How Does Cryptocurrency Work?

The reason why cryptocurrencies are such in demand right now is because Satoshi Nakamoto successfully found a way to build a decentralized digital cash system. What is a decentralized cash system? 

Decentralized System

A decentralized system means the network is powered by its users without having any third party, central authority or middleman controlling it. Not the central bank or the government has power over this system.

 

 

 

 

 

 

 

 

The problem with a centralized network in a payment system is the so called “double spending”. Double spending happens when one entity spends the same amount twice. For instance, when you purchase things online, you have to incur for unnecessary and expensive transaction fees. Usually, this is done by a central server that keeps track of your balances.

This is most commonly known as the Blockchain Technology. Cryptocurrency is derived from the word “Cryptography”, which refers to the consensus-keeping process secured by strong cryptography.

Blockchain Technology Function

Blockchain technology functions in managing and maintaining a growing set of data blocks, and this is by using the decentralized or known as the P2P (Peer to Peer) network. In blockchain, once a piece of data is recorded it cannot be edited or changed.

To put it in simpler terms, it enables you to send a gold coin via email. The P2P network is a consensus network, which allows a new payment system and the transactions of new digital money.

Let’s illustrate an example. Cryptocurrency like Bitcoin consists of its own network of peers. Every peer has a record of the complete history of all transactions as well as the balance of every account.  

By the end of every transaction and upon confirmation, the transaction is known almost immediately by the whole network. A transaction includes a process where A gives X amount of Bitcoins to B, and is signed by A’s private key. After signed, a transaction is broadcasted in the network. The information is sent from one peer to every other peer on the network.

Confirmation – A Critical Stage

Confirmation is a critical stage in the cryptocurrency system. Confirmation is everything. When the transaction is not confirmed, it has the possibility of being hacked and forged.  When a transaction is confirmed, it is set in stone. It can’t be reversed, it is impossible to be hacked, it is not forgeable as it is part of a permanent record of the historical transaction: The Blockchain. The blockchain can be likened to an online ledger, where all transactions are recorded and made visible to the whole network.  

This comes to show that cryptocurrencies are not secured by people or trust, but by complex mathematical equations. It is very secure and it’s highly unlikely that the address of a currency is compromised.  

Only miners are able to confirm a transaction. This is their role in the cryptocurrency network. They record transactions, verify them and disperse the transactional information in the network.  

For every completed transaction monitored and facilitated by the miners, they are rewarded with a token of cryptocurrency, for instance with Bitcoins. Since miners play a major role in the cryptocurrency system, let’s look at their role in more detail.

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