Cryptocurrency
By Sina Ehsanzadeh
Shahid Beheshti School
Grade 11
1- Introduction
Ever since computers have showed up, they have assisted humanity in a number of way, such as
communication, innovation, entertainment, and security.
As technology improved, new methods for older systems were offered, to cover the problems
they had, and computers surely enough helped with that in its place. Flaws in organization and
processing information were able to be greatly optimized and refined with the help of algorithms
made in and operated with computers, allowing more precise work, away from failures possible
due to naturally occurring human error.
We see this in engineering, mathematics, business, and even medical services. Of course,
economy and banking also have been improved with this. Although, major flaws have been seen
in current banking systems, even in its new electronic and digital form, such as high intermediary
costs and slow transactions, currency manipulation and censorship, and low trust in financial
institutions and governments.
In recent years however, a new method of money transactions has been offered, that solves a
multitude of current problems with the banking system, called “Cryptocurrency”. This digital
asset has been deemed many times to have the potential to become the replacement for the
current money system.
2- The History of Cryptocurrency
In 1983, the American cryptographer David Chaum conceived an anonymous cryptographic
electronic money called ecash. Later, in 1995, he implemented it through Digicash, an early form
of cryptographic electronic payments which required user software in order to withdraw notes
from a bank and designate specific encrypted keys before it can be sent to a recipient. This
allowed the digital currency to be untraceable by the issuing bank, the government, or any third
party.
In 2009, the first decentralized cryptocurrency, bitcoin, was created by presumably
pseudonymous developer Satoshi Nakamoto. It used SHA-256, a cryptographic hash function, in
its proof-of-work scheme. In April 2011, Namecoin was created as an attempt at forming a
decentralized DNS, which would make internet censorship very difficult.
Another notable cryptocurrency, Peercoin, used a proof-of-work/proof-of-stake hybrid.
Now with an insight on the origins of cryptocurrency, one would be interested in the workings of
it, and how it has gained some of its characteristics. To understand how cryptocurrency works,
we must first understand the core basis of how it is created: Blockchains.
3- What Is a Blockchain?
A blockchain is a growing list of records, called blocks, that are linked together using
cryptography. Each block contains a cryptographic hash of the previous block, a timestamp, and
transaction data. The timestamp proves that the transaction data existed when the block was
published in order to get into its hash. As blocks each contain information about the block
previous to it, they form a chain, with each additional block reinforcing the ones before it.
Therefore, blockchains are resistant to modification of their data because once recorded, the
data in any given block cannot be altered retroactively without altering all subsequent blocks.
Blockchains are typically managed by a peer-to-peer network for use as a publicly distributed
ledger, where nodes collectively adhere to a protocol to communicate and validate new blocks.
Although blockchain records are not unalterable as forks are possible, blockchains may be
considered secure by design and exemplify a distributed computing system with high tolerance
to Byzantine fault, which is a condition of a computer system, particularly distributed computing
systems, where components may fail and there is imperfect information on whether a
component has failed.
Peer-to-peer (P2P) computing or networking is a distributed application architecture that
partitions tasks or workloads between peers. Peers are equally privileged, equipotent
participants in the application. They are said to form a peer-to-peer network of nodes.
Peers make a portion of their resources, such as processing power, disk storage or network
bandwidth, directly available to other network participants, without the need for central
coordination by servers or stable hosts. Peers are both suppliers and consumers of resources, in
contrast to the traditional client–server model in which the consumption and supply of resources
is divided.
With this in mind, we can now explain how using blockchains, cryptocurrency is made.
4- How Is Cryptocurrency Made?
Cryptocurrencies use various timestamping schemes to "prove" the validity of transactions added
to the blockchain ledger without the need for a trusted third party.
The first timestamping scheme invented was the proof-of-work scheme.
Proof of work (PoW) is a form of cryptographic proof in which one party (the prover) proves to
others (the verifiers) that a certain amount of a specific computational effort has been expended.
Verifiers can subsequently confirm this expenditure with minimal effort on their part.
A key feature of proof-of-work schemes is their asymmetry: the work – the computation – must
be moderately hard (yet feasible) on the prover or requester side but easy to check for the verifier
or service provider. This idea is also known as a CPU cost function, client puzzle, computational
puzzle, or CPU pricing function. Another common feature are built-in incentive-structures that
reward allocating computational capacity to the network with value in the form of money.
The purpose of proof-of-work algorithms is not proving that certain work was carried out or that
a computational puzzle was "solved", but deterring manipulation of data by establishing large
energy and hardware-control requirements to be able to do so. Proof-of-work systems have been
criticized by environmentalists for their energy consumption.
Along with that, another system called the Proof-of-stake protocol. Proof-of-stake (PoS)
protocols are a class of consensus mechanisms for blockchains that work by selecting validators
in proportion to their quantity of holdings in the associated cryptocurrency.
For a blockchain transaction to be recognized, it must be appended to the blockchain. Validators
carry out this appending; in most protocols, they receive a reward for doing so. For the blockchain
to remain secure, it must have a mechanism to prevent a malicious user or group from taking
over a majority of validation. PoS accomplishes this by requiring that validators have some
quantity of blockchain tokens, requiring potential attackers to acquire a large fraction of the
tokens on the blockchain to mount an attack.
To become a validator, a coin owner must "stake" a specific amount of coins. For instance,
Ethereum, one of the many forms of cryptocurrency, will require 32 ETH to be staked before a
user can become a validator. Blocks are validated by more than one validator, and when a specific
number of the validators verify that the block is accurate, it is finalized and closed.
Proof-of-stake is designed to reduce the scalability and environmental sustainability concerns
surrounding the proof-of-work (PoW) protocol. Proof-of-work is a competitive approach to
verifying transactions, which naturally encourages people to look for ways to gain an advantage,
especially since monetary value is involved.
The PoS mechanism seeks to solve these problems by effectively substituting staking for
computational power, whereby an individual's mining ability is randomized by the network. This
means there should be a drastic reduction in energy consumption since miners can no longer rely
on massive farms of single-purpose hardware to gain an advantage.
5- The Architecture of a Cryptocurrency
A cryptocurrency is a system that meets six conditions:
1. The system does not require a central authority; its state is maintained through
distributed consensus.
2. The system keeps an overview of cryptocurrency units and their ownership.
3. The system defines whether new cryptocurrency units can be created. If new
cryptocurrency units can be created, the system defines the circumstances of their origin
and how to determine the ownership of these new units.
4. Ownership of cryptocurrency units can be proved exclusively cryptographically.
5. The system allows transactions to be performed in which ownership of the cryptographic
units is changed. A transaction statement can only be issued by an entity proving the
current ownership of these units.
6. If two different instructions for changing the ownership of the same cryptographic units
are simultaneously entered, the system performs at most one of them.
Now, let’s look closer at the different features within a cryptocurrency.
A. Blockchain
The validity of each cryptocurrency's coins is provided by a blockchain. Each block typically
contains a hash pointer as a link to a previous block, a timestamp and transaction data. By design,
blockchains are inherently resistant to modification of the data. It is an open, distributed ledger
that can record transactions between two parties efficiently and in a verifiable and permanent
way. For use as a distributed ledger, a blockchain is typically managed by a peer-to-peer network
collectively adhering to a protocol for validating new blocks. Once recorded, the data in any given
block cannot be altered retroactively without the alteration of all subsequent blocks, which
requires collusion of the network majority.
B. Nodes
In the world of cryptocurrency, a node is a computer that connects to a cryptocurrency network.
The node supports the relevant cryptocurrency's network through either; relaying transactions,
validation or hosting a copy of the blockchain. In terms of relaying transactions each network
computer (node) has a copy of the blockchain of the cryptocurrency it supports, when a
transaction is made the node creating the transaction broadcasts details of the transaction using
encryption to other nodes throughout the node network so that the transaction (and every other
transaction) is known.
Node owners are either volunteers, those hosted by the organisation or body responsible for
developing the cryptocurrency blockchain network technology, or those who are enticed to host
a node to receive rewards from hosting the node network.
C. Timestamping
Cryptocurrencies use various timestamping schemes to "prove" the validity of transactions added
to the blockchain ledger without the need for a trusted third party.
The first timestamping scheme invented was the proof-of-work scheme. The most widely used
proof-of-work schemes are based on SHA-256 and scrypt.
Some other hashing algorithms that are used for proof-of-work include CryptoNight, Blake, SHA-
3, and X11.
The proof-of-stake is a method of securing a cryptocurrency network and achieving distributed
consensus through requesting users to show ownership of a certain amount of currency. It is
different from proof-of-work systems that run difficult hashing algorithms to validate electronic
transactions. The scheme is largely dependent on the coin, and there's currently no standard
form of it. Some cryptocurrencies use a combined proof-of-work and proof-of-stake scheme.
D. Mining
In cryptocurrency networks, mining is a validation of transactions. For this effort, successful
miners obtain new cryptocurrency as a reward. The reward decreases transaction fees by
creating a complementary incentive to contribute to the processing power of the network. Some
miners pool resources, sharing their processing power over a network to split the reward equally,
according to the amount of work they contributed to the probability of finding a block. A "share"
is awarded to members of the mining pool who present a valid partial proof-of-work.
E. Wallets
A cryptocurrency wallet stores the public and private "keys" (address) or seed which can be used
to receive or spend the cryptocurrency. With the private key, it is possible to write in the public
ledger, effectively spending the associated cryptocurrency. With the public key, it is possible for
others to send currency to the wallet.
There exist multiple methods of storing keys or seed in a wallet from using paper wallets which
are traditional public, private or seed keys written on paper to using hardware wallets which are
dedicated hardware to securely store your wallet information, using a digital wallet which is a
computer with a software hosting your wallet information, hosting your wallet using an exchange
where cryptocurrency is traded, or by storing your wallet information on a digital medium such
as plaintext.
F. Anonymity
Bitcoin is pseudonymous rather than anonymous in that the cryptocurrency within a wallet is not
tied to people, but rather to one or more specific keys (or "addresses"). Thereby, bitcoin owners
are not identifiable, but all transactions are publicly available in the blockchain. Still,
cryptocurrency exchanges are often required by law to collect the personal information of their
users.
6- The Advantages, and Disadvantages of Using
Cryptocurrency
There are many benefits in cryptocurrency, which solve some rather big problems in current
day banking. cryptocurrencies are used primarily outside existing banking and governmental
institutions and are exchanged over the Internet. The current financial system revolves around
third-party intermediaries who process transactions. This means that if you make a transaction,
you’re placing your trust in one or more of these intermediaries. Cryptocurrencies offer an
alternative. They can be viewed by anyone, anywhere, so you can take part in the financial
markets and make transactions with no intermediaries whatsoever.
Once you make an entry in the blockchain, it can never be erased. And with the blockchain
stored decentrally across multiple computers, no hacker can access the entire chain in one go;
any information stored in it is safe for good.
Also, cryptocurrencies aren’t tied to a single currency or economy, so their price reflects global
demand rather than, say, national inflation.
On the other hand, however, there are some risks and problems that do arise with
cryptocurrencies.
You could be forgiven for thinking that digital currencies operate at lightning speed—and they
do, up to a point. But at a certain level they run into major issues which make it difficult to roll
them out on a large scale. This can be a frustrating experience for transaction participants, to
say nothing of the potential financial losses it can cause.
Cryptocurrencies might not have the risks that come with using central intermediaries, but that
doesn’t mean they’re completely free from security issues. As a crypto owner, you could lose
the private key that lets you access your coins—and with it, all your holdings. And then there’s
hacking, phishing, and all the other attempts to gain control by malicious means.
7- Conclusion
As we see, cryptocurrency has a lot of benefits, as well as quite a few flaws. Along with that, it is
a rather early thing to come around, and no one really knows if it will stay around. However, it
has shown that it has the potential to be used by all sorts of people for all sorts of reasons. Such
new innovations can pave the way to finding even better technologies, that may even surpass
this, and lead to an even brighter future.
