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Sunday, June 16, 2024

What is cryptocurrency and how it works?

The first cryptocurrency appeared on the Internet five years ago, and since then hundreds of other electronic money have joined Bitcoin, however, until now, few people know what it is, how it works and why it attracts so much attention.

Since the topic of the review is quite voluminous, and in order not to complicate the first acquaintance with cryptocurrency for many, some points in the text will be simplified to create a more understandable picture. In principle, these simplifications will not affect the description of the mechanisms of the cryptocurrency.

Features of digital currency

Probably, the main reason for the popularity of digital currency is its decentralization and the ensuing features. CV (digital currency) is not served by any central bank, and as the Bit prefix in the progenitor of all digital money hints, it works on the principle of decentralization in the network. If in a large bank the main observer of the reliability of money transfers is the bank itself, then in the CV such observers are network participants – ordinary users.

For users, the main advantage of DV can be considered the speed of transactions (sending money from one user to another). If you have ever made a bank transfer to another country, you know that this, in itself, is not an easy procedure, can also take several days. Notification of the transfer of the CV is almost instantaneous, and the confirmation of the transfer is carried out within a few minutes (for some CV less than a minute).

Another advantage of DV is the almost zero cost of transfers. If banks charge a certain fee for their services, up to several percent, then the CV is transferred from account to account virtually free of charge.

Despite their dislike of CV, large banks and money transfer systems have recently begun to reckon with its appearance. For example, eBay, the owner of Paypal, who put sticks in the wheels of the DV, prohibiting their sale at auction, just the other day abandoned such a restriction and now a special section has appeared for cryptocurrency on eBay.

An obvious advantage of CV is anonymity. If a plastic card is tied to a passport, then an electronic wallet is just a set of symbols that itself will not even output to a postal address. And if you install and use such a basic means of protection as Tor, then tracking translations becomes impossible even in theory.

The lack of centralization and central authority brings some disadvantages to the CV. For example, all transactions are irreversible (unless some intermediary is used). That is, there is no possibility to contact the bank and cancel the transfer. Money goes in one direction, and there is no possibility to return it without the consent of the recipient.

As for the other most frequently mentioned drawbacks of cryptocurrencies, which are mostly voiced by new users, it is usually mentioned the useless waste of huge computing power and energy to maintain the functionality of Bitcoin and other currencies.

You can look at this statement in another way. For example, the value of ordinary money, at least in theory, should be backed by something else, in our case gold. In the world of cryptocurrencies, the value of coins is in a sense provided by the cost of energy spent on mining and the funds spent on the purchase of mining equipment.

As for the uselessness of calculations, then, firstly, there are coins that make useful calculations. For example, during the mining of Primecoin, a search for new prime numbers is performed, and Gridcoin connects directly to the Boinc project to participate in distributed computing aimed at solving physical, astronomical, biological, medical and other problems. Well, and secondly, the huge computing power of Bitcoin is not wasted, but ensures the reliability of all transactions, and guarantees the protection of the network from possible hacker attacks, which are possible only if even more computing power is connected to the network (read below about the 51% attack), which is almost unrealistic, given the funds spent on specialized mining farms that have achieved tremendous performance over the past few years. Without the same computing power, younger CVs are vulnerable to a variety of attacks and some have already been exposed to them in the recent past.


In the CV lexicon, there is the term Block Chain. In plain language, it is a book containing records of all money transfers for all time. Suppose that this book has 1 million computers. If one of the computers sends a false message about the transfer of coins to another address (for example, to pay for goods in an online store), then the rest of the network participants will not simply accept this statement. Monetary transactions must be confirmed by appropriate signatures that cannot be forged.

In the world of cryptocurrency, there are two main algorithms: SHA256 and Scrypt. SHA256 is an algorithm for Bitcoin and several of its clones. Initially, Bitcoin mining took place on processors, but over time, programs appeared that learned to use video cards, which significantly increased the efficiency of mining. After that, the so-called ASICs (Application-specific integrated circuit) were developed – boards optimized exclusively for calculating hash functions using the SHA256 algorithm and useless in all other senses.

ASIC-boards are an order of magnitude more efficient compared to video cards, and at the same time use an order of magnitude less electricity. In principle, the disadvantage of ASIC-boards is reduced only to their high cost (for a fee with sufficient performance you will have to pay several thousand dollars), and after their performance turns out to be uncompetitive, due to the release of a new generation of ASICs, it is difficult (almost impossible) for them to find application due to their narrow specialization. In other words, they will have to be resold for a pittance or sent for scrap.

After the high cost of ASIC-boards led to the fact that only wealthy enthusiasts could engage in bitcoin mining, there was an idea to create a new algorithm called Scrypt, the main feature of which would be resistance to GPU and ASIC mining.

At first, Scrypt, as planned, worked only on processors, but the first applications for video cards appeared quite quickly. At first, it seemed that the output of specialized ASICs for Scrypt was really impossible. The fact is that calculations using SHA256 require a fairly small amount of memory, while Scrypt requires much larger amounts of memory available both in the computer and in modern video cards. The requirement of a large amount of memory makes the development and release of Scrypt ASICs not so much impossible as unprofitable, since adding the necessary amount of RAM to the boards makes them more expensive compared to video cards (at least this was believed some time ago). The advantage of video cards is their wider use (video games), and the ability to sell after use.

The first CV on the Scrypt algorithm was Litecoin, and since the source code of this currency was left open, after a while there was a real boom in altcoins (alternative coins – a common name for all CV that appeared after Bitcoin). At the moment, there are several hundred altcoins, if we consider more or less known. Their list can be found on the website of the http://com-http.us/, and this is not a complete list, although with its help you can get an idea of the total number of CV.

Which of these CV are really popular is difficult to answer, since the assessment here is purely subjective. Your own conclusion can be made by looking at the market cap (the total cost of a certain CV) on the www.cryptmarketcap.com website. As you can see, only in a small number of top coins this value represents at least some significant amount for the currency.

Despite the attempt to protect against Scrypt ASICs, all efforts in the end were in vain, although many until the very end did not believe in the possibility of their appearance. Nevertheless, they have been available for sale since the beginning of this year, although the first models traditionally lose in the price/ performance ratio to conventional video cards.

The first Scrypt ASIC in terms of performance was comparable to the top processors (up to 100 Kh/ s), but released in one or two months asIC-boards of the next generation caught up in speed with the average graphics cards worth $ 200 (400 Kh / s). Meanwhile, in just a couple of months, the first “titans” are expected to be on sale with performance exceeding the total power of several hundred Radeon 290x (100-200 Mh / s). At the same time, the currently available ASICs (400 Kh/s) require no more than 5 W for operation and are connected directly to USB ports, while video cards with similar performance pull about 200 W from the PSU.

The SHA256 and Scrypt algorithms are the most popular among CV, but in addition to them there are others, for example, Scrypt-N – another attempt to create a tough nut for ASIC boards. The prefix N in the name means that at certain intervals (months or years) the amount of memory needed to search for hash functions increases by n times (usually two), which does not exclude the possibility of creating ASIC boards for mining but makes their development even more unprofitable.

There are also CPU-only coins, which at the moment, and perhaps in principle, it is impossible to mine on anything other than processors, which makes them more “popular”, since mining does not require the purchase of expensive video cards or ASIC boards. However, such coins also have their weak points – botnets created by special viruses. Botnets are no better than ASIC farms, especially if they include thousands of computers. And to gain access to such powers, hackers do not need hundreds of thousands of dollars, a small virus epidemic is enough.

How can I get digital currency?

Any DC, like regular currency, can be bought. To do this, there are special exchanges on the Internet, for example, www.btc-e.com, where “ordinary” money is exchanged for digital ones. As a rule, the purchase procedure is as follows: transfer from a money card to an exchange -> purchase of Bitcoin at the current price -> withdrawal of Bitcoin to your e-wallet. There are other ways to replenish your account on the exchanges, in addition to plastic cards.

However, such a scheme, as a rule, works only with Bitcoins. Other cryptocurrencies are not so popular and the possibility of their direct purchase for dollars or other currency on exchanges is much less common, although recently there has been a noticeable shift in this area.

Therefore, to purchase other CV, you will need to use Bitcoins. You can also exchange Bitcoins for CV on specialized exchanges, for example, https://bter.com/. To do this, you need to transfer the right amount of bitcoins to the exchange, buy the necessary altcoins with their help and withdraw them to your wallet.

To get acquainted with the CV and understand some of the terms, let’s consider everything on the example of a very young, but quickly gained popularity cryptocurrency Dogecoin.

To start working with Dogecoin, you need to download a wallet program. This can be done on the official website, where there are versions for most operating systems, but I recommend Windows owners to use lite wallet (lite wallet) MultiDoge. Unlike the official wallet, MultiDoge does not download the entire block chain to the computer (transaction history, which currently occupies about 2 GB), which requires several hours, but works almost immediately after launch.

In the program, the user receives his own wallet with an address of the form DNmr2pr6b5MKojd1YaLuSuRCgwDnkt3gYb. Currency from exchanges or mining pools will be transferred to this address (more on this below).

To confirm the right to access the address after starting the program, a password of several dozen characters is automatically generated. Fortunately, the user does not have to remember it, since it is stored in a file (wallet.dat for the official client and multidoge.wallet for MultiDoge). This file must be protected with a password (the corresponding function is in every wallet) and copied to a safe place (the official client has a Backup function, and in MultiDoge the file will need to be saved manually). It is better to store the file in several places at once: on another computer, in Dropbox, as an attachment in an email sent to your own address, on a flash drive. The password to the file should be chosen on the assumption that the password recovery function does not exist, and in case of its loss, access to the wallet will be lost.


For Dogecoin mining, the most common Scrypt algorithm is used. Mining (from the English Mining) is translated as the extraction of mining. From a simplified point of view, mining is a search for a certain number, in which there should be a certain number of consecutive zeros. Since the probability that the result of the first hash function will be just such a number is quite low, it takes a lot of computing power to find these numbers. Naturally, when new computers are connected to the calculations, the numbers will be found faster, so the task becomes more complicated for balancing, that is, the required number of zeros going in a row increases.

After finding this number in the blockchain, that is, in the ledger of the CV, a new block is added (as an additional wagon to the train). This block contains all transactions for the last minutes, which thus remain forever “carved in stone”. It is impossible to change the value of the block in the future, since it is associated with the value of neighboring blocks, the change of which will entail a change in the entire blockchain along the chain. This approach is a guarantee that the transaction history cannot be edited. Why is this important? Because the amount of currency in each wallet is calculated from the transaction history. At startup, the program looks at all incoming and outgoing transactions for this particular address and calculates its balance based on entries in the ledger. New users tend to think that the coins are stored in the wallet file.dat, but this is not the case, this file stores only the password to access the wallet, and the coins are only numbers in the blockchain.

So, mining is the process of solving equations on a computer that allows you to find the necessary number and, using the terminology of CV, “solve the block” to add it to the blockchain. The solution of each block releases a certain number of coins, which is divided among the users who participated in the block solution. The number of coins in each block is set in the source code of the DH and in the vast majority of cases decreases over time. For example, the first 10 thousand blocks give 1000 coins for the solution of each block, from 10001 to 20000 block the reward is halved and so on. The process of reducing the reward is called halving (from the English Halving – division in half). Halving is used to artificially reduce the number of coins added, as a result of which their price on exchanges slowly moves up if the demand for them grows, remains the same or at least does not decrease by the same two times after each halving. As an example of price increases, we can recall how on May 22, 2010, the world’s first purchase for bitcoins was made. A pizza worth $ 25 was bought for 10 thousand bitcoins (1 bitcoin was therefore equal to then 0.25 cents). Since then, the price of bitcoins has increased by 180 thousand times, if we take its current value. If we take the maximum rate ($ 1150 at the end of last year), then 460 thousand times, and if you compare the maximum rate with the first cost of bitcoin on the exchange (2009), then 1.5 million times (from 0.07 cents to 1150 dollars).

There are two main types of mining, solo and pool mining. With solo mining (mining alone), the user uses only his computer to solve blocks, and this approach is now practically not used. To explain why, imagine a situation in which 1 million identical computers are involved in mining and the search for one block takes one minute. From this it follows that in one day 1440 blocks will be solved (the number of minutes per day), and the solution of 1 million blocks will take almost 700 days, or 2 years. Purely statistically, this means that each user on average will take 1 year to solve one block. That is, the abstract average user will receive the first coins only a year after the start of mining. Solo mining, however, has its own plus – when finding a block, the user receives all the coins due for this. However, from a practical point of view, solo mining significantly loses the pool to mining.

Pool mining was invented after the solution of one block in solo mining began to take too much time. Then users began to unite their efforts in pools (pool – unification). For simplicity, let’s compare pools to websites that piece together the computing power of their members, allowing you to find blocks faster. The reward in this case has to be divided among themselves in proportion to the power of each computer, but this type of mining is still much more profitable than solo, and is used in the vast majority of cases.

The computing power of the computer during mining is measured in hashes / s, that is, in the number of basic computing operations per second. For different algorithms, this indicator has a different value. For example, the performance of video cards when mining Bitcoins (SHA256) is measured in Mhesh / s, that is, millions of operations per second, and when mining Altcoins (Scrypt), the same video card already produces several hundred Khesh / s. This does not mean that Bitcoins are more profitable to mine, and only says that different algorithms have the simplest operations performed at different speeds. And since we touched on this topic, the mining of Bitcoins with the help of video cards at the moment is absolutely not profitable and does not even pay off the cost of electricity, since the performance of the most modern video card is a drop in the ocean compared to the performance of any basic ASIC chip.


Just above, the so-called “51% attack” was mentioned. This is the most well-known vulnerability of cryptocurrencies, which is that a person who has access to 51% of the computing power will be able to carry out certain frauds with the block chain. He still will not be able to manipulate earlier transactions, but he will be able to conduct the so-called Double Spending operation.

A double expense is that a certain amount is transferred from one address to another, after which, with the help of monitoring most of the network, the rest of the computers are convinced that this transaction did not exist. After that, the same amount can be spent again. Since the ability to create money out of nothing will quickly undermine the reputation of any DV, its users are closely monitoring the situation. To do this, centrally (through forums and reddit), miners are asked to switch from large pools to smaller ones.

In principle, the mere fact of controlling 51% of the network capacity does not mean that the pool owner will conduct Double Spending. Short-term profits are likely to be lower than the long-term harm of undermining the currency’s rating. Situations when one pool controlled more than 51% have already happened in the history of Bitcoin, but the attack itself was not implemented.

In addition to distributing power across the network, you can protect against the appearance of a “central” miner by improving the overall performance of the network using an ASIC. This will greatly increase the complexity of concentrating 51% of computing power in one hand, since creating an independent farm of specified capacity will have to spend millions, if not tens of millions of dollars, and setting up such a large farm will most likely not be the easiest task.

A certain danger to the CV is also represented by events known as a fork (fork- in English fork, but it is better to use the term “branching”). In such cases, a single LED book is divided into two branches (sometimes more), and in the world of cryptocurrency, as it were, two realities begin to exist that do not intersect with each other. Users who exist in one reality will not be able to translate or receive DH from users in another reality. To correct this situation, one of the branches is selected by the developers of the DC as correct and the source code of the client is updated, which works only with the correct block chain and ignores the incorrect one. To return to reality, all active participants must use the updated client. In principle, this type of fork does not pose a particular danger, although it is unpleasant for everyone. It is best in such a situation not to make any transactions on the network, so as not to lose coins if they are sent to the wrong fork.

Accidental forks occur when something violates the rules of the network, which most often happens when using mixed versions of clients. For example, in Dogecoin until version 1.2, it was impossible to transfer more than 100 million coins in one transaction, but due to the fact that the person who first made such a large transaction was on the old version of the client, part of the network considered the transaction legitimate, and part – erroneous. As a result, a fork was formed, which, however, was almost instantly corrected.

In addition to random forks, there are also planned ones. They are announced in advance and they take effect from a specific block, so users and pools have a few days or weeks to upgrade the client to the latest version. Planned forks are usually associated with changes in the mining algorithm.


Despite the fact that the digital currency has existed for more than 5 years and quite often hits the headlines of the news, most users still do not have a general idea of the principles of its work. Some compare CV with MMM or Ponzi schemes, others see in it another round of development of the monetary system and a faster and more reliable transfer system. Someone likes the opportunity to join something technologically new and potentially promising at the very beginning of development. Someone is just trying to make money on fluctuations in rates, as with ordinary stocks. There is also an opinion that cryptocurrency will help the development of third world countries by replacing unreliable local monetary units (on the example of M-Pesa in Kenya, it is obvious that this is not just someone’s imagination). And some are already calling Bitcoin the new electronic gold. Who will be right, will show not so distant future, and perhaps, as in the series “Almost Man”, cryptocurrency will eventually replace ordinary paper and electronic money.

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