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Understanding the Blockchain as a Cryptocurrency Investor
I’ve written up a simple explanation of the blockchain and cryptocurrency here. Once you have read the article and understand the concept of a blockchain, there are several more aspects of the blockchain that you need to understand as a cryptocurrency investor:
1. Open-source and Transparent
OK this sounds vague and pointless at this stage; However, it is important to understand this before we go on discussing the other aspects. Anyone who can read codes can actually verify themselves what’s written in the Bitcoin code. For example:
- How much supply Bitcoin started with
- What’s the Bitcoin inflation rate (to understand the supply and demand)
If you compare this with a common national currency which is normally controlled by a central bank, no regular people like you and I would know how much money will be printed in the next 10 years; Or what the central bank interest rate will be next year. With cryptocurrencies, these are all visible inside the code.
Cryptocurrencies are decentralized, in a sense that no one person or one entity can control them. The code does not sit in a central server somewhere, or operated by one company. But instead, the exact copies of the code are spread across the network. You can also choose to run a node yourself, where you share the blocks and transaction records of the blockchain in your machine.
3. Clear Supply and Inflation Rate
Knowing that cryptocurrencies are transparent and decentralized, we can then know exactly what’s the current supply and what’s the supply will be in the future.
Why is supply important?
Anything in this world that you can buy and sell, has a price. And the price of everything is determined by none other than supply and demand.
Imagine if every person in the world has apple trees that produce unlimited amount of apple – all with the same quality. Then the price of apple will be close to 0, as there is no point of buying or selling apples because everybody can have them for free.
Here’s another analogy: Imagine if there are only ten special edition Ferraris in the world. You’ve decided to buy one for a high price, due to its exclusivity. However, 5 years down the line, Ferrari has decided to create 10,000 more of the same car. How would you feel? And what do you think is going to happen to the price?
It has exactly the same concept as shares / stocks. To understand the value of a company, you would need to know their market capitalization, which you can get from the number of shares available and its share price. Understanding their future earnings and profit margins will be helpful as well, but that's a different subject.
Bitcoin Supply and Inflation Rate
Let’s look at Bitcoin supply and inflation rate for our example here. The chart below is based on the code of Bitcoin, and it can tell you exactly how much Bitcoin will be in circulation in any time period in the future.
Whatever has occurred and confirmed on the blockchain, cannot be undone. So if you have made an incorrect transaction by sending your funds to an incorrect address, your money is basically gone - unless if the owner of that address is kind enough to return your money. But then again, it is almost impossible to investigate which person on earth owns an address in question.
There are of course cases in the blockchain space where the opposite occurs, and it would be a big news. For example, there has been an incident in the Ethereum space: The DAO hack - where a hacker stole a large amount of Ether (~15%) in circulation. The founders and developers of Ethereum refused to allow this to happen, so they created a fork (a new branch / version of Ethereum) where this version does not acknowledge the hack has happened. The old version of Ethereum however, still exist and also known as Ethereum Classic.
5. Almost Impossible to Hack
A good and strong blockchain would be supported by a large number of miners who are securing the network with their computing power. Mining is a large business on its own. Miners are rewarded by the cryptocurrencies they mine. Essentially, these miners are competing to solve mathematical equations. Whoever solves them first and creates a new block in the blockchain, gets rewarded. Therefore these miners are willing to invest a lot of money to secure large computing power and pay for their electricity bills.
Note that the above explanation about mining, applies to proof-of-work blockchains, like Bitcoin. Some types of blockchain (for example the future of Ethereum, will use proof-of-stake system - or virtual mining). This is a whole subject on its own.
To be able to hack a blockchain, you would need to control more than 50% computing power that secures the network (known as 51% attack)
You probably have heard about some blockchain hacks in the past? These hacks are mostly occured to exchanges (Mt. Gox for example) and also smart contracts that have vulnerable security bugs (e.g. The DAO), and not hack to the blockchain itself.
To paint a picture of how difficult and expensive it is to control 51% computing power of a blockchain network, here are some examples of mining activities done by business or individuals:
Note: The information in this website and the links provided are for general information only and should not be taken as a financial advice.
Browse Crypto-Investing 101 Posts
- How to Start Investing in Cryptocurrencies
- Why Invest in Cryptocurrencies
- Cryptocurrency Market Cap Growth
- Understanding the Blockchain as a Cryptocurrency Investor
- List of Cryptocurrencies and Altcoins
- How to be Across Upcoming Crypto ICOs
- How to Assess Crypto Projects and Altcoins
- How to verify transactions on the blockchain
- Ways to Store Cryptocurrency