How is Cryptocurrency Generated?

How Is Cryptocurrency Generated

What is Cryptocurrency?

In January 2009, we saw the emergence of the first Cryptocurrency, Bitcoin. It was designed by a group of developers operating under the pseudonym Satoshi Nakamoto. It was supposed to be a decentralized peer-to-peer medium of exchange, an alternative form of currency designed to replace traditional paper money. 

Cryptocurrency is virtual money, meaning that it doesn’t exist in a physical sense, but it is a form of digital money. But what separates cryptocurrency from fiat currency? Simply this, a cryptocurrency does not operate under the government or any major financial institution like the banking sector. It’s decentralized in the sense that there is no central authority to oversee or monitor transactions, but all data stored in the blockchain is always accessible to the public for the sake of full transparency. 

For example, let’s say you’re sending someone some funds online. Your money is stored in a bank account, you have to log in to the bank’s customer portal and you’ll be sending the money electronically to another person’s bank account via the bank’s payment gateway. And this transfer of funds is usually monitored by the bank and the transaction is recorded on the bank’s servers. 

Conversely, in cryptocurrency, your crypto token or coin will be stored on a digital private wallet, and you’ll be sending it to someone else’s wallet, all you need is the receiver’s wallet’s address to send it. The transfer of crypto is secured through a smart contract and will be recorded on a blockchain. But unlike a bank’s server, the blockchain by itself is open to the public, and no central authority monitoring it, making it a decentralized system. Essentially, anyone on the internet can access the blockchain and view the transaction, making it a fully transparent mode of transfer.

This is the fundamental idea behind Cryptocurrency…

What is a Blockchain?

By now, you may have heard the term blockchain enough times. You might even have looked it up and heard that a Blockchain is a distributed ledger. But what does that mean though? 

A ledger is a record-keeping tool, used to store data and a distributed ledger means it’s open to multiple participants. The Bitcoin blockchain is a distributed ledger that holds a record of all the Bitcoin transactions that have ever happened.

Usually, in any organization, records kept on ledgers are often private and can only be accessed by certain individuals in a position of authority. In cryptocurrency blockchain, anyone can download a copy of the blockchain itself and view all the data stored within. 

The blockchain is essentially a database that can be publicly accessed on a computer, and the computer that downloads a copy of the blockchain becomes what people refer to as a ‘node’. A node is simply an active participant in the network that keeps the blockchain running. All miners attempting to mine crypto coins are nodes, however, not all nodes in the network are miners.

The job of the node is to verify every block that gets added to the chain. A blockchain is considered immutable only if 51% of the nodes in the network are verified. Upon verifying the block’s validity it gets added to the chain. Immutability means that no one can change or alter the data in the block, once it gets added. If anyone does try it, they can only change the data in the copy of the blockchain that they have on hand. Due to the decentralized nature, the rest of the nodes online will not verify the illegal change. In order to tamper with the data in the block, a hacker would need the cooperation of 51% of all the nodes in the network, which is quite impossible. As a result, making it completely secure. 

Let’s look a little more deeply into the blockchain. Because in order to understand how cryptocurrency is generated, you‘ll need a clear idea of what a blockchain is.

As the name suggests, a blockchain means a chain or network of blocks. Each block is like a cube, connected to another cube by a digital thread, and each one is identical in function. The blocks have a fixed size, which may vary depending on the blockchain. And it’s within these blocks that the transaction data is stored. Each block however has a unique hash. 

What is a hash? Imagine the hash as the unique id number of a block, each block has its own different id number, these id numbers allow the validators to identify a singular block in the chain. Furthermore, each block also has the hash of the previous block engraved in it, thereby linking one block to another.

Let’s assume that there are three blocks, A, B, and C. C block will have its own hash, and the hash data of the previous block B. B block will have its hash and the hash of the previous block A. If you know the hash of C, you could trace it to find B and if you find B, then you can trace it back to find A. But, if you know the hash of A, you cannot find B or C. This is the core design behind the blockchain where the blocks can only be traced from the latest block in the chain back to the genesis or parent block. This makes the blockchain completely immutable. Once a block is verified by the nodes and added to the chain, it cannot be tampered with. 

In the Bitcoin blockchain, each block has a maximum fixed storage capacity of 1MB. Each block also contains the transaction record, a timestamp of the transaction, a unique hash for the block, the hash details of the previous block, and the solution to a unique cryptographic puzzle. The crypto miners earn coins as rewards for solving the cryptographic puzzle that comes with verifying a blockchain.

There is one more thing that you ought to know, so to understand how blockchains work. That is the blockchain’s consensus mechanism. What is a consensus mechanism? Simply put, a consensus mechanism is a blockchain’s operating protocol. It’s what dictates how transactions on the blockchains are validated and new blocks are created. 

For example, proof-of-work is Bitcoin’s consensus mechanism. It is the algorithm that keeps the miners motivated to work for the rewards. The miners work on solving mathematical puzzles and add blocks to keep the blockchain functional. They also make it foolproof from hackers, for which in return they are rewarded with Bitcoins. The trade of bitcoins creates more transactions and thereby creating more blocks, hence the cycle.

There are many types of consensus mechanisms. Ever since the creation of Bitcoin, many different blockchains have developed many different unique operating protocols. The most popular ones are the proof-of-work (PoW), and Ethereum’s proof-of-stake (PoS) mechanism. There are many subsets of consensus mechanisms, proof-of-authority, proof-of-activity, proof-of-capacity, proof-of-burn, etc. Each one of these mechanisms has its operating functionality.

How is Cryptocurrency mined from Blockchains?

Now that we know how blockchains function, let’s see how cryptocurrency is mined from them.

When we hear the term mining, we usually imagine ourselves digging through some dark cave, but nothing could be further from the truth than that image. Mining does not necessarily mean digging through the blockchain. Think of mining as the reward you get for participating in the creation of new blocks in the blockchain. This process of ‘miners’ working to validate and add new blocks in the blockchain is called ‘mining’.

To add blocks, you need to record transactions, for that you need nodes, the miners are the nodes. A blockchain cannot function effectively without nodes. The nodes validate transactions and add new blocks. Within each block that’s being mined, there exists a solution to a cryptographic problem. Miners attempt to solve cryptographic problems using complex algorithms, which are often time-consuming and energy-intensive. The first miner to solve the puzzle in the race gets to add the latest block, for which the miner will be rewarded with the standard 6.25 Bitcoins.

Why is the number an odd 6.25 Bitcoins? You might ask. Initially, when the Bitcoin blockchain was launched, the standard reward was 50 Bitcoins for every block mined. After every 210,000 blocks that are mined or every four years, whichever comes first, the rewards get halved, this is called halving. In 2013, the mining halved to 25 Bitcoins per block, in 2016 it halved again to 12.5 coins per block and in 2020 it halved again to 6.25 coins. In 2024, it will once again be halved to 3.125 Bitcoins per block.

Bitcoin itself is a piece of code. The Bitcoin Core is open-source software, and the core is the main part of the currency. Beyond the core are the protocols that make the currency what it is. All the coins are identical, but they cannot be double-spent due to the extensive records kept behind them. 

Bitcoin does not have an unlimited supply. The maximum supply is set at 21 million coins, of which already more than 18 million coins have been mined. Due to its limited and exhaustible supply, every coin is considered a valuable resource. 

There are many coins and mining differs accordingly. To mine Altcoins like Ethereum, you have to ‘stake’ according to the rules of the proof-of-stake consensus mechanism. This process is called staking. Mining and staking are by far the most popular methods, but there are many others.

Cryptocurrency and Crypto mining has changed the world significantly in the past decade. And with more and more interest being sewed every day and advances being innovated, it’s only likely to grow bigger. It’s now your turn to find your place in all this.