week 7 (2) Flashcards
The double-spending problem
The double-spending problem refers to a potential issue in digital currencies, where the same digital token or unit of value could be spent more than once. This is a key challenge for decentralized digital currencies (like Bitcoin) because digital information can be copied easily, unlike physical currency which cannot be duplicated without detection.
Blockchain
It represents a complete history of all financial transactions in a decentralized community. Every
member of the community accepts the status quo of the Blockchain. Consensus (ensures that only one version of the transaction history is recognized by the network, preventing the same digital asset from being spent twice) is important
Private key
The private key is a randomly generated cryptographic string that acts like a password. It is essential to keep this key secret, as it provides access to your digital assets (e.g., cryptocurrency).
Private keys are used to sign transactions, verifying ownership and authorization to transfer funds
Public key
The public key is mathematically derived from the private key. You can think of it as an address where others can send you funds, or an identity that you can share publicly.
Hashing
the process of taking an input (or “message”) and applying a hash function to produce a fixed-length output, known as a hash value, hash code, or simply a digest.
Mining
is a process that creates consensus in the blockchain network. It ensures that transactions are valid and prevents double-spending by verifying all transactions.
Miner’s role
Miners verify transactions by checking:
If the transaction was signed by the private key of the sender.
If the sender has enough funds to complete the transaction.
Where the funds are being sent.
Protection against misbehavior of miners and users
Random Selection of Miners: Miners are randomly selected, and they must prove they have expended computational resources to find the correct nonce (through Proof of Work).
Mining has to be expensive: To prevent attackers from flooding the network with fake identities, the cost of mining (in terms of computing power) makes attacking the network prohibitively expensive.
Process of Mining
Transaction Initiation: When a user sends money, their wallet sends the transaction to nearby nodes in the network.
Transaction Verification: Nodes verify the transactions and broadcast them to the network, while saving the entire blockchain in a peer-to-peer network.
Mining:
Miners take the transactions and group them into a block.
The miner’s task is to find a nonce (a random string) that, when hashed with the block’s data, produces a hash that meets a certain condition (determined by the mining difficulty).
This process is known as Proof of Work (PoW), where miners engage in trial and error to find the correct nonce.
Block Addition: Once a miner finds the correct nonce, they broadcast it to the network. Other miners then verify the solution by hashing the block data and nonce.
Consensus: If the majority of miners agree on the validity of the solution, the new block is added to the blockchain.
Mining: Proof of work
- Transactions in “Limbo” (Unconfirmed): when you send crypto, the transactions are waiting to be included in the blockchain, they need to be verified and confirmed by miners first
- Miner’s role: taking the set of unconfirmed transactions and try to make them into a block.
Before the blocks are added into the blockchain, miners have to run a intensive computation to find a valid solution, proving that theyve done the work
- Find the valid nonce: to mine a block, miners must find a nonce, which is a special string of numbers or characters that, when added to the block data, produces a hash that meets a specific condition.
- Trial and Error (Brute Force): Miners use trial and error to find the correct nonce. They repeatedly change the nonce and hash the block data until they find a valid hash that satisfies the required difficulty. mining
5.Verifying the Block: Once a miner finds the correct nonce, they broadcast the newly mined block to the network, and if majority of nodes and miners agree that the hash is valid, the block is added.
Mining: How does a Blockchain look like?
Linked list containing data (transactions) and hash pointers that point to the previous block
Merkle Root: Hash structure to quickly find transactions in a block
*important: Blocks are based on preceding blocks (hash pointers). If you changed one block, all succeeding blocks would have to be changed.
Altcoins
“Altcoin” is a combination of two words: “alt” and “coin”; alt signifying ‘alternative’ and coin signifying
(in essence) ‘cryptocurrency.’ Thus together they imply a category of cryptocurrency that is alternative to the digital currency Bitcoin.
Initial Coin Offerings
An Initial Coin Offering (ICO) is a fundraising method used by startups or projects, especially in the blockchain and cryptocurrency space, to raise capital for new ventures.
How to buy cryptocurrencies?
1.1 Indirectly via ETFs (Exchange-Traded Funds)
Tracks the exchange rate of BTC and USD (+ additional exchange risk USD/EUR if you are an investor based in the Eurozone)
o Advantage: easy
o Disadvantage: limited availability in terms of covered cryptocurrencies
1.2 Directly on an Exchange: Register at an exchange that trades cryptocurrencies
o Coinmarketcap provides helpful information on exchanges
o Need to verify your identity (anti-money-laundering rules)
o Might need to buy Bitcoin first to buy other cryptocurrencies
Selling cryptocurrency
1.1 Futures Market (e.g., CBOE): You can enter a futures contract to bet on falling prices
o Example: price of 1 BTC is 4000$ at the moment. You could enter a future agree to sell BTC at
3900$ in one month. If the price is at 388$ next month, you make a 100$ profit.
1.2 Contracts for difference: CFDs are a financial instrument that forms a contract between a buyer and seller, in which each
agrees to pay the other any rise or fall of an asset by a certain date
1.3 short ETFs: These are funds that aim to provide inverse exposure to the price of cryptocurrencies. Essentially, they track the inverse of the price movement (if Bitcoin’s price goes down, the short ETF goes up).
