How is Crypto Acquired - UNDERSTANDING THE BLOCKCHAIN; Episode 5
Hey there! Welcome to another episode of Understanding the Blockchain.
You can check out previous episodes here:
Note: For this episode, we'll be using bitcoin as a reference point. But know that the method for acquiring most of the different cryptocurrencies is basically the same.
So, we’ve been exploring the origin of the blockchain in earlier episodes, we’ve talked about bitcoin and its timeline. In this episode, we’ll talk about the 3 major ways you can acquire bitcoin.
Normally, we shouldn’t be talking about this for a blockchain series. But we need to explore this to further understand how bitcoin works.
The three major ways are:
1. Purchase bitcoin at an exchange
This is probably the easiest way of acquiring bitcoin.
What then is an exchange?
Source: Pexels | Photographer: David McBee
An exchange is a private organization that exchanges cryptocurrencies for other currencies (like $, €, £, ¥, etc.). There are a lot of exchanges that have nothing to do with cryptocurrencies. Exchanges basically exchange one form or type of currency for another.
There are a lot of exchanges out there you can use to acquire cryptocurrency. It’s very easy to acquire cryptocurrency with exchanges using your local currency.
There is although a problem associated with exchanges.
EXCHANGES ARE NOT DECENTRALIZED!
Exchanges are subject to the regulations of the jurisdiction in which they run. For example, an exchange running in China will be subject to the policies and regulations made in China that affect it.
Exchanges are also easier to trace. One of the key concepts behind cryptocurrency as we explained earlier is anonymity. When you sign up on these exchanges, you sign up with all your information; name, email address, address, drivers license or some other sort of verification. This makes it very easy for transferred funds to be traced.
Exchanges also lack the security guarantees of the Bitcoin protocol. Bitcoin itself is decentralized, but exchanges are private organizations which are not decentralized and are subject to all the problems we discussed when we talked about Fiat.
In this case, the Bitcoin itself is not the problem. The problem is when you buy the bitcoin through a company, by default, the bitcoin is still held by the company basically.
The bitcoin just assigned to your account, but the company is still basically in charge of your bitcoin.
This is what makes it so easy to acquire cryptocurrency using exchanges. No setup is required.
But this still gets back to the problem of centralized currencies. The fact the exchange could be a scam or could be compromised in a hack and currencies are lost.
We’ll explore an example, Mount Gox (Mt. Gox)
Source: Wikipedia. By MtGox - MtGox.com, Public Domain, Link
Mt. Gox was an exchange that was established in Tokyo in 2010 after bitcoin was released.
By 2014, Mt. Gox was handling over 70% of all Bitcoin transactions worldwide. The case is much more different in recent times as there is currently no exchange that handles such a massive share of the global transactions.
The problem with that monopoly was that in February of 2008, eight hundred and fifty thousand (850,000) bitcoin was stolen. At that time, it was about four hundred and fifty million dollars ($450,000,000). Today, it would have been about $7.8 billion.
It was a massive heist of cryptocurrencies that belonged to people. In March 2014, they declared bankruptcy and this really caused the price of bitcoin to crash for a while.
The common misconception there was that bitcoin was hacked. Bitcoin cannot be hacked because there is no single point of failure. Unless of course you would hack 10,000+ computers across the globe. Mt. Gox was just a centralized custodian of the underlying cryptocurrency and they had a single point of failure.
Source: Pixabay | Artist: TheDigitalArtist
In recent times, there has been a lot of improvements in cyber security and there are a lot of trust worthy exchanges out there where one can acquire cryptocurrency although, I am not going to be endorsing any particular exchange in this post.
But, on bitcoin.org (this is the bitcoin foundation’s website – it is looked at as some sort of de facto authority on bitcoin), there is a list of recommended exchanges. They also still do have a disclaimer which states:
Note: Exchanges provide highly varying degrees of safety, security, privacy, and control over your funds and information. Perform your own due diligence and choose a wallet where you will keep your bitcoin before selecting an exchange.
So, their advice is buy your bitcoin from these exchanges and choose a wallet to move your bitcoin to as soon as possible. We’ll still explore what a wallet is in coming episodes.
That brings us to the second way of acquiring bitcoin or crypto in general.
2. Exchanged for good and services
This is basically exchanging bitcoin for something else from person to person (or as is commonly described, peer-to-peer).
Let’s say I sell coffee, a customer who wants to purchase coffee can pay me with bitcoin; not through an exchange, but through an app that can connect to the bitcoin protocol. There are a lot of these apps out there on both mobile and desktop and even more recently other electronic devices. We’ll explore these as well later.
Note that peer-to-peer basically means from one person to another. This is the basis on which peer-to-peer exchanges are built to avoid the problems faced by centralized exchanges.
In this case, the exchange is just a third party that has no control over the cryptocurrency. The currencies are traded within different people on the exchange and the exchange serves as an overwatch to ensure there is no fraud in exchange for a little fee.
The third way of acquiring bitcoin and cryptocurrency is through mining. This is probably the least intuitive and least approachable. You can say the least “go-to” method.
What exactly is mining?
Mining is basically the way new bitcoin and other cryptocurrencies are created or found, just like with mining gold. Definitely, pick axes aren’t used in the case of crypto mining instead, computing power is used.
Source: Pixabay | Artist: Peggy_Marco
What then is the point of mining?
We’ll be exploring this extensively in coming episodes as well but basically, miners are the people who maintain the bitcoin network. What goes on is that miners earn bitcoin for maintaining a copy of the ledger and for facilitating new transactions. So, computers are hard at work behind the scene and they get rewarded with bitcoin for that.
See you in the next episode as we further explore the beauty of the blockchain technology.