What is cryptocurrency? What does it really mean to send money via Blockchain? With this article we will try to explain and define what they are and how it works. Cryptocurrency (where Bitcoin is the best-known example) is considered the currency of the future, because it is decentralized which means that no single company or government has control over it, but society.
- What is a cryptocurrency and blockchain?
Cryptocurrency is a medium of exchange, created and stored electronically in the blockchain using encrypted techniques to control the creation of monetary units and to verify the transfer of funds.
Then what does blockchain mean? It is a decentralized and shared/distributed ledger, which multiple parties collaborate on creating without having to trust or know each other.
- How do they work?
- The whole process of blockchain starts with person A wanting to make a transaction to person B. Person A should already have bought some form of cryptocurrency. In our explanation of the process we will be using Bitcoin as an example, as it is the cryptocurrency with the highest market cap.
- In order for the system to verify who is making the transaction, they use a combination of a private and public key. When a user creates their virtual wallet, he or she gets two keys; a private one (that is unique and can be used as a way to sign transactions) and a public one (that can be used later on by the miners to check if it matches to the private one). In order to make sure that you do not use the same bitcoin to buy two different things, your wallet and the blockchain automatically look at your previous transactions to make sure you have enough bitcoins to send in the first place.
- The transaction is transferred to a network of around 6 000 computers in the world. All of them start competing as they want to update the ledger with the block of new transactions.
- In order to figure out which computer (or, as they are called, miner) should update the ledger they should solve a mathematical equation. The equation is very energy consuming and usually takes them around 10 minutes to solve. This mathematical problem usually consists of them receiving an output and then they need to figure out what the input is. For example the output that they received was =10, this means that they should figure out which sum of numbers got them the =10. Was it 1+2+3+4, 4+4+1+1 or any other combination?
- After the fastest computer (miner) solves the equation, it says that it is going to add the new block of transactions to the blockchain, but before that happens all the other miners double check the results. Firstly, they check if the problem was solved correctly and secondly, they make sure that the new block includes all the transactions that were made within the last 10 minutes. Only if more than 50 % of them agree that both conditions are met, the new block can be added to the blockchain.
- When the new block is added to the blockchain the miner that did that currently gets around 12.5 bitcoins for the work. In the beginning, the compensation was 50 bitcoins, then 25 and in a few years it will be 6. Eventually it is estimated that the last bitcoin would be mined in the year 2140. This is due to the fact that bitcoins are only mined (made) as a reward to miners for adding a new block of transactions to the blockchain.
- After all of those complicated mathematic equations and addition of blocks the transaction of person A to person B is completed.
In the infographics below you can see more information about what is a cryptocurrency, what makes it different from other currencies and which are the best three known examples of it.