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What are Cryptocurrencies and How do they Work?

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Cryptocurrencies have become a famous digital asset for traders worldwide due to its various beneficial features and functionalities. International governments and major financial institutions are researching and adopting modern technologies like the blockchain.

However, despite its widespread use and prominence, most scientists, developers and financial managers hardly understand what cryptocurrencies are.

What is cryptocurrency?

A Cryptocurrency is a decentralized, encrypted, digital currency which peers trade among themselves and confirm via a public ledger. The process of their creation is known as mining. These digital coins make use of cryptography for securing and verifying transactions.

The same cryptographic code also controls the development of new units of a specific kind of cryptocurrency. Additionally, there is a limit on how many entries can enter the database. Most importantly, no user can alter their entries once they are made unless they meet some specific conditions.

History of Cryptocurrencies

There have been many attempts in the past to create a digital transaction system. Ventures like Beenz, Flooz and Digicash failed due to ensuing fraud cases and financial issues. Their common disadvantage was the use of third parties who handled the verification and facilitation of the transactions.

Satoshi Nakamoto, an anonymous programmer  was the first to successfully attempt a feasible digital cash system. Consequently, he introduced Bitcoin. He described its features as a digital cash system, employing a peer-to-peer approach. Its biggest trait is the decentralization feature, eliminating third party servers. Such a system runs autonomously and lacks a central controlling authoritative body. One of the challenges that Nakamoto aimed to solve with Bitcoin was the issue of double spending. This can happen when an outside party handles the transactions and controls all the funds. With no central authority, Bitcoins got rid of this issue.

Cryptocurrency Transactions

In Bitcoin transactions, which involve a decentralized network, every user needs to participate and complete their task. The way this happens is through a blockchain. A blockchain functions as a public ledger containing all the transactions occurring on the network. The transactions are available to users on the network and anyone can see another user’s balance in the account.

Every transaction in the network involves a file containing the wallet addresses / public keys of the sender and recipient. Another component of the file is the total amount of transferred coins. Therefore, to conduct transactions, the sender need to sign it off using his distinct private key. Eventually, after the users on the blockchain confirms the transaction, the network broadcasts it to everyone.

Only miners can provide confirmations involving the cryptocurrencies on the blockchain network. The miners have to solve a  complex cryptographic puzzle. Then, they mark the transactions as legitimate and propagate it everywhere across the network.

After broadcasting, every node in the blockchain adds the transaction to the database. Once the confirmation occurs, the transaction become irreversible and immune to fraud. In the process, the miner receives the transaction fees as a reward. Therefore, the defining feature of a network hosting cryptocurrencies is the need of complete consensus of all the participants. Every participant on the network needs to offer consent regarding the legitimacy of the transactions and balances. In case even a single node on the network disagrees on a particular balance, the system would not work and break. However, this breakdown never happens since a lot of rules, algorithms and programs are in place in the network to prevent it.

Types of Cryptocurrencies

There are a large number of cryptocurrencies available in the market. However, six of them are better known than most:

Main Uses of Cryptocurrencies

Making purchases

Many offline and online merchants accept Bitcoin as an acceptable payment method. These kind of merchants include big online retailers like Newegg and Overstock. Some local and small shops, restaurants and bars have also started accepting Bitcoin. Bitcoin can also be used for paying for flights, hotels, apps, jewellery and even some college degrees.

However, other cryptocurrencies like Ethereum, Ripple, and Litecoin are not accepted as widely. But, this is changing. Apple is now authorizing the use of at least ten cryptocurrencies as a viable payment form in the App store.

For Investing

Cryptocurrencies offer lucrative investment opportunities to may traders and investors. Through Bitcoin investments, many people have become  millionaires. Among cryptocurrencies, Bitcoin is the most recognizable investment unit. In November 2017, one Bitcoin was worth over $7,000.

Another cryptocurrency experiencing extensive adoption is Ethereum. Since the time of its creation, it has shown an extraordinary rise in its market cap. Its value since May 2016 has risen by at least 2,700%.

Since 2013, combined market cap of all cryptocurrencies has increased by more than 10,000 %.

Risks of Cryptocurrencies

However, despite their high earning potential, cryptocurrencies involve a high-risk investment. The market value of these digital assets fluctuates regularly, more than any other asset.

Additionally, since digital currency lacks regulation, there is an additional risk of them being outlawed. Another major risk associated with them is the hacking of cryptocurrency exchanges, leading to the theft of huge amounts.


Cryptocurrencies have shown an unprecedented global rise and use, which is higher than any other form of asset.

However, the details of their operation still remain unclear to many traders. Therefore, with their high risk potential, investors should weigh the pros and cons and decide whether to invest in cryptocurrencies.



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