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  • Sagar Acharjee

What Is Cryptocurrency and How Does It Work?


True, the source code and technical controls that support and secure cryptocurrencies are extremely difficult to understand. Ordinary people, on the other hand, are more than capable of grasping basic concepts and becoming knowledgeable cryptocurrency users. The values, security, and integrity of cryptocurrencies are governed by a number of concepts.




Cryptography


Cryptocurrencies use cryptographic protocols to secure their units of exchange, which are extremely complex code systems that encrypt sensitive data transfers. Cryptocurrency developers use advanced mathematics and computer engineering principles to create these protocols, which make it nearly impossible to break, duplicate, or counterfeit protected currencies. These protocols also hide the identities of cryptocurrency users, making it difficult to attribute transactions and fund flows to specific individuals or groups.

Blockchain is a distributed ledger technology.



A cryptocurrency's blockchain is its master public ledger, which records and stores all previous transactions and activity while also validating ownership of all currency units at any given time. A blockchain is a digital ledger that keeps track of a cryptocurrency's entire transaction history. It has a finite length that grows over time, containing a finite number of transactions. Every node in the cryptocurrency's software network stores identical copies of the blockchain, which is a network of decentralised server farms run by computer-savvy individuals or groups known as miners who continuously record and authenticate cryptocurrency transactions. A cryptocurrency transaction isn't considered complete until it's added to the blockchain, which usually takes only a few minutes. A transaction is usually irreversible once it is completed. Most cryptocurrencies, unlike traditional payment processors like PayPal and credit cards, lack built-in refund or chargeback functions, though some newer cryptocurrencies do. Neither party can use the units during the period between the start of the transaction and its completion. Instead, they're being held in escrow — effectively in limbo. As a result, the blockchain prevents double-spending or the duplication and sending of the same currency units to multiple recipients.



Control is decentralised



Blockchain technology is built on the principle of decentralised control. Rather than conscious decisions made by central banks or other regulatory authorities, the supply and value of cryptocurrencies are determined by the actions of their users and the highly complex protocols built into their governing codes. Miners' activities, in particular, are critical to currency stability and smooth operation. Miners are cryptocurrency users who use a lot of computing power to record transactions in exchange for new cryptocurrency units and transaction fees paid by other users.


Keys that are kept private


Almost every cryptocurrency owner has a private key, which enables them to exchange units while also confirming their identity. Users can either generate their own private keys, which are formatted as whole numbers up to 78 digits in length, or have them generated for them by a random number generator. They will be able to obtain and spend cryptocurrency once they have obtained a key. The cryptocurrency holder will be unable to spend or convert their cryptocurrency until the key is found and returned to them, effectively rendering their holdings worthless until the key is found and returned to them. While this is an important security feature that aids in the prevention of theft and unauthorised use, it is also extremely difficult to use. Losing your private key is akin to throwing money into a garbage incinerator in the world of cryptography. While you can generate a new private key and start accumulating cryptocurrency again, you won't be able to recover any cryptocurrency that was secured by your old, lost key. Cryptocurrency users who are aware of their private keys are maniacally protective of them, storing them in multiple digital locations (many of which are not connected to the internet for security reasons) as well as on paper or in another physical form.


Wallets for Cryptocurrencies


Users of cryptocurrency have wallets that contain unique information that identifies them as the unit's owners. For units that aren't in use, wallets reduce the risk of theft. Private keys, on the other hand, ensure that a cryptocurrency transaction is genuine.

Hackers can gain access to cryptocurrency exchange wallets. For example, Mt. Gox, a Bitcoin exchange based in Japan, declared bankruptcy a few years ago after hackers systematically stole more than $450 million in Bitcoin traded on its servers. Wallets can be stored on a hard drive, in the cloud, or on an external storage device. It is strongly recommended that at least one wallet backup be kept, regardless of where it is kept. It's important to note that backing up a wallet only copies the record of a wallet's existence and current ownership, not the cryptocurrency units themselves.


Miners


Miners are in charge of keeping records for cryptocurrency communities and serving as indirect arbiters of the currencies' value. Miners rely on highly technical methods to verify the completeness, accuracy, and security of a currency's blockchain, which are often manifested in private server farms owned by mining collectives made up of dozens of individuals. The scope of the operation can be compared to the search for new prime numbers, which both require massive amounts of computational power. A new blockchain copy is created on a regular basis as a result of miners' efforts, including recent, previously unverified transactions that have not been included in any previous blockchain copy. This effectively completes the transactions that were previously unfinished. Each addition is referred to as a "block." Blocks in the blockchain are made up of all transactions that have occurred since a new copy was created.


The term "miner" refers to the fact that their work generates wealth in the form of new cryptocurrency units, earning them the title. In reality, each newly created blockchain copy comes with a two-part monetary reward: a fixed number of newly minted ("mined") cryptocurrency units, as well as a variable number of existing cryptocurrency units, which are collected from purchasers' optional transaction fees (typically less than 1 percent of the transaction value). As a historical point of reference, cryptocurrency mining was once a potentially lucrative side business for those with the financial means to invest in power- and hardware-intensive mining operations. Hobbyists cannot afford to invest in professional-grade mining equipment unless they have thousands of dollars to spare. Those looking to supplement their regular income can take advantage of a variety of freelance opportunities to earn more money. Despite the fact that sellers are not charged transaction fees, miners can prioritise fee-loaded transactions over fee-free transactions when creating new blocks, regardless of which transactions arrived first in terms of timeliness. Transaction fees are fairly common in cryptocurrency transactions because sellers have an incentive to charge them in order to get paid faster. Although previously unverified transactions on a new blockchain copy can theoretically be fee-free, this is not the case very often in practise. Cryptocurrencies automatically adjust to the amount of mining power working to create new blockchain copies by increasing or decreasing the difficulty of creating new blockchain copies via instructions in their source code — copies become more difficult to create as mining power increases and easier to create as mining power decreases — by increasing or decreasing the difficulty of creating new blockchain copies. The goal is to maintain a consistent average interval between new blockchain creations over time. Bitcoin, for example, takes 10 minutes to complete a transaction.


Supply is limited.


Despite the fact that mining creates new cryptocurrency units on a regular basis, most cryptocurrencies are designed to have a finite supply, which is a key guarantee of value. In general, this means that as time passes, miners will receive fewer new units per new block. Miners will eventually only be compensated for their efforts through transaction fees. However, this has yet to occur in practise, and it is unlikely to do so for some time. If current trends continue, the last Bitcoin unit could be mined as early as the mid-twentieth century — not exactly soon. Cryptocurrencies are inherently deflationary due to their finite supply, making them more akin to gold and other precious metals, which have finite supplies, than fiat currencies, which central banks can theoretically produce unlimited supplies of.


Exchanges for Cryptocurrencies


Many less commonly used cryptocurrencies can only be exchanged through private, peer-to-peer transfers, making them less liquid and difficult to value than other currencies, crypto, and fiat. Bitcoin and Ripple, two of the most popular cryptocurrencies, are traded on secondary exchanges similar to forex exchanges for fiat currencies. (The now-defunct Mt. Gox is an example of an exchange.) Cryptocurrency holders can use these platforms to exchange their holdings for major fiat currencies like the US dollar and euro, as well as other cryptocurrencies, including less popular ones. In exchange for their services, they take a small percentage of each transaction's value — usually less than 1%. Importantly, cryptocurrencies can be exchanged for fiat currencies on specialised online exchanges, implying that each has a fluctuating exchange rate with major world currencies such as the US dollar, British pound, European euro, and Japanese yen. Cryptocurrency exchanges are crucial for creating liquid markets for popular cryptocurrencies and determining their value in comparison to traditional currencies. On some cryptocurrency exchanges, you can even trade cryptocurrency derivatives or track broad-based cryptocurrency portfolios in crypto indexes. Exchange rates, on the other hand, can be extremely volatile. For example, following the collapse of Mt. Gox, Bitcoin's US dollar exchange rate dropped by more than half, only to rise more than tenfold in 2017 as cryptocurrency demand exploded. Cryptocurrency exchanges are also vulnerable to hacking, as they are the most common target for digital currency theft by hackers and cybercriminals like those who brought down Mt. Gox.