How Does Cryptocurrency Work?
Cryptocurrency is a term that is becoming more and more well-known thanks to the rapid rise of Bitcoin in the last ten years. However, as with any new technology, cryptocurrency can, on its face, appear difficult to get your head around.
For many people, the jargon associated with cryptocurrency is enough to put them off getting involved with it. However, we’re here to tell you that it isn’t as complex as it first appears. This is because, at its core, using cryptocurrency is not that much different to an online bank transaction.
The only key difference is that, unlike the money in your wallet, cryptocurrency is completely autonomous from banks, governments or any single organisation.
While this has opened up a world of innovation, it has also, understandably, raised a couple of questions about the security of cryptocurrency.
With that in mind, we’re going to breakdown exactly what cryptocurrency is, how you can use it and why it is one of the most secure forms of currency in the world.
Where Did Cryptocurrency Come From?
Currency in some form has existed for as long as civilisation itself. Ancient forms of money date back thousands of years, while early forms of banking can be seen as far back as 2000 BCE in Babylonia. Here, individuals could deposit gold with temples for a fee, who would then use it to lend.
It’s no wonder then, that after thousands of years of development, most of us are hesitant about exploring a currency based on anything but the tried and tested model of banking.
The common theme in the history of currency is the need for a third party who manages the movement of money. Whether it’s an ancient Babylonian temple or your local high street bank, a middleman has always been required to keep a ledger of money coming in and out along with who’s involved in the transaction.
That is, until now.
Attempts to digitize cash and remove the need for a middleman had been taking place for decades, however, they were never successful because the prospect of double-spending could not be solved.
When using traditional currency, your bank keeps track of what you’re spending and who with. That means you can’t spend the same £10 twice. So, if you take away the bank, there’s no one to stop you double-spending, which is a serious problem.
Of course, you may be asking, “why do we want to get rid of the middlemen anyway?” Well, any industry that involves people is capable of being the victim of human error and emotion. Finance is no different and the ramifications of human mistakes can be truly global – just look at the 2008 financial crisis.
This is exactly what the person or persons operating under the name of Satoshi Nakamoto thought when they began developing the first cryptocurrency and the technology to go with it: Bitcoin.
This new form of currency allowed, for the first time, for trust in financial transactions to be digitized by taking people out of the equation.
What is Cryptocurrency?
One of the most prevalent pieces of misinformation out there is that cryptocurrency and Bitcoin are the same thing. This is not the case, and there are actually thousands of other crypto coins and tokens used in the world today.
When it comes to what cryptocurrency is, the amazing thing is that it while it may be very different, it still operated in a similar manner to the currency we’re used to using every day.
One of the key things that make cryptocurrency different from sterling or dollars is the fact that it exists on a decentralised network, meaning it does not require a middleman, such as a bank. Cryptocurrencies also only have a finite reserve of coins, unlike fiat currency (sterling, dollars, etc.), where more can always be printed.
Instead, cryptocurrency uses cryptography (from which it gets its name), which is the art of writing or solving complex codes. This is what allows the digital transactions to take place without the need for a human-led organisation to track where the money is going.
How is this possible, you ask?
Solving the Ledger Issue
As we touched up, the difficulty in creating a digital currency was not in creating accounts or setting up transactions. Instead, the problem was in keeping track of how currency was moving without a centralised organisation to keep a record.
In a decentralized network, you need to keep every single entity to do their part in creating a ledger to track the balances. In short, every part of the network needs to have a list of all transactions taking place to refer to, so double-spend cannot happen on future transactions.
Another way to think of this decentralized network is as a posh spreadsheet that everyone can see. When a transaction using a cryptocurrency is made, a stamp needs to be added to the sheet that can never be changed and everyone can see.
Satoshi Nakamoto successfully developed this new type of technology, which is called blockchain and can be thought of as an underlying operating system cryptocurrency uses.
While blockchain was originally created for Bitcoin, practically every cryptocurrency now uses its own version of the technology, meaning nearly every cryptocurrency has its own public ledger.
Every time a transaction is made a new block of code is added to the chain. This code can then be read for future transactions to eliminate the risk of double-spending.
The beauty of blockchain is because the ledger is created entirely by computers (which we’ll come onto in a moment) it is completely protected from human interference. In fact, in order to make fraudulent transactions on a blockchain network, an attacker would need to control 51% of global mining power, and even then there is no guarantee of success.
When you consider that the Bitcoin network is estimated to consume more power than all of Switzerland, you begin to appreciate what a tall order attempting to hack cryptocurrency networks can be. For that reason, blockchain makes cryptocurrency one of the most secure forms of currency ever created.
What Powers Cryptocurrency?
So, blockchain allows for the existence of a currency that doesn’t rely on a centralised organisation like a bank, but who exactly is doing all the work? After all, a bank has thousands of employees, so who replaces them?
The answer is computers that are capable of processing cryptocurrency transactions and verifying them by adding them to the blockchain. How these computers work is best explained by looking at a similar example: the internet.
In order for the internet to function, three things are required. These are:
- The fundamental technology itself
- Websites for users to access
- Servers to host the websites and keep them running
Cryptocurrency technology works in much the same way. Instead of the internet, blockchain is the fundamental technology on which everything is based.
Where a website uses the internet to exist, cryptocurrency coins use blockchain technology.
Finally, rather than having servers to power websites, cryptocurrency uses mining rigs (which are really just powerful computers) to process the transactions and update the blockchain. In other words, mining rigs stamp the public spreadsheet that is the blockchain.
It is these mining rigs that do all the heavy lifting and allow transactions to take place. It is also these rigs that you can use to make money out of cryptocurrency.
How to Make Money with Cryptocurrency
Anyone who has ever owned a website knows that the server space to host the website is not free. Whether you pay £15/month or £200/month, the power to make a website live has a monetary value.
It’s exactly the same for cryptocurrency. In order for transactions to take place, crypto mining rigs have to process them, and this isn’t free.
Businesses that have a cryptocurrency know this, which is why they say thank you to anyone who uses a mining rig to power their transactions. This thank you comes in the form of cryptocurrency coins, which can then be exchanged for fiat payment on the open market.
This is where the notion of “mining” cryptocurrency comes from. You get to choose which transactions your rig powers, which is determined by the coin you wish to mine.
How Much Do You Need to Know about Cryptocurrency?
As we said at the beginning of this blog, cryptocurrency can be difficult to get your head around. However, hopefully, you now have a clearer understanding of what cryptocurrency is and how it works.
Of course, it’s possible that you now have more questions than ever, and we want to help you answer them. Before we do though, it’s important to note that you don’t have to be an expert on cryptocurrency to make it work for you.
Just as you don’t need to know the technicalities of what happens after you use a debit card, you can be successful with cryptocurrency without knowing the ins and outs.
So, if you’re curious to learn more about making money from mining cryptocurrency, get in touch to learn how we can help you.