How Does Cryptocurrency Work?

“First, let’s establish the worth of a Bitcoin to the value of a USD. As of the time of this post, one Bitcoin is equivalent to…”

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By Block Society

Starting From Scratch 

In the most basic terms, cryptocurrency is a currency that is both encrypted and decentralized, meaning it is transferred from peer-to-peer without the use of a third party. With the absence of third-party intervention, transactions made using this digital currency are confirmed in a public ledger through a process known as mining.

Before looking at how specific cryptocurrencies function, we must gain a basic understanding of the essentials of cryptocurrency before we can fully answer the question: “how does cryptocurrency work?”

What Is Cryptocurrency?

If you are living in the 21st century, there is no way you haven’t heard about cryptocurrency. While the word is recognizable to nearly everyone, very few people know what it is. In its simplest definition, cryptocurrency can be defined as a new method of transferring value (money). Though that may sound straightforward, the surprise comes when people learn that there is no cryptocurrency central bank, nor a giant server room somewhere holding all the data. No big bad bank, no central server to process transactions, and no putting faith into a financial system that lacks transparency.

But, how? How does something entirely digital turn around and garner value? Cryptocurrency runs on something called a blockchain, which is a system ran by miners. Miners use extremely powerful computers to keep track of cryptocurrency transactions, thus providing security and reason for value. The most critical metric of value is community participation, and large-scale adoption of cryptocurrency is undoubtedly unfolding.

 

“Verifying transactions using this method gives everyone an equal opportunity to see what happened, versus being forced to take the word of a single bank. To add to that, the integrity of the blockchain is enforced using cryptography.”

✔ A Brief Origin

Bitcoin was created by an unknown developer, or group of developers, in 2009 working under the alias of Satoshi Nakamoto. The reason that Nakamoto remains anonymous is the exact reason for cryptocurrency- no third-party intervention. The extended purpose of Bitcoins creation was to provide a monetary system that is not controlled by a central authority, significantly reduce the possibility of corruption in banking, all while providing a viable option for peer-to-peer transactions. Remember, most people use a bank for security reasons. Cryptocurrency has an answer for that. Cryptocurrency works within something called a blockchain, a blockchain is a digital public ledger that holds all cryptocurrency transactions in chronological order. Verifying transactions using this method gives everyone an equal opportunity to see what happened, versus being forced to take the word of a single bank. To add to that, the integrity of the blockchain is enforced using cryptography.

✔ Public Ledgers

The public ledger is a record keeping system to keep track of the transactions made in the realm of cryptocurrency. This public ledger keeps the identity of the participants encrypted, as well as using other cryptographic techniques to keep them anonymous. It also effectively keeps track of the cryptocurrency balance of the participants, in bitcoin the public ledger is called the blockchain. The blockchain takes the place of the traditional central authority that Nakamoto was trying to avoid. Without it, the cryptocurrency network would be impossible.

✔ Transactions

Funds transferring between two digital wallets is known as a transaction. That transaction must await confirmation after being submitted to the public ledger. When a transaction is made, wallets use an encrypted signature called a cryptographic signature. This cryptographic signature provides mathematical proof that the transaction belongs to the owner of the wallet. Miners will confirm the transaction then proceed to add them to the public ledger.

✔ Mining

The miners are the ones who go through the process of creating cryptocurrency. The process of confirming transactions and adding them to the public ledger is known as mining. The effort of the miners is essentially what gives cryptocurrency its value. In addition to its creation, the miners also keep track of the currency. To add the transaction to the ledger, the “miner” must complete a difficult computational puzzle (perhaps a mathematical problem). Anyone can confirm the transaction since mining is open source. The “miner” who is first to solve the puzzle adds a “block” of transactions to the ledger. The relationships between blocks, transactions, and public ledgers ensure that no one can easily alter a block. After the block has been added to the ledger, the transaction is permanent, adding a small transaction fee to the “miners” wallet. The process of valuing the coins based on the miner’s work is also known as a proof-of-work system.

✔ The Complete Relationship

Although we have explained the separate and basic components of cryptocurrency, it is essential to understand the whole picture of a transaction. In cryptocurrency, the miner creates the currency that is then available to be used or traded. If the assets are traded, buyers and sellers meet on a Cryptocurrency Exchange that mimics the stock market. Before any transaction can be permanent, it must be put into the public ledger and approved. The cycle then repeats itself.

✔ Adaptive Scaling

Adaptive Scaling is the idea that cryptocurrencies are built with measures, ensuring they will work in both small and large scales. The size of a standard bitcoin block is 1MB. There have been different solutions suggested to mitigate the problem of congestion on the cryptocurrency networks. A popular answer presented is Ethereum, which has an adjustable block size. Other solutions have been a sleeker alternative to Bitcoin, like Litecoin. Regardless of the method used, adaptive scaling is an integral part in ensuring the cryptocurrency network will run smoothly.

✔ Cryptographic

Cryptocurrency uses encryption (a type of cryptography) to verify transactions as well as controlling the creation of coins.

✔ Decentralized

All transactions in cryptocurrency are controlled by code, open source, and rely on peer-to-peer interaction. In cryptocurrency, there is no single entity to manage the currency.

✔ Open Source

Cryptocurrencies are open source meaning developers can create API ’s in addition to being able to join or use any network.

How Does Cryptocurrency Work In The Real World?

We have gone over different aspects of cryptocurrency, but how does it relate to the U.S. dollar? First, let’s establish the worth of a Bitcoin to the value of a USD. As of the time of this post, one Bitcoin is equivalent to 6,265 U.S. dollars. That number can and will often change due to the volatility of the market. As Bitcoin continues to grow, there are more and more cryptocurrency ATM’s popping up, providing a relatively quick and easy way to convert crypto into real-world money. In addition to this, most people have access to a variety of online exchanges that allow for quick conversions so you can get to spending. Last but certainly not least, merchant accounts for businesses across the globe are merely starting to incorporate the collection of bitcoin for their products or services. The trajectory is clear; cryptocurrency is here to stay.

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