What is cryptocurrency in simple words?

The main thing

• Cryptocurrencies are virtual assets, the functioning of which is provided by a network of decentralized computer nodes (nodes). Most of them are built on the basis of the blockchain – a database of transactions in a chain of related blocks.
• Cryptocurrencies are mainly used for settlements between network users, payment of commissions for transfers, as well as for storing capital. However, they may have many other features and limitations. In some blockchains, you can issue an unlimited number of cryptocurrencies.
• Depending on the functions and scope, different types of cryptocurrencies are distinguished, including stablecoins, NFTs, governance tokens, and wrapped assets.
• Blockchain allows you to interact directly and without restrictions with cryptocurrencies. Decentralization and lack of control of any country or organization eliminate the possibility of blocking funds and other risks.

When did cryptocurrencies appear

Proposals for the creation of cryptocurrencies were made even before the advent of the Internet. The first algorithms aimed at transferring value over the Internet were proposed by the American cryptographer David Chaum. In the late 80s, he founded a related project called DigiCash. However, that ended in failure.

One of the projects close to modern cryptocurrencies is b-money. The project was founded by programmer Wei Dai. In b-money, he first proposed a Proof-of-Work (PoW) consensus mechanism for finalizing transactions and a distributed database for storing information about transfers.

Bitcoin, created by an anonymous user named Satoshi Nakamoto, was the first successful cryptocurrency to be widely adopted. The algorithm of the blockchain of the same name is largely based on the ideas of Wei Dai and, in a broader sense, the cypherpunk movement.

The next step in the development of virtual assets was the Ethereum smart contract platform, which was founded by Vitalik Buterin. The launch of the main network took place in 2015. Thanks to smart contracts, the Ethereum blockchain made it possible to issue an unlimited number of crypto assets and program their functions.

Cryptocurrencies and blockchain: differences from traditional finance and money

The reliability of the blockchain and the data protection mechanisms embedded in it have made cryptocurrencies a worthy alternative to the traditional monetary system. Transfers of digital assets can be made directly between users, and the network protocol represented by many independent nodes is responsible for their verification and confirmation. Once a transaction has been sent and verified, it cannot be undone.

Information about transfers is stored in an open database. Blockchain is the key technology that allows you to interact with virtual assets. The cryptographic methods used in it exclude the possibility of changing data on completed transfers.

Thanks to decentralization in the blockchain, it was possible to solve the problem of a single point of failure in databases and payment systems, providing universal protection from censorship. Virtual assets in public blockchains are not subject to the influence of regulatory authorities and external manipulations. The third-party does not have the ability to freeze the funds or cancel the transaction.

Cryptocurrencies may not be under the control of any one entity, allowing them to be used in any jurisdiction. Bitcoin is the most famous example of such an asset. New virtual assets are released during the operation of the blockchain. The algorithm of operation of a particular digital asset includes such parameters as the total emission and the rate of issuance of new coins.

The user can create an unlimited number of addresses. The latter usually do not allow you to get information about him. Only specialized blockchain analysis tools make it possible to track the movement of funds and determine the sources of their receipt.

How Cryptocurrency Works: Key Features

blockchain

Most cryptocurrencies use a technology called a blockchain. The latter is a sequence of hierarchically linked blocks. It contains a database of all conducted transactions. New transactions are written into blocks that are created by node operators. Each of the computer nodes stores its own copy of the blockchain and, in the course of reaching a consensus, confirms new blocks, passing the result to other nodes. Based on this information, user balances are changed.

Hashing

Hash functions are widely used in cryptocurrencies. The latter allows you to “collapse” an arbitrary array of data into one line – a hash. The blockchain is a single whole since each subsequent block includes the hash of the previous one. The use of other data leads to a significant change in this line. The algorithm excludes the possibility of canceling a transaction without changing all subsequent blocks.

consensus algorithm

The consensus algorithm is responsible for confirming transactions and verifying all blockchain data, in which network members, and nodes, participate. The most popular consensus algorithms are the already mentioned Proof-of-Work (used in Bitcoin) and Proof-of-Stake.

In order to confirm transactions, the nodes consume processing power or block their own funds, which act as a guarantee of data validity. After adding a new block, it is no longer possible to re-spend the funds spent at the current stage. In the process of reaching the algorithm, its participants receive new cryptocurrencies (both in PoW and PoS ). Thus, these mechanisms serve as a way to issue a new cryptocurrency.