What are cryptocurrencies and how they work?

2 min reading

Cryptocurrencies are kind of digital money created on the basis of an algorithm. Cryptocurrencies work autonomously, outside traditional banking and government systems.

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What is cryptocurrency?

Cryptocurrencies use cryptography - a type of digital encryption that allows to secure transactions and regulate the generating of new monetary units. Bitcoin, the original and so far best known cryptocurrency, was launched in January 2009. Currently more than 1000 cryptocurrencies are availible on the market.

Cryptocurrencies are very different from traditional currencies. Nevertheless, they can still be bought and sold like any other asset. 

Cryptocurrencies have become known as digital, alternative or virtual currencies. The reason for their creation was to provide an alternative payment method for online transactions. However, so far they have not gained wide acceptance in the business and consumer environment, and their value is still too volatile to be considered a credible and adequate payment method. As a decentralised currency, it has been designed in such a way that it is not subject to government interference or external influence, and the crypto economy instead is monitored by internet protocol peer-to-peer. The individual units that make up a cryptocurrency are encrypted strings of data that have been encoded to represent one defined unit.

First cryptocurrency

Bitcoin is considered to be the first decentralised cryptocurrency. Like all cryptoes, it is controlled by the blockchain transaction database, which acts as the general ledger. It was created by Satoshi Nakamoto, but it is not certain whether the creator hiding under this name is one particular person or maybe a group of people.

The cryptocurrencies were designed to slowly limit the creation of new units over time. The number of units is supposed to remain in circulation in advance. This reflects the characteristics of goods such as gold or other precious metals. For example, the total number of Bitcoins is going to be 21 million. Some cryptocurrencies like Ethereum, function a little differently. Emissions are limited to millions of Ethereum tokens per year, which is 25% of initial supply. Limiting the number of Bitcoins ensures "rarity", which in turn gives the currency its value. Some people claim that the creator of Bitcoin actually modeled cryptocurrency on precious metals. As a result, mining is becoming increasingly difficult as the reward for the miner decreases by half every few years. 

Characteristics of the cryptocurrencies

There are a number of key rules that govern the use of cryptocurrencies exchange and transactions.

Encryption in the case of cryptocurrencies is based on two basic issues - hashing and digital signatures:

  • Hashing verifies the consistency of data, maintains the blockchain structure and encodes account addresses and transactions. It also generates cryptographic puzzles, i.e. mathematical problems that enable the so-called extraction and creation of new blocks in the blockchain.
  • Digital signatures enable users to verify their identity as owners of encrypted information without the need to disclose it. This technology is used to sign cash transactions. It proves that the account owner has agreed to the transaction.