Cryptocurrencies have existed for less than a decade. Yet, it can feel like understanding the ins and outs of cryptocurrencies and blockchains would take well over a decade, if it can be done at all.
Luckily, that feeling doesn’t last forever. Once you’ve got a firm grasp of the cryptocurrency basics, you’ll be able to dig a bit deeper into how the technology works and things will start to really click. From there, you’ll be capable of analyzing different projects and determining which ones you want to invest in. As an extra bonus, the deeper you dig, the more fun learning about cryptocurrencies will become.
On that note, here are some more terms that will be important for you to understand, to help you on your way to becoming an educated investor.
The basic concept behind proof-of-work (PoW) is this: make it costly to mine on the blockchain and you’ll deter spam and other malicious activity by miners.
For a trustless, decentralized system to exist, there has to be an incentive for participants in the system to “follow the rules”, so to speak. Of course, the best kind of incentive is an economic one. Proof-of-work is an effective incentive for miners to be honest because the financial cost of being dishonest is significant.
A normal computer can process tons of transactions very quickly and inexpensively. PoW systems use cryptographic puzzles to make it more difficult to mine a block on the blockchain.
For a miner to even mine at all, they will incur a significant cost. Moreover, if a miner proposes a block that has invalid transactions, the other miners will reject the block and the original miner won’t earn a reward. In this way, being a miner only makes sense if you intend to process transactions honestly, otherwise it is just throwing money away.
Proof-of-stake (PoS) is an alternative and less expensive form of mining new blocks on the blockchain. Here, mining power is attributed based on the proportion of coins held by a specific participant. For example, if somebody owns 10% of the total Bitcoins in existence, they would have 10% of the total mining power if Bitcoin were a PoS system.
The idea behind this is that somebody who owns the currency will want to see it go up – incentivizing them to be honest. This eliminates the need for cryptographic puzzles which make mining more costly, and thus reduces the waste and environmental impact of running the network.
Scalability refers to the ability of a system to maintain or improve its performance as its workload increases. In cryptocurrency terms, this means the ability of the network to process transactions cheaply and quickly as increasingly more transactions occur.
Block size is one of the key terms in the scalability debate. It simply refers to the storage capacity of a single block on the blockchain. For example, the Bitcoin blockchain currently has 1MB blocks, while the Bitcoin Cash blockchain has 8 MB blocks. This correlates to having the ability to process about 3 transactions per second for Bitcoin, and 24 transactions per second for Bitcoin Cash.
Increasing the size of blocks to some arbitrarily high number unfortunately isn’t a solution to the scalability issue. As block size increases, the size of the entire blockchain increases along with it, making it more difficult to store the entire blockchain and run a full node.
As of December 2017, Bitcoin’s blockchain is 140 GB, while Bitcoin Cash’s blockchain is 155 GB, reflecting the increase in block size that occurred in November when Bitcoin Cash was created. For the time being, this isn’t a big issue for Bitcoin Cash, but it remains to be seen what the impact will be in the years to come.
Off-chain or 2nd Layer solutions are ways to address the scalability problem by processing transactions without using the blockchain. The goal of such solutions is to maintain the security and trustlessness of the blockchain while being able to process hundreds of thousands of transactions per second instead of only tens or hundreds of transactions per second.
As famous Bitcoin pioneer Hal Finney wrote in 2010:
“Bitcoin itself cannot scale to have every single financial transaction in the world be broadcast to everyone and included in the blockchain. There needs to be a secondary level of payment systems which is lighter weight and more efficient.”
There are different ways of accomplishing this, including the aforementioned Lightning Network and another solution, child chains.
Child chains are an alternative 2nd layer solution to blockchain scalability in which the size of the main blockchain is reduced by processing transactions and storing snapshots of the blockchain on secondary blockchains. Child chains can retain all of the features of the parent (main) chain, and they can communicate with each other easily through the main chain.
This is the solution implemented by Ardor.
Hash rate is the measure of how much processing power a network has. In other words, the hash rate is a reflection of a network’s mining power. To give you an idea of this, the current hash rate of the Bitcoin network is about 12,000,000 TH/s. 1TH/s is 1 trillion hashes per second, or 1 trillion calculations being performed by the miners per second on the network.
Understanding the terms in this article will give you strong foundational knowledge for diving deeper into crypto. Sure, there will still be some complex computer science discussions that most of us can’t follow even if we understand crypto very well.
For the most part, however, you’ll be able to actively contribute to discussions in whichever communities you participate in. Better still, you’ll be able to confidently teach other people about cryptocurrencies.