Getting started in cryptocurrency.

Welcome to my new series on cryptocurrency.

What they are, what they do and how to get involved.

This is part three of a larger series that began with learning about, What are cryptocurrencies? and continued into part two of the series with a closer look at cryptocurrency wallets and getting started in the cryptocurrency space.

These two guides will give you a solid start to exploring crypto and making your first foray into the area.

Personal security, setting up wallets, researching tokens and managing a portfolio. Very important basics for anybody looking to know more about this area.

So what is the technology behind all of this?

What makes it all run and let us play crypto games and earn interest on our investments?

While we don't need an in depth knowledge of blockchain technology to participate it's good to know what the terms mean that we see on a day to day basis and be able to make better choices based on information rather than hype.

Today’s topic: Behind the scenes of cryptocurrency.

In this post we are going to look at the following topics and try to gain a better understanding of these four areas.

DLT - Distributed ledger technology.
POW - Proof of work.
POS - Proof of stake.
Smart contracts.

Cryptocurrency is not just magical internet money as a lot of people would have you believe but a robust eco-system of smart contracts and ledgers that track your assets across the internet. These assets have a value on the open market just the same as shares, money or artworks would do depending on their perceived value and supply/demand factors the same as any other type of asset.

While you do not need to know how to program these contracts or how each cryptocurrency differs from it's competitors. It is always important to have a general understanding of how these things operate to make educated choices in this space and understand what you are buying into.

There is a big difference between buying Bitcoin. Which is mined through proof of work and has a total supply of 21 million tokens with a decentralized governance. To a new token with unlimited supply, large founders stake and no security. Or compared to a fast and feeless proof of stake token like Hive or Wax that are built to host apps, games and nft's. This is where knowledge is key.

Ref: Changelly

When choosing your crypto investment or where to build a new project. The blockchain that you choose is just as important as picking a building for your new business would be. You need to look at what fees are there, what opportunities, what facilities, what resources are there to build with. If you are just buying a stake in one of these projects then it is still as important to know how they will operate and the opportunities and limitations to these choices.

Ref: Pixabay.

Part 1: Distributed Ledger Technology.

What is distributed ledger technology or DLT?

This is the technology best known for underpinning blockchains.

This type of digital system records the transaction of assets across a decentralized network of ledgers which record each of these transactions at the same time in all of these ledgers.

This system of recording the transactions across multiple ledgers over multiple locations creates a secure record of each entry that can be verified against all of the other ledgers for authenticity.

This is a good resource to show the process more clearly as it can sound a bit confusing at the start.

This architecture represents a significant change in how information is gathered and communicated by moving record-keeping from a single, authoritative location to a decentralized system in which all relevant entities can view and modify the ledger. As a result, all other entities can see who is using and modifying the ledger. This transparency of DLT provides a high level of trust among the participants and practically eliminates the chance of fraudulent activities occurring in the ledger.
As such, DLT removes the need for entities using the ledger to rely on a trusted central authority that controls the ledger, or an outside, third-party provider to perform that role and act as a check against manipulation.
Ref: Techtarget.

Blockchain technology can be used across multiple industries and has more and more emerging use cases across society but for our purposes it is best known for cryptocurrency and crypto transactions.

When you send crypto from one wallet to the next this transaction gets recorded in all of the ledgers which track that cryptocurrency. This is a secure but transparent process that can be verified by reading the blockchain explorer which shows all of these transactions.

Part 2: Proof of work.

From Investopedia:

Proof of work (PoW) is a decentralized consensus mechanism that requires members of a network to expend effort solving an arbitrary mathematical puzzle to prevent anybody from gaming the system.
Proof of work is used widely in cryptocurrency mining, for validating transactions and mining new tokens.
Due to proof of work, Bitcoin and other cryptocurrency transactions can be processed peer-to-peer in a secure manner without the need for a trusted third party.
Proof of work at scale requires huge amounts of energy, which only increases as more miners join the network.

The most well know example for a Proof-of-work token is of course bitcoin.

Bitcoin is mined for profit by using your computer to solve complex computer equations and compete for rewards. You compete against the other "miners" to solve these equations and get rewarded. Your chances of being selected are linked to your computing power.

I like this explanation from Blocklr

Proof of Work (PoW) is a piece of data that is hard and costly to produce, but easy to verify once it’s been generated.
Essentially, members of a given community work to solve a complex puzzle. This is the “work” in Proof of Work (PoW).
In order to create the data—or solve the puzzle—a miner must compute through a very complex equation. Because each attempt at the equation builds on previous solutions, any new solution essentially verifies previous work.
At the same time, the work required to solve the equation generates a new piece of data. This is then added to the growing chain of data. From there, the process basically starts over again.

As new Bitcoin supply reduces over time and more people are competing for less rewards with the mining it has gotten expensive to mine for bitcoin. At this stage you would need very powerful computers to achieve a successful proof of work which is the reason that there are some environmental concerns over this method that requires large amounts of computing power to achieve small results.

This is similar if less extreme in the case of other proof of work tokens and is the reason why the second largest crypto in Ethereum is currently moving to proof of stake which doesn't require the same large amounts of computer power to maintain the network and is much better for the environment.

There is a full breakdown of the technical details in this post by Ledger.com but it is more than we need to know for a basic guide.

Proof of work requires computer power to compete for rewards.
Rewards are generated for verifying transactions.
There is a high electricity cost to proof of work blockchains like bitcoin and Ethereum.
Governance is based on work put into growing that chain and where computer power is directed.
By default the majority will want it to succeed and follow good practices to get there.
Nodes are software used to run the technology and validate the blockchain.

Part 3: Proof of stake.

Proof of stake is where a user takes their cryptocurrency and stakes it to the matching blockchain. This gives them a say in the operation of the blockchain equal to their stake in that network. There is usually interest paid to the staker as a reward for taking part in the structure of that blockchain.

Your stake gives you voting rights on the governance of that blockchain and a say in who runs the nodes, makes changes to the code of the blockchain and maintains the integrity of the network.

This system is based upon community governance to ensure the safety and accuracy of the blockchain and it's data by choosing entities to run the chain based on your stake in that chain.

Just like proof of work, the theory is that people with the largest stake will have the most interest in seeing the blockchain run properly and vote accordingly. The more distributed and decentralized that these votes are then the safer it's data is.

The biggest flaw in this theory is if one group holds enough stake in the network that they can use it to vote maliciously or in their own self interest to the detriment of the entire eco-system. It has happened in the past where there is a large founders stake or centralized fund.

The most famous example to date is the use of stake to take over the STEEM blockchain by Justin Sun. It's a fascinating story on governance, proof of stake theory, community action and blockchain technology.

This article by [Tim Copeland] goes through the saga in great detail and is worth a read.(https://decrypt.co/38050/steem-steemit-tron-justin-sun-cryptocurrency-war)

There are hundreds of different examples of Proof of Stake blockchains such as,

WAX
HIVE
SOLANA
CARDANO
COSMOS

Which all have different purposes and abilities. They might have the same governance structure but they all have different features based on their design and purpose.

Choosing which blockchain to use as a developer depends on a lot of different factors but can be vital to the long term success of the project and that is what us users are looking for.

Part 4: Smart contracts.

These are exactly what they sound like. Smart contracts are digital contracts which are stored on the blockchain and run when their conditions are met. These are what allow us to run defi, gaming, tokens and all of the rest by automating processes and taking trust out of the equation.

They run on a very simple IF/WHEN/THEN basis.

IF I list a card on the market at X price.
WHEN a buyer transfers X price to my wallet.
THEN the card moves to their wallet.

Luckily as a day to day user we don't have to write our own smart contracts but in this scenario the marketplace that you are using will have the contracts running behind the scenes and when you list your card for sale it creates a new contract which is there waiting to be triggered when it's conditions are met.

This has a lot of benefits to the whole industry and can be used for a range of services. Some of the benefits are:

Speed, efficiency and accuracy.
- Once a condition is met, the contract is executed immediately. Because smart contracts are digital and automated, there’s no paperwork to process and no time spent reconciling errors that often result from manually filling in documents.
Trust and transparency.
- Because there’s no third party involved, and because encrypted records of transactions are shared across participants, there’s no need to question whether information has been altered for personal benefit.
Security.
- Blockchain transaction records are encrypted, which makes them very hard to hack. Moreover, because each record is connected to the previous and subsequent records on a distributed ledger, hackers would have to alter the entire chain to change a single record.
Savings.
- Smart contracts remove the need for intermediaries to handle transactions and, by extension, their associated time delays and fees.

Ref: IBM - What are smart contracts.

You can see how these would be very useful for developing different services in the blockchain industry and the advantages these contracts bring over traditional options.

They are the basis for a lot of the crypto apps that we will be using on a daily basis so it's helpful to know what they are as the term comes up quite often.

For a more detailed look at smart contracts you can check out this guide from blockgeeks,

For now a basic idea is fine to get started in the industry as we see further development these will be the engine parts of a blockchain. We just need to know how to drive the car not how to fix the engine.

Summary

This post is an overview of how cryptocurrency and blockchain systems run. It's very basic but explains a few of the terms that you will come across quite often and it's good information to have.

Future posts in this series will be aimed at operating across the different areas linked to cryptocurrency now that we know how it works.

The main take away for anybody looking to get started should be,

Do your own research.
Know your blockchain functions.
Find the best option for your task..
Be wary of scams.
Security comes with real decentralization. Watch out for projects with a large amount of stake controlled by one entity.