At first glance, cryptocurrency market seems like a gamble but taking a deeper look at the mechanism and meaning of cryptocurrency makes it easy to understand the math ruling the market.
Concept of Cryptocurrency
What is Cryptocurrency?
Cryptocurrency is the digital currency system that allows global monetary transactions without the need of a central authority. Cryptocurrency uses cryptography for security. It is secured by purely math.
In late 2008, Satoshi Nakamoto invented the first cryptocurrency Bitcoin and in his announcement, he said that he developed “A Peer-to-Peer Electronic Cash System. “
Idea behind Cyptocurrency
The idea behind developing cryptocurrency is to develop a decentralized digital cash system. For the working of a decentralized cash system, a payment network with account, balances and transaction is needed. Every payment network has to prevent the problem of so called double spending (preventing one entity spending the same amount twice).This is the job of a central server who keeps record about the balances.
(Double spending:-It is a flaw in the digital cash system in which same single token can be spent more than once due to risk of digital information being duplicated or reproduced.)
In a decentralized network, every single entity of the network have to do this job. In order to check whether there is double spending or to check whether future transactions are valid or not, every single entity has the list of all the transactions.
In simpler definition, Cryptocurrency is just limited entries in a database that cannot be changed without fulfilling specific conditions.
How every single entity can keep a consensus about records?
For this network to be successful, all the peers in this network has to agree about the records. A single disagreement about a record can break everything. Therefore there has to be complete consensus among the peers.
Mechanism Ruling the databases of Cryptocurrencies
The mechanism behind the cryptocurrency consists of network of peers and every peer in this network has complete record about every transaction and thus balance of every account.
For example:-There is a transaction that says,” Megan gives Z bitcoin to Cody” and this transactions is signed by Megan’s private key. Moment the transaction is signed, it is being broadcasted in the network and every peer in the network has a record of that transaction.
The transaction is known to the whole network once it is signed. However, a transaction gets confirmed after a specific amount of time only.
Confirmation plays an important role in Cryptocurrencies as till the time a transaction is confirmed, it is considered as pending and therefore it can be forged. After a transaction is confirmed, it becomes a part of the Blockchain (historical transaction record).
Blockchain is a decentralized and digitized public ledger which keeps record of all cryptocurrency transactions in a chronological order without the need of a central recordkeeping system.
A copy of the Blockchain is automatically downloaded on each node (every computer connected to a network).
Blockchain works on Peer-to-peer network in which each node communicates with its set of neighbor and so on. Each node can join and leave the network any time. All the transactions are broadcasted on P2P network and each receiving node (computer connected to network) forwards it to neighbor.
What is Cryptocurrency Mining?
Miners play the role of confirming the cryptocurrencies transaction. They mark the transactions as legit and spread them in a network. Once the transactions gets confirmed, every node adds it to the database which then becomes part of the blockchain.
Definition of Miners: – As cryptocurrency works on decentralized digital cash system, there is no authority to delegate the task of confirming the transactions. Therefore, some kind of mechanism is imperative to prevent one ruling party from abusing it.
To fix this problem, Satoshi Nakamoto, decided to set the rule for miners that they will have to invest some work of their computers to qualify for the task of confirming the transactions. Moreover, miners will have to solve a cryptographic puzzle and will have to find a hash which is a product of cryptographic function which connects the new block with its predecessor. This is known as Proof-of-Work. In Bitcoin, it is based on the SHA 256 Hash algorithm which is the
basis of Cryptographic puzzle, which miners compete to solve. When a puzzle is solved, a miner can build a block and add it to the blockchain. As a reward, he gets a specific number of Bitcoin.
How Bitcoins can be created?
When Miners solve a cryptographic puzzle, a Bitcoin is created. Miners compete to solve this puzzle. Amount of computer power miner invests depends on the difficulty of puzzle a miner has to solve. As the difficulty of the puzzle increases, a miner has to increase the amount of computer power. Moreover, a specific amount of cryptocurrency can be created with the given amount of time. This is a part of cryptocurrency process that no peer can break.
Thus understanding the meaning, process and mechanism ruling the process of cryptocurrency is an imperative part to understand the reason behind the rising and falling price of Cryptocurrency. Every peer in the network plays an important role as an agreement or a disagreement about a transaction, so a single disagreement by any peer in the network can break the complete transaction.
Also Read: How to Value a Startup