What is Cryptocurrency?
That definition might seem downright cryptographic right now, but, by the end of this overview, you won't need a decryption key to understand crypto.
In a 2008 white paper entitled, "A Peer-to-Peer Electronic Cash System," Nakamoto provides the first description of blockchain. Blockchain is the technology that enables cryptocurrency to work like government-issued (fiat) currencies without the involvement of any central bank or trusted third party.
Specifically, blockchain solves the "double-spending problem" associated with digital cash. Since digital information is easily copied, digital money requires a mechanism that reliably prevents a currency unit from being "duplicated" or otherwise spent more than once.Why is it called a blockchain?
A block includes a reference to the block that immediately precedes it. The blocks create a chain, linking one to another through references to prior blocks. Cryptographic hash functions create the references to the preceding blocks by mapping sets of data to strings of letters and numbers called hash digests. Changing the data automatically changes the hash digest. To change a block in the ledger, a hacker would have to reproduce the entire chain of blocks following it since not doing so would create a chain of invalid hash values that would not be accepted by the cryptocurrency network.
New blocks cannot be added to the blockchain without a miner computing a valid solution to the block's puzzle. With every transaction, the blockchain grows longer and the amount of computing power required to add a new block increases. The blockchain by design becomes increasingly tamper-proof; a hacker today would need computing power equivalent to the majority of the computing power on the cryptocurrency network to successfully alter transactions.
Another method of establishing distributed consensus to add to a blockchain is known as proof of stake. Instead of requiring vast amounts of computing power, the proof-of-stake method enables the cryptocurrency holders with the most wealth or the oldest stakes to create blocks by verifying transactions. Stakeholders are selected semi-randomly and with additional mechanisms in place to prevent the wealthiest individuals from creating fake transactions or otherwise exerting too much power over the blockchain.
How cryptocurrency worksTo own or pay for something in cryptocurrency, you need a wallet for that currency. A cryptocurrency wallet doesn't actually hold any currency; it merely provides an address for your funds on the blockchain. A cryptocurrency wallet also includes private and public keys that enable you to complete secure transactions.
You can buy or sell cryptocurrency in exchange for a fiat currency, such as the U.S. dollar, using a cryptocurrancy exchange. Exchanges, which can hold deposits in both fiat and cryptocurrencies, credit and debit the appropriate balances of buyers and sellers in order to complete cryptocurrency transactions. You can also use cryptocurrency to buy something, like a product or service.
Every time you buy cryptocurrency or use it to complete a purchase, you authorize the movement of a specified amount of the cryptocurrency from your wallet address to the wallet address of the seller. The transaction is encrypted with your private key and pushed to the blockchain. The cryptocurrency network's miners access your public key to confirm that your private key was used to encrypt the transaction. Once the block that includes your transaction is confirmed, the ledger is updated to show the new cryptocurrency balances for both your address and the seller's address. This entire process is conducted by software.
Cryptocurrency works because blockchain works. Blockchain technology gives everyone a copy of every transaction and uses the blockchain to ensure that everyone's copy is, and remains, the same. That transparency makes cryptocurrency transactions work.