Cryptocurrency, How it works?

Cryptocurrency is a digital currency which entails Cryptography to ensure transaction Security. Bitcoin, developed in 2009 was the first cryptocurrency which is widely accepted.

The whole Idea of the cryptocurrency revolves around the concept of Decentralized records. Unlike the current banking transactions which involves Centralised Records.

We will understand this in later part of the Blog. First let me put across the conditions which a digital currency should meet to be called Cryptocurrency.

Here we go, the conditions are-

  • There is no need for Centralised Authority.
  • At any point of transaction, Information regarding Ownership and Cryptocurrency Units are kept by the System.
  • Creations of new Cryptocurrency units, their circumstances of creation and their Ownership is defined solely by the system.
  • Ownership of Currency can be proved only by Cryptographic process.
  • System allows the transactions involving change of ownership of cryptographic units.
  • In a situation of Getting two different instruction regarding change of Ownership of same cryptographic units. Then the System will perform at most one Instruction.

How to define the validity of Cryptocurrency?

Well this Task is very well handled by “BLOCKCHAIN“. Blockchain is a collection of continuous records which are resistant to change. It an open distributed ledger that efficiently records the Transaction involving two parties. Blockchains are managed by protocols consisting new block validation with Peer to peer networks. Once transaction is recorded it becomes resistant to any change.

A “BLOCK” comprises three element

  • Information that provide Linkage to previous Block.
  • A timestamp
  • Transaction Data

Timestamp?

In most of the cases Cryptocurrencies uses Timestamping so as to avoid the third party validation. Most common Timestamping scheme includes:

  • Proof of work – Timestamping scheme or
  • Proof of Stake- Timestamping scheme (consensus is achieved through Show of ownership of certain amount of Currency)

Some cryptocurrencies uses both Proof of stake and Proof of work Timestamping as well.

There is one more Element of Cryptocurrency. That is MINING. So What Exactly MINING IS?

In brief terms, Mining is actually the validation of transactions over Cryptocurrency Network. Mining has actually contributes to the increased processing power of the Networks. Minors share their processing Powers to validate the transaction. Successful Minors are also rewarded with new Cryptocurrency units as part of network Incentives.

I hope that above segment gave you some idea about few terms of Cryptocurrency network. Let’s get to understand how it works?

To understand this we will consider an example of purchase an Item at a Supermarket (accepting both cryptocurrency and Normal currency). We will take up this example using normal currency and Cryptocurrency.

SENARIO 1: Transaction with Normal Bank Card- (Centralized Data Record)

Consider you have 1000$ in your account linked the Card. You went to the supermarket and decided to purchase a product worth 500$.

You went to the payment counter and presented your card to the POS (Point of sale) agent. He will swipe your card and POS server will send a connection / Verification request to bank server so as to verify whether you have transaction amount in your account or not? Bank server will verify you record and respond accordingly. Now considering we have 1000 $ which is less than the requested transaction amount, Bank Server will put a green signal to the transaction and will deduct 500$ from Account and record 500$ as new Balance. Bank will earn on account of transaction charges. You can understand this better by below flow chart.

SENARIO 2: Transaction with cryptocurrency wallet- (Decentralized Data Record).

Consider the Same situation as scenario one, and you have proceeded to the payment counter with cryptocurrency wallet. Now in this transaction there is NO entity called BANK. Here are the steps for transaction.

You presented your Cryptocurrency wallet to the POS.

POS server send request to cryptocurrency network comprising thousands of record keepers around world, having records of your Cryptocurrency. Now to proceed for the transaction, all the records should reflect one amount.ie 1000$ (worth cryptocurrency).Cryptocurrency network will verify all the records. Owing to the consensus of the all the records. Transaction will be proceeded. And 500$ worth cryptocurrency will be deducted and new Balance (BLOCK) will be recorded by all the record keepers around the world.

There isn’t any single record. Rather in this case multiple copies of your transaction ledger is distributed to multiple recorders around the world. Hence if there is any discrepancy with any particular transaction. Then network server will verify other records and disqualify the transaction accordingly. Please bear in mind the thousands of record keeper which we are talking about are no human. They actually computers of the Peer to peer Cryptocurrency Network.

In above case the transaction will be proceeded and one of the recorder will be rewarded randomly, as an incentive to the transaction. Below flow chart can help you understand this better.

 

I hope this article was helpful to you in Understanding How cryptocurrency works.

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