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Although cryptocurrencies have swiftly gained popularity over the past couple of years, many still are unaware of how they work and what advantages come with using them. Read this article to find out more about blockchain and cryptography behind cryptocurrencies.

13

Jun, 19

What are Cryptocurrencies and How Do They Work?

What is a Cryptocurrency?

A cryptocurrency is a digital asset designed to work as a medium of exchange that uses strong cryptography to secure financial transactions, control the creation of additional units and verify the transfer of assets. In essence, they are limited entries in a database that no one can change unless specific conditions are fulfilled.

The Emergence of Cryptocurrencies.

Although during the 90’s tech boom many attempts were made to create a digital currency, they all inevitably failed due to fraud and financial problems. All these systems used a Trusted Third Party approach, meaning that the companies behind the digital currencies were responsible for verifying and facilitating transactions. These tasks are very complex and a single company is not up to par with completing them, thus making the idea of creating a fully functional digital cash system seem impossible.

In early 2009, however, an anonymous programmer under the alias of Satoshi Nakamoto introduced the first ever cryptocurrency, the Bitcoin. It was described as a peer-to-peer electronic cash system which is completely decentralized, meaning there are no servers involved and no central controlling authority. Although since then the number of cryptocurrencies has risen well over a thousand, Bitcoin still remains the dominant one, occupying around 40% of the market share.

How do cryptocurrencies work?

A cryptocurrency consists of a network of peers. Every peer has a record of the complete history of all transactions and the balance of every account. Once a transaction is requested, it is broadcast to a peer-to-peer network of computers called nodes. Essentially, a transaction is a file that states: “user A gives X amount of cryptocurrency to user B”, which is signed by user A’s private key.  These steps involve basic public key cryptography and P2P technology.

The transaction is known almost immediately by the whole network and enters the ‘pending’ status until it is confirmed. In this state, it is still not considered as part of the blockchain and can be forged. Only miners can confirm transactions by solving a cryptographic puzzle. They take the transactions, mark them as legitimate and release them into the network. Once a transaction is confirmed, it is added to the database of every node and becomes irreversible and unforgeable. The miner also receives a reward and transaction fees (if applied).

What are the pros and cons of using cryptocurrencies?

Here are some advantages to using cryptocurrencies:

  • Fraud: Since cryptocurrencies are completely digital, they cannot be counterfeit or reversed arbitrarily by the sender like it is possible with credit card charge-backs.
  • Identity Theft: When giving credit card credentials to a seller, you give them access to your full credit line. The store initiates the payment and pulls the designated amount from your account. Cryptocurrencies, on the other hand, use the “push” method which allows the sender to send exactly what is desired to the recipient with no further information.
  • Immediate Settlement: Bitcoin contracts can be designed to either eliminate or add third party approvals, reference external facts, or be completed at a future date or time at a fraction of the expense.
  • Access to Everyone: There are over 2 billion people with internet access who don’t have access to traditional exchange systems. These individuals are primed for the cryptocurrency market.
  • Lower Fees: In most cases, there are no transaction fees when dealing with cryptocurrencies, as the miners are compensated by the network. Nevertheless, many expect that most users will engage in a third-party service for creating and maintaining their own bitcoin wallets. These services provide the online exchange system for cryptocurrencies, and thus are likely to charge fees.

Although there are so many advantages to cryptocurrencies over fiat ones (i.e. regular money), the bottom line is: it will need years of exposure to the global system before the masses start accepting it as a tool for global commerce.

Even if the world isn’t ready to start fully accepting cryptocurrencies as payment methods, MonoVM is! We accept nearly all mainstream cryptocurrencies as payment gateways for any of our services.