What is crypto-currency and how does it works?

 

Image: Cryptocurrency
Image Source: CalvinAyre.com

What is cryptography?

A cryptocurrency (or crypto currency) is a digital asset designed to work as a medium of exchange using cryptography to secure the transactions and to control the creation of additional units of currency.

It allows transacting parties to remain anonymous while confirming that the transaction is a valid one.

It is not owned or controlled by any institution – governments or private.

Bitcoin became the first decentralised cryptocurrency in 2009. Since then, numerous cryptocurrencies have been created like Ethereum, Ripple, etc.

How does cryptocurrency works?

Image Explaning of how Bitcoin works

Here I’ll explain, by using Bitcoin as an example, how cryptocurrency works but before that let’s understand some of the basic concepts:

Public Ledgers: Ledger, in laymen terms, is a book or other collection of financial accounts. Similarly, in cryptocurrency world, a public ledger is a space where all confirmed transactions from the start of a cryptocurrencies creation are stored. The identities of the coin owners are encrypted, and the system uses other cryptographic techniques to ensure the legitimacy of record keeping. The ledger ensures that corresponding “digital wallets” can calculate an accurate spendable balance. Bitcoin call this public ledger a “transaction block chain

Transaction: Transaction in cryptocurrencies means same as in conventional fiat money; transfer of funds b/w two digital wallets. That transaction gets submitted to a public ledger and awaits confirmation. When a transaction is made, wallets use an encrypted electronic signature (an encrypted piece of data called a cryptographic signature) to provide a mathematical proof that the transaction is coming from the owner of the wallet. The confirmation takes a bit of time (ten minutes for bitcoin) while “miners” mine (i.e. confirm transactions and add them to the public ledger)

Mining: In simple terms, mining is the process of confirming transactions and adding them to a public ledger. In order to add a transaction to the ledger, the “miner” must solve an increasingly complex computational problem. Mining is an open-source so anyone can confirm the transaction. The first miner to solve the puzzle adds a “block” of transaction to the ledger. The way in which transactions, blocks, and the public blockchain ledger work together ensures that no one individual can easily add or change a block at will. Once a block is added to the ledger, all correlating transactions are permanent and a small transaction fee is added to the miner’s wallet (along with newly created coins). The mining process is what gives value to the coins and is known as a proof-of-work system.

Address: A Bitcoin address, or simply address, is an identifier of 26-35 alphanumeric characters that represents a possible destination for a bitcoin payment. Like e-mail addresses, you can send bitcoins to a person by sending bitcoins to one of their addresses. However, unlike e-mail addresses, people may have different Bitcoin addresses and a unique address should be used for each transaction. Most Bitcoin software and websites will help with this by generating a brand new address each time you create an invoice or payment request.

Wallet: A Bitcoin wallet is a collection of private keys but may also refer to client software like Bitcoin Core used to manage those keys and to make transactions on the Bitcoin network.

Now let’s trying to consider a fictitious example. Suppose you are an aspirant of civil services examination. You follow GKVarsity ardently and it’s helping a lot in your preparation. One fine morning, you thought of donating some money to GKVarsity (don’t worry this is just an example) for their social service which they are doing by helping aspirants in their preparation. Among the payment options, paying through bitcoin is also available. You choose to pay through Bitcoin mode. When you’ll do the same an address (defined above) will be created automatically or GKVarsity can make one offline using some tools and send you the address. This address is where you have to send the money.

How will you send it?

You must be using some client software like Bitcoin Core or some e-wallet to send the amount to the address created by GKVarsity. Remember, your wallet contains several private keys for each of your address. When you’ll request your client software to send GKVarsity the donation amount, your client software will use one of your private key to transfer fund from.

After this is done, miners (term defined above) will use the public key to verify that the transaction is coming from the legitimate account owner. Miner has to solve a complex computation problem to verify a transaction after which he/she adds a block of transaction to the ledger (explained above what is ledger? What is miner? Read them properly)

Once a miner confirms the legitimacy of the sender by solve the complex problem, the transaction gets successfully done.

I hope it’s clear. If there is any question or doubt, do comment in comment section below and I promise that I’ll revert back with the solution as soon as possible.

 

References:

https://visual.ly/community/infographic/technology/bitcoin-infographic

http://www.investopedia.com/terms/c/cryptocurrency.asp

An article from The Hindu newspaper titled “Bitcoin trade may come under SEBI”

http://cryptocurrencyfacts.com/how-does-cryptocurrency-work-2/

1 thought on “What is crypto-currency and how does it works?”

Leave a Reply