Cryptocurrency and blockchain are a complicated subject, especially for those uneducated about many of the concepts that are involved with the sector. Even those that are slightly more educated about crypto than the layman can misunderstand concepts. Before getting too deep into cryptocurrency, it’s certainly a good idea to learn about the basic concepts of the digital asset sector. That’s why we’ve created this guide to basic crypto concepts for you to understand.
Four Key Crypto Concepts
There are, at least, four key concepts that you should learn about cryptocurrency and by extension, blockchain. Below we will discuss the five concepts as simply as possible, while aiming to provide useful analogies where applicable to help relate them to more well-known concepts.
One of the first things we need to separate is blockchain and cryptocurrency. Cryptocurrency wouldn’t exist without blockchain, but blockchain can exist without cryptocurrency. Blockchain itself is the technology that allows cryptocurrency to function; it’s the infrastructure that crypto is built upon.
A blockchain is a distributed ledger or database, which is shared across multiple computers in a network (these computers are known as nodes). The difference between a regular database and blockchain is the way the data is collected and stored: in blocks. Blocks have a set storage capacity for data (such as transactions between users) and when the block is filled it gets closed and linked to the previous block, creating a chain, hence, blockchain.
The easiest analogy for separating blockchain and cryptocurrency is to think of blockchain as the Internet and cryptocurrency as the websites you can find on it. There are a variety of domain (website) providers for the Internet just as there are a variety of blockchains that cryptocurrency can be found on.
The Blockchain Trilemma
The blockchain trilemma is the main hurdle which blockchains need to get over in order to become the disruptive technology they are touted to be. It’s thought that public blockchains will have to sacrifice one of the three components of the trilemma in order to succeed, and that problem is what most blockchain developers are trying to solve.
The three components of the trilemma are: decentralization, security, and scalability. Let’s discuss each in earnest.
Decentralization is perhaps the most important piece of the trilemma. The purpose of decentralization is to remove the need for intermediaries in processes such as financial loans, while also preventing data from being censored or controlled by a single source. These are referred to as centralized sources or authorities. The issue with centralized sources is they present a single point of failure.
For example, many people use Google’s Two-Factor Authentication (2FA) to help secure various accounts. If someone were to gain access to the servers where this data is stored, they’d have access to all users’ information. Similarly, if those servers went down, every user wouldn’t be able to log in to accounts that use 2FA until the problem was solved.
Security is just what it sounds like, the security of the blockchain. It’s difficult to make a network decentralized and secure, while also being fast (scalable). The Bitcoin network is extremely secure and decentralized, but it has always had to solve the issue of scalability. Many networks can achieve faster throughput (the speed at which transactions are sent and confirmed), but have to sacrifice security to do so. This is done by either reducing the number of nodes involved or where they are located. Either way, it centralizes the network and makes it more vulnerable to the issues noted in decentralization.
With blockchain, scalability refers to the ability for the network to maintain its speed and support a growing number of users. If a blockchain starts to perform worse as more users begin utilizing the network, that is a network with poor scalability. There are many networks, such as Bitcoin, which have good security and decentralization, but poor scalability as the network can only process 7 transactions per second at a base level. If Bitcoin can solve scalability, then it will also solve the trilemma.
A good analogy for scalability is to think of a restaurant that’s featuring a special, or has been featured in the news or something similar that would increase demand. If the restaurant doesn’t buy more of what’s required for the special, or increase staffing and ordering if they’re expecting more customers, it won’t be able to meet demand and will suffer in various ways.
Wallets and Recovery Phrases
A cryptocurrency wallet is simply a place to store your cryptocurrencies. Crypto wallets work differently than your traditional one, with the biggest difference being that you can’t really lose a crypto wallet. Even if the device you had your crypto wallet on is lost or stolen, or you simply get a new device, you can recover your wallet in its entirety. This is because when you set up a crypto wallet you’re given a 12 or 24-word list, called a recovery phrase. It can be used to restore your wallet whether you lost your device or simply got a new one.
Be sure to keep the recovery phrase in a safe place. If it’s lost then you can’t recover the wallet. Alternatively, If someone else finds out your recovery phrase, then they can recover your wallet and spend your funds. It’s kind of like leaving out your Social Security and credit card information for someone to find.
Public and Private Keys
Crypto wallets work using two separate sets of keys: public and private. Public keys are a receiving address, not that different from using someone’s email to send them money. Sure, you know their email in order to send them the money, but you don’t know their email password, or their banking information. However, unlike an email address that simply requires a password in order to be accessed, you need a private key in order to sign transactions (as in send) with your wallet.
A private key can be thought of like a signature, and which is in fact a long string of alphanumeric characters. Private keys are stored within your cryptocurrency wallet and are only used when you go to sign a transaction. This is often in addition to a spending password you set for the wallet which is like your PIN and this essentially approves use of the private key to sign the transaction. Private keys, like recovery phrases, should never be shared, and are intentionally difficult to actually access and see within your wallet as a result.