A cryptocurrency is basically a digital asset that functions as a medium of exchange. Transactions using cryptocurrency are secured using cryptography.
Apart from securing the transactions, cryptography also regulates the creation of new units and verifies asset transfers.
To put it simply, cryptocurrencies are alternative currencies or digital currencies. They are also referred to as virtual currencies.
One of the key features of cryptocurrency is that it is decentralized in terms of control. In contrast, the money we use in the real world is controlled centrally by central banking systems.
The decentralized control is achieved through a public transaction database called a blockchain, which functions as a distributed ledger.
The First Cryptocurrency
Bitcoin was the first cryptocurrency to be created. It came out in 2009. Since then, several other alternatives such as Litecoin have been developed. In fact, alternatives to Bitcoin are even referred to as Altcoins.
Satoshi Nakamoto is said to be the person behind the creation of Bitcoin. However, it is believed that he never intended to create it. His original goal was to develop a proper form of digital cash.
When he created Bitcoin, he released it into the public realm referring to it as an “electronic cash system that relies on a peer-to-peer network to eliminate double spending.
The development of a decentralized digital cash system is what’s considered to be the greatest aspect of Satoshi’s work.
The Simplified Definition
If what you have read so far confuses you, here’s a more simple explanation. Cryptocurrencies are just entries within a database that cannot be altered unless and until a few conditions are met.
It’s similar to how actual money works. For instance, the money in your bank account is just a set of entries in a database. They are changed when specific conditions are met.
The same applies to physical money. Exchanges take place when certain conditions are met. You sell something and you get paid in return.
Money, in general, is just a verified entry in a particular database of balances, transactions, and accounts.
How it Works
A cryptocurrency like Bitcoin is made up of a peer network. Each peer in the network keeps a record of the entire history of transactions. They also keep a record of the balance if each account.
A transaction, with regard to cryptocurrencies, is basically a file that states “Tom gives X Bitcoins to Dick” and is registered by Tom’s private key.
Once registered, the notification of the transaction is signaled to the whole network, communicated from one peer to another.
The entire network becomes aware of the transaction. But, confirmation occurs only after a certain amount of time has passed.
Confirmation is a very important component of cryptocurrencies. In fact, it’s all about confirmation. If a transaction doesn’t get confirmed, it’s status is “pending” and that means it can be forged. But, once it’s confirmed, it is irreversible. It becomes a fixed part of the blockchain.
Transactions are confirmed by those who mine cryptocurrencies such as Bitcoin. This is, pretty much, their purpose. They collect transactions, validate/authenticate them, and make them known to the network.
Every confirmed transaction must be added to the database by each node. It needs to become a core part of the blockchain.
To do this, miners are incentivized with a token of the currency, such as a single Bitcoin.
Mining is something anybody can do. There are no authorities in a decentralized network. So, in order to prevent abuse, Satoshi devised a system that required miners to leverage their computing systems.
They are required to locate a hash (the result of a cryptographic function) that links the fresh block to its predecessor. This is referred to as “Proof of Work”.
There are certain algorithms used for each type of cryptocurrency.
These algorithms are what goes into creating the cryptologic puzzles that miners must solve to acquire a token of the cryptocurrency. Once the puzzle is solved, the miner can construct a block and include it into the blockchain.
The incentive here is that the miner can add a coin-base transaction to acquire a single token, such as a single Bitcoin.
To put it simply, Bitcoins can only be acquired by solving cryptographic puzzles. However, as puzzles get more complex, you need more computing power, which regulates the number of Bitcoins a single miner can acquire.
This is what prevents abuse at the end of the day.
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