Say there is a coin that’s currently worth hundreds of US dollars but it’s not made of gold, platinum or any precious metal. In fact, it’s not kind of coin you can hold it in your hand or stick in a piggy bank. It’s a digital currency which means it only exists electronically.
We are talking about cryptocurrency such as Bitcoin. It does not work like most fiat money. It isn’t attached to a state or government so it does not have a central issuing authority or regulatory body.
Basically, that means there is no organization deciding when to make more cryptocurrency, how many to produce and keeping track of where they are.
So how cryptocurrency does works?
Cryptocurrency would not exist without a whole network of people and a little yet important thing called cryptography. Let’s take an example of world’s first cryptocurrency to understand the working principle of cryptocurrency.
Cryptocurrency or bitcoin is a fully digital currency and you can exchange it between computers in the worldwide peer-to-peer network. Unlike media files, cryptocurrency isn’t a string of data that can be duplicated but it’s actually an entry on a huge global ledger called the blockchain. The blockchain records every crypto coin transaction that has ever happened. And as of late 2016, the complete ledger is about 107GBs of data.
So when you send someone a bitcoin it’s not like you’re sending them a bunch of files instead you are basically writing the exchange down on that big ledger. Even though the blockchain is a central record there’s no official group of people who update the ledger and keep track of everybody’s money like the bank. It is decentralized and distributed among the nodes (computers) on the blockchain.
In fact, anybody can volunteer to keep the blockchain up to date with all the new transactions and a ton of people do it all works because there are lots of people keeping track of the same thing to make sure all transaction is accurate.
Moreover, cryptocurrency is kept pretty safe thanks to cryptography which is it’s considered a cryptocurrency. Specifically, bitcoin stays secure because of keys which are basically the chunk of information that can be used to make mathematical guarantees about messages.
When you create an account on Bitcoin network which you might have heard called a wallet. That account is linked to two unique keys a private and public key. In this case, the private key can take some data and basically mark it also known as signing it so that other people can verify those signatures later if they want. These keys are the essential elements to execute the transaction on blockchain network.
But there is a problem that might happen with timing called network delay because a lot of people are keeping copies of blockchain all over the world. Network delays mean that you won’t always receive the transaction request in the same order to add the new block.
To add a new block off to the chain each person maintain ledger has to solve a special kind of math problem created by cryptography hash function. The process of solving the mathematical problem and validating the transaction is called mining. A hash function is an algorithm that takes an input of any size and turns it into an output with a fixed size.
Computers or peers that were specially designed to solve these hash problems take, on average, about 10 minutes to solve each mathematical problem, In case of Bitcoin. Computers with high-end computational power are supposed to solve these algorithms first and validate the transaction by adding a new block on blockchain and receives a certain amount of reward in form of cryptocurrency.