Cryptocurrency Explained: How Does Cryptocurrency Work?

Cryptocurrency is a digital currency, or medium of exchange, that can be used to purchase goods and services. You can exchange US dollars for cryptocurrency in much the same way you exchange dollars for casino chips or arcade tokens. Cryptocurrency transactions are stored in a public ledger using blockchain technology and secured by cryptography. Unlike traditional currency, which is stored in a central bank and managed by regulatory financial institutions, cryptocurrency is decentralized.

In 2008, Satoshi Nakamoto founded Bitcoin (BTC), the first cryptocurrency, and introduced blockchain technology to the world. Bitcoin remains the largest cryptocurrency, but there are now thousands of different cryptocurrencies on the market today including Bitcoin Cash, Ethereum, Litecoin, Cardano, Dogecoin, and XRP. They are often called altcoins because they are alternatives to Bitcoin. The cryptocurrency market has also inspired the rise of online brokers like Coinbase, which allow you to purchase different types of cryptocurrencies.

Cryptocurrency works a lot like PayPal or a credit card, except you exchange digital assets for goods and services instead of US dollars. To make a transaction with cryptocurrency, you must exchange currency with a peer using a digital wallet known as a cryptocurrency wallet. A cryptocurrency wallet is software that allows you to transfer funds from one account to another. To complete a transaction, you need access to a password, known as a private key. The private key is much like a bank account. You can own multiple keys and own all the funds sent to those keys. Transactions are recorded on a public ledger, which shows the transaction totals without revealing the identities of the parties involved.

Cryptocurrency mining is the process required to verify transactions. It involves a massive amount of computing power and complicated algorithms, but those who are successful at solving problems through mining can earn reward coins, tokens, or transaction fees.

To understand how cryptocurrency is unique, you need to understand two basic components: blockchain and cryptography.

• Blockchain technology: Blockchain is a database that keeps a record of cryptocurrency totals and transactions. It stores data in "blocks" that are linked, or "chained," together in chronological order. Unlike traditional currency, there is no central authority overseeing blockchain. It is a distributed ledger that can be viewed by all cryptocurrency users. Processes known as “proof of work” or “proof of stake” are often built into this system to create new blocks and validate transactions.
• Cryptography: Cryptography is a means of making the blockchain secure. Cryptographic codes, also known as "hashes," link the blocks together, making them impenetrable to hackers. These hashes are a lot like a secure password—it's easy for a user to create one, but nearly impossible for a stranger to guess it.

Cryptocurrency functions a lot like traditional currency in the sense you can make purchases and treat it as an investment.

• Purchases: You can use cryptocurrency to purchase goods online as well as hire people to perform services. Cryptocurrency exchanges can be made for fiat currency—or national currencies such as USD—and can be traded for different digital currencies.
• Investment: You can also invest in cryptocurrency by purchasing a given amount at one value and selling it when the value increases. Cryptocurrency values are subject to volatility; the total value of a cryptocurrency, or market cap, can rise and fall quite quickly.

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