generated for every 10 min. It usually
takes 2 weeks to generate 2016 blocks. Thus, difficulty level is readjusted every
two weeks
3. For every two weeks, the difficulty level is computed as follows:
 Mining Difficulty
✓ The same formula is applied after 2016 blocks have been generated.

✓ If less then 2 weeks time is taken to generate 2016 blocks, then current difficulty
needs to be increased

✓ If more than 2 weeks time is taken to generate 2016 blocks, then the current
difficulty needs to be reduced. This is how bitcoin network dynamically changes
the difficulty level.