The Nature of Cryptocurrency

Estimated read time 9 min read

Last year, Bitcoin skyrocketed, and other coins sprung up like mushrooms after a rain. There are already more than 1,000 types.

Many people are asking, has the era of cryptocurrency really arrived? In the future, will humans no longer use US dollars and renminbi, but instead use cryptocurrencies? With so many varieties, which coin should I use? Do you want to invest some now?

I also wanted to know the answers to these questions, so I spent a lot of time reviewing information and researching protocols. The “Blockchain Introductory Tutorial” and “Bitcoin Introductory Tutorial” published two weeks ago are my learning experience. However, those two tutorials mainly introduced basic concepts and discussed the feasibility of the protocol, but did not answer a fundamental question: What exactly is cryptocurrency?

Here are my thoughts on this issue. Before reading, if you already know about blockchain and Bitcoin, that’s good; if you don’t, that’s okay. This article does not involve technology and only discusses the most basic principles.

1. What is money?

We all know that the RMB is money, the U.S. dollar is money, and gold and silver are money. Let me ask a question, why can they become money?

You might answer because they have value, or are a proxy for value. However, there are so many valuable things, why are only these varieties becoming money?

The answer is easy to think of, because people generally believe (agree) in their value, and the value of other things is difficult to obtain general recognition and cannot become money. For example, there is no universal recognition of the value of stamps, and they cannot be used as money anywhere except stamp collectors. Generally speaking, the more people agree, the more versatile the money is.

I once traveled to Russia and the local currency was the ruble. However, once it leaves Russia, no one believes in its purchasing power, so the ruble is useless after leaving Russia. On the contrary, people all over the world believe in the value of the US dollar, so the world can use it. When I paid the bill in dollars, I found that the Russians were very satisfied.

Therefore, the essence of money, or the essence of currency, is its credibility. It must convince people that it is valuable before it can become money and be collected and paid for.

2. Credibility

Why does money have to be trustworthy? Because the other party must believe in its value, otherwise you can’t pay it. So, the next question is, is the trustworthy thing money?

My answer is Yes. Whether something can become money only depends on whether people believe in its value. Whether it is really valuable or not is not important at all.

If Jack Ma writes “This note is worth 10,000 yuan” on a piece of paper, he signs his name below and attaches an anti-counterfeiting mark. Do you think this note is money? I assure you, this is money. If you use it to pay, people will accept it. Jack Ma is equivalent to issuing a new banknote.

The same is true for Bitcoin. What it is doesn’t really matter. The important thing is that it must ensure that it is credible so that enough people believe in its value before it can become money.

3. The credibility of Bitcoin

The core problem that Bitcoin wants to solve is to create a credible digital certificate. Because this certificate is trustworthy, it can be used as currency.

The technical foundation of Bitcoin is cryptography, because only cryptography can guarantee its credibility. Once the encryption is broken, it cannot be used as currency. This is why this type of digital certificate is called “cryptocurrency”.

Technicians are interested in Bitcoin for another important reason. This technology may be used wherever reliable digital credentials are required.

4. Characteristics of Bitcoin

Bitcoin has three characteristics. Because it achieves these three points, it is trustworthy and can be used as money.

First, it cannot be stolen (easily). Or conversely, it prevents you from stealing from others and you can only spend your own money. Because you must have someone else’s private key to withdraw his money. Under normal circumstances, you cannot get other people’s private keys.

Second, it cannot be faked. Every Bitcoin can be traced back to its source, and all Bitcoins come from rewards received by miners. Miners can only get rewards by creating new blocks, which is very difficult, so it is impossible to forge Bitcoin.

Finally, it cannot be spawned in bulk. The reason is the same as the previous one. The issuance rate of Bitcoin is stable. It is now 12.5 new every 10 minutes, then halved every four years, and finally stops growing. Therefore, unlike banknotes, the government’s excessive issuance will not lead to inflation.

5. Does Bitcoin have an entity?

Due to the reasons to be mentioned later, Bitcoin cannot have an entity and cannot achieve the scenario of “taking a coin out of your pocket”. All transactions must be completed through the Internet.

You may say, money has a physical entity, how can there be intangible money? The answer is just the opposite. Money should be intangible. Those physical money are actually a waste of material materials. Because the technology is not developed enough, it has to be made into entities.

When I was a kid, I had to use cash to buy things, otherwise I couldn’t prove that I had purchasing power. Only through physical money can we ensure that the other party actually received the money. If the banking industry is developed, cash will no longer be needed and bank cards can be used. When paying, the other party copies the bank card number and checks the bank “Does this account have money?” The bank replied that the money was available, OK, the transaction was completed.

However, the Internet makes physical bank cards no longer needed. If there is an open central accounting system, anyone can check it. You transfer the money to the boss’s account. The boss checks it and finds that it has been received. The transaction is automatically completed. The whole process is invisible. What bank card is needed? ?

This central accounting system has been implemented and is called blockchain.

6. The role of blockchain

The blockchain is a database that records all transactions and is used as a central accounting system.

The core of each transaction is a sentence, such as “Zhang San transferred 1 Bitcoin to Li Si.” In order to prove the credibility of this sentence, Zhang San added a digital signature to it. Anyone can use Zhang San’s public key to prove that this is indeed Zhang San’s behavior. On the other hand, others cannot forge Zhang San’s digital signature, so it is impossible to forge the transaction.

When the miners receive this sentence, they first verify the credibility of the digital signature, and then verify that Zhang San indeed owns these Bitcoins (each transaction has the number of the previous transaction, which is used to query the source of the Bitcoin). After the verification is passed, start writing this sentence into the blockchain. Once written into the blockchain, everyone can query it, so the Bitcoin is considered to have been transferred from Zhang San to Li Si.

The role of the blockchain is to permanently save this sentence so that anyone can view it, and no one (including Zhang San himself) can no longer modify it.

What is currency? In fact, this is the sentence. This sentence completes a payment. We usually pay in RMB, but actually we just use banknotes to express this message. If everyone could write/read to a central accounting system (blockchain) in real time, then there would be no need to carry currency at all.

7. Double spending

As mentioned before, transactions cannot be forged. However, since each transaction is a string of binary signals, it can be copied. For example, the sentence “Zhang San transferred 1 Bitcoin to Li Si” may be copied by others, or may be copied by Zhang San himself and submitted to the blockchain.

If this sentence is written into the blockchain twice, it means that Zhang San can spend the same money twice. However, when writing the transaction for the second time, querying the blockchain revealed that Zhang San had already spent the money, thus determining that this was an illegal transaction and could not be written to the blockchain. Therefore, copy trading is not possible.

What is more troublesome is another situation where Zhang San pays the same amount of money to two people. He first submitted a transaction to the blockchain “Zhang San transferred 1 Bitcoin to Li Si”, and then submitted another transaction “Zhang San transferred 1 Bitcoin to Wang Wu”. Both transactions may be considered real transactions and thus enter the blockchain. Therefore, there must be a way to prevent this from happening.

Scenario 1: The same miner received both transactions. Then he will realize that they cannot be established at the same time, so he will choose one of them to write to the blockchain.

Scenario 2: Miner A receives the first transaction, and miner B receives the second transaction. They each will determine that this is a legal transaction, and write these two transactions into two blocks respectively. At this time, the blockchain A fork occurs.

The Bitcoin protocol stipulates that the branch that first reaches 6 blocks after the fork point is recognized as the official blockchain, and other branches will be abandoned. Since the generation speed of blocks is determined by computing power, which transaction will eventually be written to the blockchain is completely determined by how much computing power the branch it is in can attract. The hidden logic is that if the majority of people (computing power) choose to believe a certain transaction, then it should be true.

To sum up, double spending is not possible. Because the central accounting system always has a way of finding out that you spent the same money twice. However, this also illustrates one of the costs of Bitcoin, which is that transactions cannot be confirmed in real time and must wait for at least an hour.

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