Cryptocurrencies have become a global phenomenon known to most people. While still somehow geeky and not understood by most people, banks, governments and many companies are aware of its importance. A cryptocurrency is a virtual currency (it only exists on computers) designed to work as a medium of exchange. It uses cryptography to secure and verify transactions as well as to control the creation of new units of a particular cryptocurrency. Essentially, cryptocurrencies are limited entries in a database that no one can change unless specific conditions are fulfilled. Satoshi Nakamoto, the unknown inventor of Bitcoin, the first and still most important cryptocurrency, never intended to invent a currency. His goal was to invent something; many people failed to create before digital cash, which was to found a way of how to build a decentralized digital cash system. But how does a cryptocurrency works?
To use cryptocurrency, you don’t need to understand it (any more than you need to understand the monetary system to use a credit card). However, if you want to understand cryptocurrency you need to understand the concept of digital currency, the concept of blockchain (both a ledger of transactions and a technology), and the concept of cryptography. After-all, cryptocurrency is a digital currency, where transactions are recorded on a digital ledger called a blockchain, and every process along the way is secured by cryptography. Cryptocurrency works a lot like bank credit on a debit card. In both cases a complex system that issues currency and records transactions and balances works behind the scenes to allow people to send and receive currency electronically. The main difference between cryptocurrency and bank credit is that instead of a banks and governments issuing the currency and keeping ledgers, an algorithm does. Cryptocurrency is transferred between peers (there is no middleman like a bank). Transactions are is recorded on a digital public ledger (called a blockchain). Transactions and the ledger are encrypted using cryptography (why it is called “crypto” “currency”). It is also decentralized, meaning it is controlled by users and a computer algorithm and not a central government.
How does cryptocurrency work? Transactions are sent between peers from “cryptocurrency wallets” by matching up public codes which relate back to user-held private passwords (AKA cryptographic “keys”). Transactions made between peers are recorded on a public ledger of transactions called a “blockchain.” All users of a given cryptocurrency have access to the ledger if they choose to download a “full node” wallet (as opposed to holding their coins in a third party wallet like Coinbase). The transaction amounts are public, but who sent the transaction is encrypted. Each transaction leads back to a digital “cryptocurrency wallet.” Whoever owns the password (or key) to the wallet, owns the amount of cryptocurrency denoted on the ledger. When someone sends or receives cryptocurrency, when they send from one wallet to another wallet using a set of private and public passwords, that transaction is queued up to be added to the ledger. Many transactions are added to a ledger at once. These “blocks” of transactions are added sequentially. That is why the ledger and the technology behind it is called “block” “chain” it is a “chain” of “blocks” of transactions.
How does blockchain work?When a peer-to-peer cryptocurrency transaction is made, that transaction is sent out to all users with “full node” wallets. Specific types of users called miners then try to solve a cryptographic puzzle (using software) which lets them add a “block” of transactions to the ledger. Whoever solves the puzzle first gets a few “newly mined” coins as a reward. Sometimes miners pool computing power and share the new coins. The algorithm relies on consensus. If the majority of users trying to solve the puzzle all submit the same transaction data, then it confirms that the transactions are correct.
What is cryptocurrency mining? People who are running software and hardware aimed at confirming transactions to the digital ledger are cryptocurrency miners. Solving cryptographic puzzles (via software) to add transactions to the ledger (the block chain) in the hope of getting coins as a reward is cryptocurrency mining.
Cryptocurrencies are most likely here to stay – and here to change the world. This is already happening. People all over the world buy Bitcoin to protect themselves against the devaluation of their national currency. Banks and governments realize that this invention has the potential to draw their control away. Step by step Cryptocurrencies are changing the world. And whether we want to accept that or not, and whether we understand it or not we only have two options: we can either stand beside and observe or we can become part of history in the making.