How Do Cryptocurrencies Work?

Most of us have heard about many cryptocurrencies, like Bitcoin or Ethereum, but we may not know exactly how they work. As we all know, fiat currencies, like dollars, each have a unique serial number associated with them. It can also be seen in credit cards; each one has its special password or pin number, and the bank keeps all this information.

When you want to move your money into another account or deposit it, your bank and the government confirm your identity, and they know your account number and your name. It is almost how cryptocurrency works. Each cryptocurrency is like the serial number on your physical money, just without the physical money, and all the cryptocurrency can be divided into smaller pieces like regular money.

What Is A Wallet Address?

Instead of a credit card, you can put your cryptocurrencies in a ‘wallet’. Your wallet address is like your bank account, but without a third party like a bank controlling your transactions. To create a cryptocurrency wallet, you don't need to provide your identity, and each cryptocurrency held in your personal wallet is held only by you. If one loses access to their cryptocurrency wallet, they lose all their cryptocurrency in that wallet forever. So you need to be careful!

What Is A Ledger?

Now we know that with crypto there is no gold or paper; there is just transfer of digital assets. Instead of having several banks record and track transactions, there are just massive spreadsheets of the transactions with crypto. It is called a ledger, and it’s a database that stores all the transactions and is accessible to everyone.

What Is The Difference Between Coin And Token?

• Coins have their own blockchain: Coins are cryptocurrencies native to their own blockchain, meaning that they have a particular blockchain. Coins are used to pay fees on their native network, transfer value, and reward miners when a new block is mined. While tokens don't have their own blockchain and can even exist on multiple blockchains, they are built on top of another protocol like Ethereum. Instead of being used for activities like payment fees, tokens have their special use-cases, specific to the project they have been made for. 
• Coins are harder to create: Another difference between coins and tokens is that coins are hard to create and need a lot of time and cost, but tokens are easy to make in a fairly short time.

What Is A Blockchain?

Blockchain is just one type of distributed ledger, and as the name suggests, it is a sequence of blocks. Each block contains some data, hash of data, the hash of the block and the hash of the previous block. The data stored inside the block depends on the type of the blockchain. For example, the Bitcoin’s blockchain stores the details about transactions, such as the sender, receiver and the amount of the transferred Bitcoin. In the case of Bitcoin, blocks can store about 1500 transactions, and since blocks are limited, they get filled up, and we need to add more blocks to the system. All these blocks are linked together to make chains of blocks, and then we have a blockchain.

How Does Blockchain Work?

Imagine you want to send money to your friend. Through the blockchain, a block represents the transaction and is shared with all the network computers. All the computers validate the block and the transaction. Therefore, the block is added to the chain, and finally, the transaction gets verified and executed.

Why Blockchain?

Blockchain creates trust between different entities. With blockchain, we can transfer money without a trusted third party immediately. It's a public, open-source ledger, i.e., everyone with a network can see the transactions and decide whether the transactions are valid or not. Blockchain technology is the solution to the problem of centralisation. Also, it is a system for keeping records for everybody and making falsification impossible. Strong and complex encryptions protect blockchains because each user has a copy of the data ledger, a hacker will not be able to alter the data in the blockchain.

Conclusion

Although entering the cryptocurrency world can be a challenge and understanding it takes patience, in this blog and other posts in Cryptologi.st, we elaborate on essential details in simple terms. By reading this article, you have become one step closer to perceiving this challenging world. Follow our educational post in Cryptologist.st to be an educated investor and make confident investment decisions.