What is Cryptocurrency and How Does It Work?

What is Cryptocurrency Science

Everything you need to know about cryptocurrency—from how it works to how you can get started.

There are over 4,000 cryptocurrencies in circulation today – from Bitcoin (BTC) and Ether (ETC) to Ripple (XRP) and more. In 2020, Chinese investors made over US$1 billion in Bitcoin profits. Lucrative and easy, more and more people are considering investing in cryptocurrency for the future.

Plus, according to Tesla, SpaceX and The Boring Company CEO Elon Musk, cryptocurrency makes the existing information system for money more efficient. In an interview, he explained, “If the core efficiency of money improves and if money has less error, in terms of Government interference or fraud, [it] will lead to a better standard of living and give more power to the individual.”

So, what are cryptocurrencies and how exactly do they work?

What is a cryptocurrency?

It is a digital currency used to buy goods and services. Like cash, you can exchange it for a product, but only virtually. For instance, if you want to buy a Tesla, instead of offering cash, you can transfer Bitcoins to the seller’s account. Cryptocurrency is backed by blockchain technology and uses cryptography to secure all transactions—hence the moniker “crypto.”

Why is cryptocurrency so popular?

1. It allows for easy international transfers

Unlike the traditional way of making international payments by going to the bank and paying a fee, cryptocurrency allows for direct transfer at a low cost. You are not required to pay a significant transfer fee.

2. There is no third-party interference

No bank or organization is donning the hat of a middleman; the process is decentralized. Blockchains allow peer-to-peer transfer of funds, with miners, who solve complex mathematical problems, validating the transfer.

3. It is fast and secure

On an average, cryptocurrency transfers take between 20 seconds and 10 minutes. These transfers are stored in blocks or ledgers across many devices, ensuring that the encryption cannot be tampered with or hacked.

4.It is autonomous

Cryptocurrency guarantees autonomy by assigning people unique codes instead of having them use their personal information. This is a double-edged sword. It helps protect the identity of the users and avoid fraud, but it also allows for illegal activity.

Understanding blockchain: the science behind cryptocurrency

As the name suggests, blockchain is a chain of blocks that contains information about a transaction (who sent it, how much, and how many bitcoins they have left). Each block consists of unique information encrypted in cryptography (using algorithms like SHA256 and Ethash). These encryptions can only be decoded by the sender and receiver using their private key.

Each user has a private and public key. The private key is like a digital signature used to validate the transfer of cryptocurrencies; you must keep this confidential. Users share their public keys to receive money.

How does it work?

At the outset, one needs to have a digital wallet – a pen drive or an account on a cryptocurrency exchange – to store the cryptocurrency. By using exchange platforms like Binance, Coinbase and Robinhood, one can set up a wallet and start trading.

Here’s how it works: Say you have to pay Sam for their services. So, using one of the cryptocurrency exchange platforms mentioned above, you initiate a payment of 2 Bitcoins. But, before the Bitcoins reach Sam, the payment must be validated. That’s the job of the miners who solve complex mathematical problems to validate the transfer. This is known as mining Bitcoins or Proof of Work (PoW). In return for their energy, they get paid in freshly minted bitcoins. Then, finally, the amount reaches Sam.

Storing information in a block

Once the amount reaches Sam, the transactional information – from who sent it to how much – gets stored in a block. This information is encrypted in complex cryptography (or hashes) so that only the sender and receiver can view it using their private key. That ensures that nobody can hack the blockchain.

Now, when another transaction occurs, the information gets saved in a new block. This new block will be connected to the previous block using a chain. And this chain will be made using cryptography. So, not only can one not alter or delete the chains, but no one can hack them either.

Then, these blockchains (or databases of information) are made available on a public ledger across many devices, making it all the more impenetrable for hackers.

The challenges of cryptocurrency

1. Irreversible payments

Once you make a payment using cryptocurrency, it gets stored in a block. If you enter the wrong public key of the receiver or the wrong amount, you cannot get the currency back.

2. Volatility

As the past year made clear, there is no accounting for the stability of the cryptocurrency. Its value constantly fluctuates, so you never know when you might incur a loss.

Should you invest in cryptocurrency?

That depends on your financial standing and how much risk you are willing to take. After all, cryptocurrency is volatile – while it can result in mind-blowing profits, it can also lead to terrible losses. In May 2021, Bitcoin prices fell 30%, sending shockwaves through investors.

In an interview, the founder of Her First $100K Tori Dunlap suggested using the 5% rule, wherein you invest only 5% of your portfolio in volatile assets like cryptocurrency. Rest assured, while investing in crypto, one must be equal parts careful and courageous.

Image Source: Unsplash

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