You definitely tend to hear a lot of new terms when you first start trading crypto.
Mining, layer 2s, proof of stake, gas fees – what does it all mean??
We know how hard it is to learn all these terms, so we’ve curated a simple guide to help you understand.
Question #1: What is a blockchain? Is it like infrastructure for cryptocurrencies?
Answer: A blockchain is a decentralized digital database that securely stores records across a computer network’s nodes, allowing different types of data to be stored. However, all the data is immutable and irreversible.
Information in blockchain is grouped into blocks, and each block is connected to the previous one using cryptography. Everyone on the network keeps a copy of the chain, so no single person controls it, and new data is added through consensus mechanisms (e.g., Proof-of-Work, Proof-of-Stake)
Imagine blockchain as the underlying infrastructure and fundamental layer that empowers cryptocurrencies and other decentralised applications.
Cryptocurrencies run on top of the blockchain and use it to record transactions, prove ownership, transfer value, and keep everything secure and verifiable without a central authority.
Question #2: What is proof of stake vs proof of work? What is bitcoin mining?
Answer: Proof of Stake (PoS) is the consensus mechanism that reduces the need to use computational power by randomly selecting validators to confirm transactions and create new blocks in the blockchain. It is used by Ethereum, Solana, Cardano, Avalanche, etc.
Proof of Work (PoW) is a consensus mechanism that requires computational effort to validate transactions. The first one to solve complex mathematical puzzles gets to add a new block and earns rewards. It is used by Bitcoin – when people talk about Bitcoin mining, they are referring to this process.
Question #3: What is a gas fee? How to use it?
Answer: Gas fees are essential for executing transactions and smart contracts, like paying a transaction fee for passing. Gas fees are most commonly seen in Ethereum transactions; when you move Ethereum or ERC-20 tokens from one Ethereum wallet to another, you have to pay a gas fee.
The fee compensates the network for using its computer power, as the cost paid to validators for processing your transaction.
The methodology of how the gas fee works is that each transaction has a gas amount that depends on how much work it needs.
The amount of gas fees paid depends on how busy the network is. If the network is busy, the gas fee rises. On the other hand, if the network is quiet, the gas fee drops. This is why sometimes gas fees for Ethereum can spike during periods of market volatility.
Question #4: What’s the difference between layers in blockchain
Answer: The blockchain ecosystem uses layered approaches to boost efficiency.
- Layer 0: Infrastructure consisting of the underlying hardware, protocols, and network infrastructure that support blockchain operations. It includes physical components like servers, computers, and internet protocols, as well as interoperability protocols that facilitate communication across different blockchains.
- Layer 1: The data layer: the primary blockchain where transactions are processed, such as Ethereum
- Layer 2: The networking layer where off-chain scaling solutions connect and facilitate communication between blocks. For example, Optimism and Arbitrum are Layer 2s that speed up Ethereum transactions by taking them to a separate layer.
- Layer 3: The consensus layer, where the consensus protocols and mechanisms are stored and performed
- Layer 4: The application layer, where applications are built to interact with blockchain
Question #5: What are stablecoins?
Answer: Stablecoins are a type of currency designed to maintain a stable value pegged to a traditional fiat currency such as USD, offering a less volatile alternative to cryptocurrencies like Bitcoin.
Stablecoins resolved the biggest issue: volatility. However, why not use an actual fiat currency instead of stablecoins?
Stablecoins, basically the cash equivalent of digital assets, can provide the means to engage seamlessly in the digital assets space, or ‘on-chain. It can be used for transferring money instead of relying on the traditional banking method.
Tether (USDT) and USD Coin (USDC) are the most widely used of stablecoins, pegged to the U.S. dollar with a 1:1 backing. Additionally, stablecoins are a cash equivalent of digital assets, so they can be used for payments, trading on exchanges, and remittances. They tend to be backed by bank deposits and short-term liquid assets, US Treasury bonds, and other short-term debt instruments.
Cons of Blockchains
Blockchain technology is innovative and secure, but it still struggles with speed, fees, energy usage, complexity, regulation, and risks in respective ecosystems.
The disadvantages of blockchains:
1. Slow and Limited Scalability: can only process a limited number of transactions per second. Transfers can take several minutes to hit one’s wallet account
2. High Transaction Fees: when networks get busy, fees can be expensive, making transactions inefficient and too costly
3. Energy Consumption: some blockchains use a lot of electricity, especially Bitcoin, which requires mining and leads to high operational costs
4. Irreversible Transaction: once a transaction is confirmed, you can’t undo it.
This can be detrimental since you can
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- Send funds to the wrong address
- Get scammed
- Make a simple mistake when inputting a wallet address
5. Complex for Beginners: the learning curve can be steep when trying to understand how wallets and transfers work, as a simple mistake can mean losing all your funds, causing stress
6. Regulations and Legal Uncertainty: different countries have different rules and regulations, and some of them are unclear, which may incur business risk, tax complexity, and compliance challenges
7. Storage & Data Bloat: since the full history of a blockchain needs to be stored permanently, the nodes require increasingly large amounts of storage capacity, making decentralization harder
Why is blockchain technology the future of payments and transactions?
Blockchains are the future of innovative banking – making payments and transactions more transparent, convenient, and seamless.
Blockchain technology is transforming cross-border payments, offering more efficient and affordable solutions when compared to the traditional banking system.
The benefits are the significant reduction in transaction costs. Blockchain transactions enhanced the frequency of transactions by eliminating intermediaries, reducing fees and making cross-border transfers more economical and borderless.
Transfer tokens like USDT and ETH to BTSE on the blockchain by clicking here.
