Because Bitcoin and its siblings numbering over 1500 use encryption technology to produce their coins or tokens, cryptocurrency is a collective name attributed to the whole basket of digital currencies. A simple way of understanding cryptocurrency is the way people use a debit card or PayPal for buying goods or transacting money. One exception however is that you need to open an account with any of the cryptocurrency exchanges before you can use bitcoin or similar coins collectively known as altcoins. It is also important to understand how a particular exchange is more suited to your needs and on the same note, the ones that you should avoid. Coinbase, Kraken, Bitfinex, Gemini, and Bitstamp are among the more popular crypto exchanges. You should also make sure that the exchange you choose to work with will accept the coin/coins you own or plan to own.
There is no physical form for a cryptocurrency unlike the fiat currencies. Therefore, you can only see your currency on a mobile screen or a computer screen. Typically a block would look something like this:-
“01000000000100000000000000001976a91424f046543cfce2354562bf60876cebb2b4596bc588ac00000000” and the maze of alphabets and numerical make up your coin or the block. Cryptography is the basic science that drives the blockchain technology that is integral to all cryptocurrencies.
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Process involved in a cryptocurrency transaction
When you initiate a transaction, for instance, transferring $1000 to a friend, the transaction details are first entered into a distributed digital ledger known as ‘block’. Then, the transaction gets encrypted with the help of cryptography which also gives the currency the name cryptocurrency. There is no central authority or government backing for any cryptocurrency. It is a completely decentralized mechanism controlled by a network of computers and each computer within the network is known as a node. Once a block is generated, it is broadcasted to the network and each participant in the network verifies the data within the block. It is important that every single participant within the network approves the transaction and the data within the block. Even a single disagreement would render the transaction void. The nodes within the network can be anywhere across the globe or closer home. In most situations participants within a network are strangers and therefore the chances of any manipulation is nearly extinguished. Every cryptocurrency needs an electronic ‘wallet’ to store the currency and every time a transaction is made, the wallet is credited/debited. Owner of the cryptocurrency controls his wallet through a password known as private key. When cryptocurrencies are sent from one wallet to the other, the transaction is placed in a queue and added to the digital ledger with the help of public and private keys. While several transactions can be added to a ledger instantaneously, the related blocks get added subsequently. This is also how the technology derives its name ‘blockchain’, meaning a chain of block transactions.
Creating a block and adding it to the blockchain
Now, this is not everybody’s cup of tea. Mining crypto coins, creating blocks, adding blocks to a blockchain are inherently technical. In broader terms you need plenty of patience in addition to your skill to be a successful cryptocurrency miner. The cryptocurrency, or the brand (like Ethereum, Ripple, Litecoin) you pick would also be important because the rewards may not be identical. To understand deeper the process of creating a block and adding it to a blockchain, you can go here.
Consensus process avoids double spend
In other electronic payment systems, double spending is avoided through master source of authority that follows rules laid down for authorizing every transaction. With cryptocurrency, the system is decentralized a consensus among the nodes within the network following identical protocol as well as proof of work takes over the place of the central authority. Thus, there are unique properties that are not available with centralized systems. For instance, when a user keeps his private key of bitcoin secure, and the transaction has adequate confirmations, the bitcoin owned by him cannot be stolen or misused irrespective of the nature of excuse or reason. Since bitcoin transactions are also final, merchants need not go through the hassle of obtaining additional information such as name, billing address etc. and bitcoin or other cryptocurrencies can be used with complete anonymity of personal information. This finality of transactions also enables smart contracts where ‘code is law’.
Another major contributor to the proliferation of cryptocurrencies is the trust factor. While trust is important in every transaction, financial transactions in particular rely heavily on trust. Trust is also expensive because you have to part with a fee to a central authority or an intermediary. The blockchain technology which is at the core of any cryptocurrency nearly guarantees this trust factor since every element of a transaction is automated and there is no central authority or intermediary. In turn, this impacts not only the cost of the transaction but also the time taken to complete a transaction. Typically a cross-country financial transaction can take up to 7 days before the money physically moves from one account to the other. On the other hand, a crypto currency transaction can be completed in less than a minute.
Yet another factor where trust plays a major role is the intervention of facilitators with a large network in converting one currency to the other, applying real time exchange rates and crediting the recipient with his local currency. Many a times, foreign exchange markets tend to be volatile and merchants had little control on the exchange rates. With cryptocurrencies all transactions are executed on real time basis. That puts a great advantage in the hands of the merchant because he can initiate a transaction at exchange rates most beneficial to him on a given day.
Although Bitcoin is the first ever cryptocurrency introduced to the world, in 2018 the population of the cryptoworld has swelled to over 1500. As you would have imagined, there are also a good number of scams out there and therefore you should exercise abundant caution.