Cryptocurrency: How Blockchain Digital Money Works

For sure you’ve read or heard terms such as “Bitcoin”, “Blockchain”, and “Cryptocurrency mining”. Chances are your newsfeed has at least 1 article on cryptocurrency every day. You might even come across contentious online discussions on the validity of cryptocurrencies as a medium of exchange. There are stories of people becoming millionaires a few years after investing in Bitcoin leading many to wonder if it’s too late to ride the wave to riches.

If you want to learn about cryptocurrency, you’ve come to the right place! Technology can be daunting to learn but we will do our best to breakdown the salient points about cryptocurrencies in the simplest way possible.

What Is Cryptocurrency?

cryptocurrency coin on table

Cryptocurrency is a medium of exchange that capitalizes on the advantages of blockchain technology to facilitate financial transactions through the Internet. Thus, to better understand the definition of cryptocurrency, we should explain what blockchain technology is all about.

Think of a blockchain as a digital ledger which records all financial and economic transactions. The ledger is not managed by a central authority, but by a group of computers. The blocks of data are secured by cryptographic principles which are referred to as the “chain”.

Because there is no central or singular authority overseeing the blockchain, the information that is recorded can be seen or accessed by anyone and makes everyone who participates in cryptocurrencies accountable for their actions.

This level of transparency gives the cryptocurrency market the semblance of having a democratic system and is one of the digital currency’s main attractions to investors.

Also, the absence of a central authority means it is unlikely for cryptocurrencies to be placed under government control. The appeal of cryptocurrencies for investors is that its movements may not be influenced or interfered by the government and its agencies.

P2P-Technology In The Cryptocurrency Network

cryptocurrency wallet app

Peer-to-Peer or p2p-technology governs the cryptocurrency network. Each peer is updated on the balance of all accounts in the network and thus, knows the history of transactions made in the network.

Every transaction is transmitted to all peers in the cryptocurrency network. A transaction is simply information that details what transpired between peers. For example, the amount of Bitcoin one peer gives to another peer.

It may seem oversimplified, but this is the basis of cryptocurrency p2p-technology.

While knowledge of the transaction is immediate within the network, the confirmation of the transaction will take time.

The Role Of Cryptocurrency Miners

Confirmation is another important concept to understand about cryptocurrencies. A transaction is at the risk of getting forged if it remains unconfirmed. Confirmation means the transaction becomes part of the historical record of cryptocurrency transactions – the blockchain.

The task of confirming transactions lies with the miners. When miners come across transactions, they confirm them and distribute legitimate transactions within the network.

The transaction is then added by the node to the database and is included in the blockchain. As a reward, the miner is given a cryptocurrency.

With a decentralized system, Satoshi established a rule for anyone who wants to become a Bitcoin miner.

The rule is that miners should find a cryptographic function called a hash which connects a block to its predecessor. Satoshi believed that if you want to become a Bitcoin miner, you have to work for it. The hash represents the work put in by the Bitcoin miner and is called “Proof of Work”.

A Bitcoin miner has to solve a cryptologic puzzle. Once the puzzle is solved, the Bitcoin miner can create a block and include it in the blockchain.

He might also want to add coinbase transactions which provide a particular number of Bitcoins. This process is the only way one can create Bitcoins that are valid.

Thus, the more difficult the puzzle, the greater the level of computer power a Bitcoin miner has to invest. A miner can only create a limited number of tokens within a given time.

Generally, cryptocurrencies are tokens that are recorded in a digital database with no centralized authority. The word “cryptocurrency” can be broken down into 2 words: “Crypto” and “Currency”.

“Crypto” because the process is based on cryptography – miners have to solve a cryptographic puzzle to create the tokens or the currency.

Bitcoin: The Accidental Cryptocurrency

Bitcoin is synonymous with cryptocurrency. It is the first one that comes to mind whenever someone hears the word “cryptocurrency”.

Not many people know that Bitcoin was created by a Japanese inventor, Satoshi Nakamoto. The thing is, Satoshi did not set out to create a currency. Satoshi was looking to invent a decentralised digital cash system.

A digital cash system is basically a network that receives payment and records all transactions, balances, and accounts. What made Satoshi’s digital cash system different was that it did not lead to double-spending.

Double-spending or the instance where a person pays twice for the same amount happens in a centralised digital cash system because a central server keeps track of the balances.

Satoshi’s decentralised digital cash system does not have this server. Every participant in the network is accountable for his transactions. For the decentralised digital cash system to remain stable, the network must arrive at a consensus.

With Satoshi’s model for the decentralised digital cash system, having absolute consensus was possible even without a central authority.

What Are The Properties Of Cryptocurrencies?

No Permission Needed

Cryptocurrency is software that can be downloaded by anyone for free. You don’t have to ask permission or gain clearance to use it.
Incognito – Transactions in cryptocurrencies are delivered to addresses made up of 30 characters. Names are not required. You cannot connect the transaction with someone in the real world.
Permanent – Once the transaction is confirmed, it is permanent and cannot be reversed. Not even the President of the United States can undo the transaction.

Global in Nature

Cryptocurrencies are transacted through computers located worldwide. Whether you send Bitcoins to your next-door neighbour or to your brother who is working overseas is immaterial.

Highly-Protected

Investors love cryptocurrencies because of its high-level security. Only the person who owns the key to the public cryptography system can send cryptocurrencies.

What Are The Monetary Properties Of Cryptocurrency?

The fact that cryptocurrencies are not subject to government control or regulation, makes banks and other financial institutions wary about them. The decentralized system of the cryptocurrency network is a complete turnaround from the mechanism of traditional monetary systems that banks operate in.

Managed Supply of Tokens

There is a limit set on the amount of tokens available in a cryptocurrency. For example, with Bitcoin, the limit will be reached by the year 2140. This means it is possible to calculate the amount of cryptocurrency available to date.

Cryptocurrency Is Not Debt

Unlike fiat money which is generated by debt, cryptocurrency is just for the bearer’s account. It is not subject to government controls. Anyone can use cryptocurrency.

5 Different Types Of Cryptocurrencies

Bitcoin

bitcoins

Without a doubt, Bitcoin is the most popular cryptocurrency in the market. It is the one that started in all. Bitcoin has set the benchmark for other cryptocurrencies. Likewise, it has become the medium of choice for cyber-criminals. The value of Bitcoin rose from zero to $650 in just 7 years. It is estimated that Bitcoin’s daily transactions averaged over 200,000 per day.

Ethereum

Following closely behind Bitcoin is Ethereum which was created by Vitalik Buterin. What makes Ethereum unique from Bitcoin is that it can validate complex programs and contracts called “states”. After its DAO contract was hacked, the company moved to create Ethereum Classic which did not require a consensus. Since then, Ethereum has introduced new tokens such as Augur and DigixDAO.

Ripple – XRP

is the cryptocurrency of Ripple but it does not function in the same way as other types such as Bitcoin and Ethereum. Instead of storing and exchange value, XRP functions as a token that serves to protect the network from spamming activities. Therefore, Ripple is a cryptocurrency that does not have miners as the coins have already been mined.

Litecoin

Regarded as the silver standard to the gold standard that is associated with Bitcoin, Litecoin handles faster transactions, offers more tokens, and features an entirely different algorithm compared to other cryptocurrencies. While Litecoin fell in favor with investors in the last few years, it continues to be actively traded and viewed upon as a viable option to Bitcoin.

Monero

This type of cryptocurrency uses the CryptoNight algorithm which introduced ring signatures, a technological innovation that prevented transactions from being followed. Unlike other cryptocurrencies which used CryptoNight, Monero was the first one that was not pre-mined. Monero’s popularity fell when reports surfaced that cyber-criminals were using it for their activities.

Conclusion

The immense popularity of cryptocurrencies created a bandwagon effect in the industry. Almost overnight, new cryptocurrencies were being introduced in the market. Some survived, many expired. The initial investors became wealthy while those who tried to ride the wave, caught the crest before it collapsed, and lost money.

Regardless of all the tumult and chaos, the cryptocurrency is not a fad. It is slowly becoming a trend. With so much uncertainty surrounding geopolitics and the global economy, cryptocurrencies provide a hedge versus adverse movements in the foreign exchange market.