What is Cryptocurrency, and How does it Work?

What is Cryptocurrency and how it works

Cryptocurrency existed long before Bitcoin completely took over the entire crypto market. This digital, or virtual currency, is secured by cryptography which makes it impossible to counterfeit or double-spend the money. In this article, we will dive into the definition, history, and alternatives to current cryptocurrencies.

What is Cryptocurrency?

As mentioned, a cryptocurrency is a digital cash. Payments and transactions are all done via Internet, which means it’s completely paperless. A cryptocurrency is being managed by a network of computers, and its value is primarily based on supply and demand. There are many types of cryptocurrencies, with various functions. Regardless, each cryptocurrency is supported by decentralized peer-to-peer network called blockchain. Cryptocurrencies leverages blockchain technology to gain decentralization, transparency, and immutability.

Due to the decentralized nature of blockchain, cryptocurrencies are not controlled by any central authority like Federal Reserve System. This makes the cryptocurrencies theoretically immune to the traditional government control and interference.

How does Cryptocurrency work?

Satoshi Nakamoto, the Bitcoin inventor, never intended to invent a currency when he first presented Bitcoin in late 2008.

In his announcement, Satoshi said that he developed a “Peer-to-peer Electronic Cash System”, or in other words, a digital cash.

“Announcing the first release of Bitcoin, a new electronic cash system that uses a peer-to-peer network to prevent double-spending. It’s completely decentralized with no server or central authority.” Announced Satoshi on SourceForge in January of 2009.

It is important to note that digital cash is something that has been thought about since the advent of the internet, but all previous effort have completely failed. Before Bitcoin, there was DigiCash in 1990s, an electronic cash company based in Amsterdam. DigiCash was unable to grow the company through the expansion of its user base, and has filed for bankruptcy in 1998. Then there was also e-gold, the first widely used internet money, introduced in 1996. Unfortunately, it was later shutdown by the US Government in 2008 because of several criminal abuse cases.

How does Cryptocurrency and Blockchain Works

Note that previous digital cash systems are centralized. That means, it was being controlled by an authority, or a central entity. Satoshi’s invention, on the other hand, is completely decentralized, like a peer-to-peer network file sharing. It is also his solution to prevent double-spending.

To realize a digital cash system, you need payment network with accounts, balances, and transaction. That is fairly easy to understand. However, there is one problem every payment network has to solve, and it is how to avoid double-spending.

In the previous centralized digital cash systems, this is usually done by a central server which keeps the records about balances. With decentralized digital cash systems, this central server doesn’t exist.

Remember when we said that Satoshi solved this problem using a peer-to-peer network? Because there is no central server to validate these balances, Bitcoin uses every single entity of network to do this job. Every peer in the network have a list of all the transactions to check if all the future transactions are valid, or block attempts to double spend.

How Cryptocurrency Mining works?

Every successful transaction is broadcasted in the network, sent from one peer to another. Since Bitcoin doesn’t have a central server to validate these transactions, it will need more computers or websites for mining. The word “mining” in Bitcoin mining actually means solving complicated mathematical problems with cryptographic hash functions which is associated with blocks containing the data of all the transactions. It is called mining because by helping to solve these mathematical problems, the user is being rewarded with small amounts of cryptocurrency of their own. Bitcoin can only be created by solving these mathematical problems.

Types of Cryptocurrencies

Bitcoin might have been the most popular choice for many, but there are actually many alternatives to it. In this part, we will look into the alternatives, and how they work.

1. Bitcoin

It is the most popular cryptocurrency today. It is considered to be the original cryptocurrency, and is an open-source software.

Bitcoin’s blockchain technology allows users to make transparent peer-to-peer transactions, all without central authority. While everyone can see the transactions (as funds are locked in public key cryptography), only the owner of the fund can access or decrypt it using a “private key”.

2. Litecoin

Launched in 2011 as an alternative to Bitcoin, Litecoin is also open-source and completely decentralized. However, Litecoin is said to feature faster transactions than Bitcoin, and the coin limit can reach up to 84 million versus the 21 million of Bitcoin. It also operates in different algorithm. Bitcoin uses “SHA-256” while Litecoin uses “scrypt”.

3. Ethereum

Created in 2015 as an open-source platform, Ethereum blockchain tracks the ownership of every cryptocurrency transactions, while also focusing on running the program code of any decentralized applications, allowing the developers to pay for transaction fees and services on the Ethereum network. This means, Ethereum can not only process transactions, but also complex contracts and programs.

4. Ripple

Launched in 2012, Ripple acts both as a cryptocurrency – XRP, and a digital payment network for financial transactions. It allows any type of currency exchanges, from USD to Bitcoin to gold, and EUR and also connects to banks, unlike the other cryptocurrencies.

What makes Ripple different is that its primary focus is not for peer-to-peer transactions, but rather moving large number of sums in every transaction. Also, unlike Bitcoin which demands heavy hardware for mining, Ripple has no mining as all coins are already pre-mined.

5. Monero

This cryptocurrency is the best example of the CryptoNight algorithm. The CryptoNight algorithm was invented to add privacy features that are missing on Bitcoin. Every transaction done in Bitcoin is documented in blockchain, leaving a trail that can be followed. Using the concept called ring-signatures, the CryptoNight algorithm is able to cut through this trail.

Earlier attempts to CryptoNight, such as Bytecoin, was rejected by the community as it was heavily premined. Monero was the first Bytecoin clone that is non-premined.

How to keep Cryptocurrency safe?

How to keep cryptocurrency safe in wallets

Best way to keep the funds safe is via cold storage, or being offline. Basically, it means storing address and the key needed to access the cryptocurrencies in external hard drive, or paper wallets. And only try to use the information online when doing a transaction.

However, if you like trading your bitcoins, there’s no sense of having it offline. There is a plethora of Bitcoin wallets available in many app stores. Trusted Bitcoin wallet such as the Luno Bitcoin Wallet will help secure your coins, all in the convenience of your smartphone.

Luno has been around since 2013, and features a sophisticated Bitcoin security system which have never been compromised. This has to expect as the team experts at Luno comprises of people who has worked with top tech and finance, such as Google, Amazon, Morgan Stanley, and Barclays. And yes, you can also buy and sell Bitcoin via Luno.

More about Cryptocurrency

  1. Every transaction is irreversible: Unlike soft digital currencies like PayPal, hard digital currencies like Bitcoin doesn’t have the ability to dispute or reversed when used. That means, if X accidentally sent it to Y, X can’t do anything about. If the fund was stolen by a scammer, or if your computer was hacked and your fund disposed, there isn’t any way to get it back.
  2. Pseudonymous: Unlike PayPal or any soft digital currencies, you can never associate transactions nor accounts to anyone. When you receive a Bitcoin, it is sent from addresses, which basically is an address made up of 30 random characters. Catching scammers via these so-called addresses is impossible.
  3. You can use it without asking for permission. There is no gatekeeper to cryptocurrency. Software used to receive and send cryptocurrencies is free to use and download. Bitcoin, for example, is open-source and can be downloaded from their website.
  4. Instant and secure transactions. Since cryptocurrencies are being processed via peer-to-peer network, all transactions are instant, all around the world.

It is also secured as cryptocurrency funds are locked in public key cryptography system, and only the owner of the private key can send cryptocurrencies. That means, while everyone can see the transaction, only the owner of that Bitcoin can decrypt it using his private key.

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