Every week, we try to understand for you a subject that is in the news, but which can seem a little difficult…
Bitcoin, Dogecoin, Ethereum… we hear more and more about crypto-currencies as an investment in the future. But how do they work and why such enthusiasm? We decrypt.
What is cryptocurrency?
Cryptocurrencies are virtual and decentralized currencies. Virtual because, unlike traditional currencies such as the dollar or the euro, they are completely dematerialized. There are no coins or banknotes and you cannot pay in cryptocurrency by check or credit card. If you own Bitcoins, their existence is reduced to a line of computer code.
They are decentralized because unlike traditional currencies, there is no central organization that controls its course or the validity of transactions. This is also the genesis of crypto-currencies.
Bitcoin, the first crypto-currency on the market, was created in order to eliminate intermediaries during exchanges and to emancipate oneself from banking institutions. Transactions are therefore made through a peer-to-peer (or peer-to-peer) payment system, i.e. they pass directly through the network, from one computer to another, without going through by a central control body. Read more to get more information about this.
Indeed, when A transfers €10 to B, the transaction is checked and validated by A’s bank, B’s bank and by the Central Bank (in the case of the euro, the European Central Bank). During a transaction in crypto-currency, the principle is different. The idea is that transactions are no longer validated by a single and central intermediary but by a multitude of networked individuals. This is the principle of blockchain.
What is blockchain?
We can compare the blockchain to a ledger in which are listed all the transactions carried out with a crypto-currency since its creation. Each line of the book represents a transaction made with the cryptocurrency in question and each cryptocurrency has its own blockchain, or its own account book.
This ledger has very specific rules and operation. Thus, the blockchain is based on two main pillars: transparency and security.
The blockchain principle of transparency
One of the characteristics of a blockchain is that it is transparent. Anyone can consult all the exchanges of the blockchain and register their own transactions very simply, on the sole condition of being a member. Being a member of the blockchain is therefore imperative if one wishes to trade with the cryptocurrency concerned. Despite the criterion of transparency, each member is anonymous and associated with a number, out of concern for privacy. This is where things get tricky.
The blockchain is highly secure, which may seem counter-intuitive given that all transactions are virtual. Indeed, how to prevent hacking or fraud and other double expenses?
A double spend is a fraudulent act which consists in falsifying digital currency by duplicating it or creating it from scratch. Imagine that A owes B €10 and C €10. If A pays B in cash, he gives him a €10 note. He cannot therefore pay C with this same ticket since, materially, he no longer possesses it. In the same way, if, originally, A did not have the 10€, he cannot claim to have them to give them to B since he does not have them. Double spending is therefore impossible when exchanging in fiat money (material money, i.e. coins and notes).
But the problem is quite different with digital exchanges, when you pay by credit card or cryptocurrency for example. Since everything is virtual, if A owes €10 to B but does not have them, he can still claim to have them to give them to B since nothing is materially verifiable. Indeed, numerically, a transaction simply corresponds to the writing of a line of code. This is why when you make a transfer, the transaction goes through your bank, which checks that you have the money to transfer before validating the transaction. However, in a cryptocurrency exchange, the transaction does not go through a bank. Cryptocurrency developers therefore had to find another means of validating transactions to prevent fraud.
This is where the blockchain principle is revolutionary. Let’s go back to our ledger metaphor.
Because of the principle of transparency, everyone can register their transactions in the account book and everyone has access to the transactions of others. But this also means that it is impossible to falsify or erase a line from the account book. First, because once a transaction is entered there, the process is irreversible. Second, because each line entered in the account book must agree with the previous lines to be validated.
Indeed, a blockchain is made up of blocks, comparable to the pages of an account book. In each block is registered a certain number of transactions carried out by means of the crypto-currency concerned. Each block is linked to the blockchain, i.e. to the other blocks composing it. This means that it is impossible to tamper with a block without invalidating previous blocks, and therefore the entire blockchain.
Why is transaction verification so secure?
Take the example of Bitcoin. In order for each transaction block to be validated, they must first be verified, in order to prevent double spending and fraud. However, this verification is not carried out by the banks, but directly by members of the blockchain who have volunteered for this task. These voluntary members are called miners. Each block of Bitcoin transactions is thus mined, that is to say verified and then validated by the miners. In exchange, with each block that a miner validates, he earns a certain amount of Bitcoins.
The big difference with traditional currency transactions is that anyone can volunteer to be a minor.
With blockchain technology, the intermediary of banks is thus replaced by whoever wants, provided you have a computer and a powerful enough graphics card.
When a block is mined, it is linked to the blockchain and connected to the next block (much like a chain) which makes it indestructible. In addition, the interdependence of the blocks makes them tamper-proof.
In addition, the blockchain is becoming more complex and is being built very quickly. Attempting to hack a block of the blockchain would mean on the one hand invalidating and therefore having to rebuild all the previous blocks, even though the chain would continue to be built at the same time, each block being, as we said, connected next. It would therefore most likely be a losing race.
Moreover, the amount of energy required for such an operation would be such that it makes the process very improbable or even impossible.