A Quick Primer on Bitcoins, Blockchains, Cryptocurrencies, and Cryptocurrency Investing

Introduction to Bitcoin, Blockchain, and Cryptocurrency

Bitcoin

Bitcoin is the most popular cryptocurrency. It is intended to function similar to fiat currencies — fiat currencies are currencies that are controlled by governments. Bitcoin is abbreviated BTC when quoted or discussed.

Blockchain

A block chain is a digital ledger. For now, think of it is a data file on your computer. Each row of the data file is a “block” and in each row there is data about the transactions that occurred in that block.

  1. Once a block is added to the block chain it is permanent and the information inside of it cannot be changed
  2. The official source of record of the block chain is not owned by any person, group, or other entity or entities. In classic blockchains, such as Bitcoin, any computer can choose to become a member of the blockchain at any time using free, straightforward software that is easily attained and installed. Becoming a member of the blockchain does not require significant hardware.

Cryptocurrency

Cryptography is a field of science for hiding information. You are exposed to cryptography every day through your computer passwords.

  • You pay your electric utility $100
  • You receive $250 from your uncle
  • you will always get an output that is the same length
  • there’s an infinitesimally small probability of getting the same output for any two inputs
  • and there’s currently no way to back out the inputs from the output — you could only find the inputs through some manner of trial and error, which currently would take all the computing power in the world potentially millions or billions of years to solve without getting lucky.

Coming Back to Blockchain

Imagine two transactions occurred on 1/1/2021 between 9:00 AM and 9:05 AM. We want to store these transactions to a ledger.

Bringing it All the Way Back to Bitcoin

Bitcoin is one of the earliest developed and popularized blockchains. If you look at the Bitcoin blockchain, each block stores transactions between “wallets.” That’s it, every block is just a ledger of transactions, where all the transactions are bitcoins. Wallet A sends X amount to Wallet B.

  • One beginning “3KAeyi” received most of the BTC, .63736145
  • And the remainder went to “1GknVE” for .016 BTC
  • A very small amount .0004 was held back as a fee to reward the “miner” that solved the cryptographic puzzle for the block first. At $32,000 a BTC, this is about a $13 fee to the participant that solved the puzzle.

Quickly, What is Mining a Block

Let’s say we want to write the transactions inside of block 2 to the blockchain, and they are the only transactions occurring on the network, so they are only the transactions that will go in the current block being mined.

  1. We launch the software to write to the blockchain on our computer
  2. This software connects to a random number and selection of other computers on the blockchain
  3. The software downloads the full blockchain from beginning of time to now, it’s a few hundred gigabytes
  4. You announce to these computers that you want the transaction recorded, they repeat this transaction to all connections, and this spreads across the entire network quickly
  5. At the same time, all of the computers on the network are trying to solve a puzzle. A common one is to find a string that can be added to the input strings, that when included, produces a hash with certain number of leading 0s. It’s a matter of trial and error, but it’s much simpler than finding an exact string of 64 characters.
  1. At this point, I would share my solution to the block chain network. I would share my block, which contains the transactions, and the solution to the puzzle (in this case “adamwas”).
  2. This would be picked up by the other miners on the network, who can instantly verify that they have at least the same transactions waiting to be mined and that the puzzle answer works.

INVESTING IN CRYPTOCURRENCY

There are an endless number of cryptocurrencies and their closely related alternative, cryptocurrency tokens. The nuances of differences between each cryptocurrency or token is beyond the scope of this write-up. For introductory purposes and the mechanics of acquisition, trading, or selling, the distinctions are not material.

  • Some people consider Bitcoin a good diversification asset for a portfolio of investments. Historically, the returns of Bitcoin and other cryptocurrencies have low correlations with other asset classes. However, as Bitcoin and others become more broadly owned by traditional investment participants such as large funds and institutions, their correlations with traditional investment asset classes will most likely increase.
  • Some people consider Bitcoin a good hedge against inflation. There is a finite and constrained supply of Bitcoins. Therefore, if the supply of the fiat currencies, such as the U.S. dollar, are increased, then each Bitcoin should be worth more dollars.

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