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What Is Cryptocurrency and How Does It Work?

March 16, 2020

Imagine if a 12-year-old boy received $1000 from his grandmother, invested it, and became a teenage millionaire.

Sounds like fantasy, right? Well, it really happened. Erik Finman was tipped off by his older brother to invest the $1000 gift check from their grandma in exchange for bitcoins. Little did he know that the bitcoin demand would multiply, and he would soon become a teenage millionaire. Today, Finman stands with 450 bitcoins to his name, worth $4.5 million in 2019 despite the blow that cryptocurrency faced.

According to recent statistics, the global blockchain market will go up to $57 million by 2025. As per these estimations, it can easily be said that cryptocurrency despite the highs and lows is here to stay and expand in the business industry.

But first, have you ever wondered…

  • How this cryptic currency exchange medium came into being?
  • What cryptocurrency actually is?
  • How and why was it created?

If so, this guide will be your go-to in no time!

Exploring the depths of cryptocurrency 

When bitcoin was first released as open-source software in 2009, people thought cryptocurrency would just be a fad and won’t be able to hold for long. Fast forward a decade and this technological advancement has not outstayed its welcome. Bitcoin came into being very mysteriously. To this day, even after many people have come forward and claimed to be the inventor of bitcoin, speculation is still ongoing.

Satoshi Nakamoto is presumably a single-handedly genius person or a pseudonymous name for a team of geniuses that came up with the first-ever blockchain technology for developing bitcoin in 2008. Not only did the developer improved and introduced the design concept, but added a level of difficulty by using a hash function method to record time on the blocks without requiring them to be signed by the third party trusted source. 

This stabilized the rate by which the blocks are added to the chain. Due to the success of this design, Nakamoto implemented it as the core component for bitcoin, where it has remained the same ever since. More advanced and growing in size with time but the basic design implementation is still there serving as the public ledger for all the transactions happening on the network.

Ever since then, many other cryptocurrency types have followed through. According to recent publications, there are over 3000 altcoins in existence right now with even more to come. To put it briefly, Cryptocurrency is a digital alternative to our standard cash money that holds its value in terms of the supply and demand rather than a centralized regulatory authority. With all these different types of cryptocurrencies having their own functional variations, each digital currency is supported through a similar decentralized peer to peer network.

Cryptocurrency is nothing more or less just a medium of exchange. What makes it different is that it is a digital asset designed using strong cryptography to make financial transactions more secure, control additional units being created as well as the verification of the transfer of assets. Cryptocurrency uses decentralized monitoring systems in contrast to the centralized controlling and regulatory networks of digital currency and banking.

Blockchain is a distributed ledger technology through which the decentralized controlling of each cryptocurrency works. It is basically a growing list of records or blocks that are linked through cryptography. As per its basic design, a blockchain is valuable because it is immune to modifications in its data. It ensures that the cryptocurrency is kept under tracking regardless of the fact that they are held in a digital wallet or used within a trading transaction.

Bitcoin was the first of all cryptocurrencies for many things. One of them was bitcoin established the system in which the main proxies that are the sender and the receiver of these coins were to abide by certain rules.

  1. They had to sign off on each payment and create a digital signature.
  2. Each person had a public as well private encryption key to make it possible.
  3. Every transaction had to be first verified for accuracy.

These rules gave the system its guaranteed privacy and anonymity. It became so transparent for people to deal through bitcoin that it was successful in the domain where it was launched. At the core of this system resides ledger.

bitcoin transactions flowchart

Source

The ledger 

According to G2, blockchain is “a decentralized public ledger where crypto transactions are recorded. This ledger is maintained across a network of peer-to-peer linked computers.”

All types of cryptocurrency have this ledger where transactions are made public to ensure the system’s transparency as promised. It basically forces everyone to play fair by taking away the risk of spending extra.

So let’s say you invested in cryptocurrency through a significant exchange. Obviously, the intention behind your purchases was to spend the money acquired after. So the natural step to take now will be to verify your transaction when it is unconfirmed. The transaction – at its early stage – is still unofficial and doesn’t become official until it is made the part of the official record of historical transactions kept in the blockchain. The verification is then carried by the cryptocurrency miners to add to the public ledger.

Cryptocurrency mining 

It is the job of a miner in cryptocurrency network to confirm transactions. They take transactions, mark them as legitimate, and allow them to be spread all over the system. When a transaction is confirmed by the miner, every intersection of the transaction has to become a part of the database – in turn, becoming a part of the blockchain. Miners are then rewarded within the existing domain of cryptocurrency through whatever type of currency is being used. For example, if it's bitcoin, a miner will be rewarded with a said particular number of bitcoins as there are no specifications attached to becoming a miner.

Cryptocurrency mining is an essential aspect of the system. Since a miner’s job is the core activity within the cryptocurrency system. As a decentralized network is working at the core of this system, there is no superior authority to delegate these tasks. Therefore, a correct and fixed procedure that cryptocurrency follows is to stop the ruling party from abusing it. The mechanism works in a way that even if somebody plans to enter the system and crash it, there is no loophole present in the network, mining, or blockchain to cause the system to break immediately.

But even this was then managed initially when Satoshi developed bitcoin. He set up a rule that said that miners need to invest their computerized working in qualifying. Supposedly, if we take an example that someone creates many peers to spread throughout the network and forge transaction, it would cause the system to break. This is why miners are needed to find a hash that connects a new block with the previous one in the chain.

A hash is a product of a cryptographic function based on the SHA 256 Hash algorithm and is called Proof of Work

How are cryptocurrencies created? 

After a miner is through with a solution, they are responsible for building a block to be made a part of the ongoing blockchain. They are given a so-called right to add a coin based transaction which provides them with an incentive of several bitcoins. It is the only way for creating valid bitcoins as the miners solve the cryptographic puzzle. As the difficulty level of the puzzle increases, the computer power that the miner is investing will be accounted for only a specific amount of time. It is that part of the consensus no peer in the network can break.

One thing we tend to forget is that first and foremost, cryptocurrency is software. Every function that is a part of regular software works in a similar fashion to how cryptocurrency work. From every transaction, to its recording, data storage, and more, is dictated by code. When a cryptocurrency's primary function is to act as a medium of exchange or of monetary value, the transactions are stored in the blockchain. It is why the algorithms are generally written or designed to award coins to computers who add transactions to the blockchain.

Therefore, for the majority of the types of cryptocurrency, the only way to create new coins or tokens happens when people globally run their hardware to add transactions. Otherwise, there may be other ways defined within the software of the cryptocurrency to create coins.

The best part to work with cryptocurrency is the transparency of the system. It is public, so anyone can check how coins are created. It depends on how the code defines the supply and inflation of the coin. It is the main reason why even knowing if the coin will be inflationary or deflationary is possible and not hidden. 

Types of cryptocurrency 

The prospect of cryptocurrency is that it can act like actual and real money but because it takes the form digital or virtual money that is not managed by the government or the centralized banking system of the country. On the contrary, with the new decade on the rise and an immense technological age paving its way, cryptocurrency is an actual product of the digital age with has no banks, government or any middleman involved for that matter.

Although all coins fall under the umbrella concept and term of crypto, there are two sub-categories to types of cryptocurrency: altcoins and tokens. 

Altcoins 

The term altcoins refer to alternatives of bitcoin, including namecoin, peercoin, litecoin, dogecoin, and auroracoin, among others. Namecoin is considered to be the first to call itself an alternate to altcoin since its inception in 2011. These altcoins have a limited supply, and in order to keep their balance in check and reinforce their perceived value, they claim to be better versions of bitcoin. 

Tokens 

Unlike altcoins, tokens are created and distributed through an ICO, which is the initial coin offering. Their values are represented through bitcoins, security token or utility token. Their functionality works both ways that they can be used as an alternative to money as well as to describe a function. For example, bitcoin and ether from ethereum are considered to be crypto tokens and others are all altcoins. 

Taking the leap with Facebook Libra cryptocurrency 

It wills news to you just as it was news to us that now Facebook is also getting into the money-making business. Well, if we do see it technically, then it is not the actually the money-making business, but still, digital finances and banking are far from Facebook’s main domain of work.

However, Facebook announced in June 2018 that “Facebook Libra is a simple global currency and financial infrastructure that empowers billions of people.” In short, Facebook is planning to distribute their very own cryptocurrency to the masses.

Cryptocurrency is designed to play according to the up-and-coming digital age. Powered by similar blockchain technology, this much-awaited project is all set to allow users to not only shop, but even send currency via Facebook’s own safety checked applications such as Messenger, WhatsApp, and Instagram. It is going to include other channels such as Uber, Spotify, and MasterCard under the umbrella domain to make payments and usage more comfortable.

Facebook's reputation is trusted enough that people will consider getting their hands on any new technology associated with the organization. A quick look at its promised features is enough to tell you that the platform is soon going to become a reliable source of transactional exchange and a rich medium of payments for many people.

Cryptocurrency isn't cryptic 

Cryptocurrency is synonymous to transparency. There is not a single hidden feature, trait or a software drawback that is hidden from the public eye. From the curation of the coin to its creation, validation, it became official, and the transaction is completed, everything is done under the public eye on the same general ledger that is used for every other transaction as well.

Dabbling in cryptocurrency has allowed us a direct connection to deal with a money exchange medium without it having any hidden regulatory policies attached to it. With little to no external factors involved in assisting its value, cryptocurrency is most definitely the product of tomorrow.

The rumors that surround cryptocurrency and thus cater to its negative marketing image being portrayed to the masses should be made clear. People should not only learn but be made aware that cryptocurrency is a thing of the future. And with the new decade having just started and Facebook promising its entrance in the domain, it is highly likely that cryptocurrency will gain popularity again. 

Gone are the days when cryptocurrency was a phase. It is here to grow, expand, and intervene in every financial aspect of our lives. Not only is it going to make the transaction more accessible, but banking systems will automatically become safer, given the fact that cryptocurrency systems are protected and made spam and hack-free. 

To get started with cryptocurrency yourself, discover available cryptocurrency software and see how you can get in on the next technological financial innovation! 

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