In the previous lesson, we introduced you to the world of cryptocurrencies, and you understood what they are and how they are developed using cryptography. In this lesson, I’ll take you through how cryptocurrencies work.
Now, before we begin, here’s something you’ll need to know. First, not all cryptocurrencies work the same way. For instance, Bitcoin is a digital currency that one can use to buy a product or subscribe to a service, like how your fiat/conventional money is used.
However, not all cryptocurrencies serve the same purpose. For instance, USDT (Tether) is a stable coin cryptocurrency. The value of USDT is attached to the value of US Dollars, which means 1 Tether = 1 USD. This digital asset was created to prevent the frequent surge and dip in cryptocurrency prices. So people who want to take lesser risks can buy this crypto asset.
Several other cryptocurrencies, each with its purpose and new kinds of virtual currencies, are being developed as the industry progresses.
But despite whatever their purposes are, these cryptocurrencies work using blockchain technology, which is what this lesson will be about.
Blockchain technology is essentially a secure decentralized virtual ledger as opposed to a centralized ledger.
Decentralized System Explained
Think of your banking systems. Any money you send to another person virtually has to go through the bank and the payment gateways. A virtual ledger owned by the bank will make a record of that. So now, this system is centralized because there’s one central authority that stores all the transactions between all the people using the bank’s services.
Blockchain, on the other hand, is a decentralized and secure ledger. Think of blockchain as a network that connects different people together. There are various transactions that can occur between various people who are present on this network with the help of their computers.
Every time a transaction occurs, a record of it is made. Now let’s say there have been a 100 transactions. This means there will be a 100 records. Since the blockchain is decentralized, all these 100 records are not stored in one location. Instead they are distributed and stored on different computers that are present on the network.
How Is A Blockchain Made Secure? How Does The System Work?
Now, security is another crucial aspect of the blockchain. So how does it achieve such a high level of security?
Every cryptocurrency transaction record is in the form of a virtual block or data unit. Think of a virtual box (block) that has details of the sender, receiver, amount, and a unique ID to identify that box. This unique ID is called a hash, and it is calculated using the contents of the box I mentioned above.
The box (block) also has the unique ID of the previous block that contains data of the last transaction on the network. This previous unique ID is also used to calculate the unique ID of the current block. So now, as new transactions occur, they are recorded as blocks, their ID is calculated and linked to the previous transaction block, thus forming a chain of blocks or, as we call it, blockchain.
For example, say person A sends 10 bitcoins to person B. Now, this block say Block 1 contains this transaction with the following details:
- Sender: Person A and their details
- Receiver: Person B and their details
- Amount: 10 Bitcoins
Along with these there will be two unique IDs
- ID of the the previous block say Block 0.
- ID of the this current block calculated using the above details.
Thus Block 1 points to Block 0. Subsequent transactions say Block 2, Block 3 and Block 4 will each point to the previous block.
Block 0 ← Block 1 ← Block 2 ← Block 3 ← Block 4
This system is more secure because anybody trying to access the block would first have to decrypt/decode it. Even if someone does so and tries to modify the information within the block, it’d automatically change the unique ID.
If the unique ID is changed for this block, the person has to change the ID of other blocks on the chain, which is tedious.
Hence the system becomes highly secure.
Hence, this is how cryptocurrencies and their transactions work on blockchain technology! Next, we’re going to walk through how you and I can transact with cryptocurrencies as beginners.