Ever since Bitcoin was launched in 2009, "to buy or not to buy" has become almost as quintessential as "to be or not to be". Fast forward to today, where we have access to thousands of cryptocurrencies, and the question turns into "to buy or not to buy what exactly?".

In this article, we'll go through the basics of crypto, exploring how they work and why they’re a popular form of currency.

What is crypto?

Cryptocurrency, or crypto, is a digital currency that has no physical form. Think of your regular bank account – quite often, you don't see the money coming in or out of it. You get your funds transferred to you electronically. When you use your bank card to pay for goods and services, the money gets deducted from your account and transferred to other establishments electronically as well. Crypto is exactly that – a currency that exists only in digital form.

You cannot withdraw crypto from an ATM as you normally withdraw cash using your credit or debit card. That is to say, crypto ATMs exist too, but their functionality differs from cash ATMs. With a crypto ATM, you can exchange regular money, also called fiat, for cryptocurrency or vice versa. However, since crypto has no physical form, it cannot be withdrawn.

The other significant difference between crypto and traditional currencies is decentralisation. Unlike fiat money, controlled by financial institutions and governments, most digital currencies are decentralised and not controlled by anyone. Moreover, there is also no centralised place to store crypto transactions – they are recorded on a public network of thousands of computers, called a blockchain.

What is blockchain?

Imagine a company has a large book of accounts to keep a record of all their expenses, income and other documents to verify payments. Blockchain is pretty much like that – a digital ledger that keeps track of all cryptocurrency transactions that have ever happened. The difference is that this ledger is not kept within an accounting team – everyone in the crypto world can access it. However, if this ledger were an excel file, this public access would be limited to 'View only'. No one gets the 'Edit' access – not the accounting team, not even the CEO, to continue the company analogy. That's what makes crypto transactions so secure – the participants can access the public record and check its validity, but they cannot alter it to their own benefit.

It may seem a little controversial – if everyone has access to everything, they can easily access sensitive data, too, right? Not quite. The reality couldn't be further from this. Let's see how it works.

Private and public key

Every person taking part in a crypto transaction has a set of two keys – a private and a public key. Both keys are unique combinations of numbers and letters that give access to certain functions.

A private key is like a password to your online bank account – you don't want to share it with anyone because it gives access to all your funds. With crypto, a private key is the equivalent of a password to your crypto wallet. No one on the blockchain can access other participants' private keys, and it is crucial to keep them secure.

A public key is like a bank account number or, in this case, a digital wallet address where crypto assets are stored. It is public and can be accessed by anyone, just as you would share your bank account number so someone can transfer funds to it. Everyone can also see how much money the wallet contains.

Every cryptocurrency transaction is secured through cryptographic techniques: the sender authorises the transaction with their private key, creating a digital signature. This signature, along with the transaction details, is verified on the network using the sender's public key but without disclosing the private key itself. Once confirmed and added to the blockchain, the funds are controlled by the recipient, who can then create new transactions with their own private key.

So, due to public key accessibility, everyone in the blockchain network can see when a transaction happens and that X amount of crypto has been moved from wallet A to wallet B. However, since no one can access the receiver's private key, they can only 'View' this transaction but not 'Edit' it.

This process also plays an important role in cryptocurrency mining.

What is crypto mining?

All the transactions stored on a blockchain are grouped into blocks that are connected into a chain – that's where the name comes from. In a nutshell, mining means verifying these transactions, putting them together in blocks and adding these blocks to the blockchain.

There are different types of blockchains and methods of transaction validation. Bitcoin blockchain, for example, uses a system that is called Proof-of-work. As Bitcoin is arguably the most popular virtual currency, and many other cryptocurrencies are mined the same way, we'll take Proof-of-Work as an example to explain how mining generally works.

Whenever a new transaction gets signed off by a sender, it is distributed to the network. At this point, this transaction is still unconfirmed. A miner picks it up and checks whether it's authentic. Using a public key, miners can determine whether the transaction has been signed off by a sender and ensure that the sender owns the required amount of crypto.

That's a simplified explanation. What actually happens in the background is complex mathematical equations that a miner needs to solve.

Crypto mining requires advanced hardware and software. This, in turn, uses up a lot of energy. That's why hypothetically, anyone can become a crypto miner, but not everyone has the resources for it. However, the crypto mining industry is still very competitive due to its incentive – successful miners are rewarded with new coins. Bitcoin miners, for example, receive several Bitcoins every time they add a new block, so the reward makes the work worth it.

If we compare the mining process with a company's book of accounts, a miner would be an accountant who checks all the transactions and adds a new page to the book.

Why is crypto secure?

As we already discussed, decentralisation and cryptography make cryptocurrencies very secure. The former provides transparency by keeping all the records public, while the latter protects sensitive information. In reality, cryptography plays a bigger role in protecting cryptocurrency.

When a miner collects enough transactions to form a new block and solves a mathematical equation, the block becomes part of the chain. The links connecting one block to another are also cryptographically encoded and are nearly impossible to hack.

Each new block has a piece of code from the previous block within it. Imagine three blocks of different colours – block A is blue, block B is yellow, and block C is red. The way cryptography works, block B wouldn't be entirely yellow – it would have a spot of blue. The red block would have a spot of yellow, a spot of blue, and so on. The different colour spots within each block are the code that gets transferred down the chain as new blocks are created.

Altering just one transaction within a block would change its colour (code), and all the consequent blocks would be affected in a domino effect. Since all this data is public, it would be immediately noticed by the network. Moreover, altering a transaction would require so much computing power that the cost would exceed the potential reward. This mechanism also solves the double-spending problem – everyone can see that a certain Bitcoin or a part of it has already been transferred to someone, so the sender cannot transfer it to someone else again.

What about all the crypto hacks that happen occasionally?

Unfortunately, they do happen, but in most cases, a cryptocurrency hack happens when private keys are not secured properly and get stolen. However, it is extremely hard to distribute the stolen crypto in a network where everyone can track transactions, so most hackers get caught eventually.

Hence, if you own cryptocurrency, one of your main goals is to protect your private key at all costs. However, there are alternative ways to make crypto work for you – you can take advantage of cryptocurrency's volatility and trade digital coins without buying them via CFDs. Check out our How to trade crypto article to find out more details about it.

Crypto Trading Articles

TOPICS

How to trade crypto

What affects crypto prices?

What are CFDs?

TOPICS

How to trade crypto

What affects crypto prices?

What are CFDs?