What are cryptocurrencies and how do they work? Are a good technology or investment? Read the article

How do Cryptocurrencies work?

There has been more and more talk about cryptocurrencies in recent times, both as an investment and as technology. However, not everyone knows what cryptocurrencies are and what is the meaning of words like Bitcoin, Ripple, Ethereum, and so on.

In this article, we will explain what cryptocurrencies are and how they work.

Cryptocurrencies are digital currencies based on cryptography, created to guarantee decentralized (between users, free from the control of any government), anonymous, and secure transactions.
Their history begun in 2008 when an anonymous inventor, “Satoshi Nakamoto”, published a paper entitled “Bitcoin: a peer to peer digital cash”. In this paper, Satoshi introduced Bitcoin, the first cryptocurrency. It allowed a decentralized and anonymous transaction validation system.
In the following years, the features of Bitcoin earned a great success, leading to an increasing use of Bitcoin, and a significant price growth. Today, there are thousands of negotiated cryptocurrencies derived by Bitcoin, each with its own technology similar to bitcoin’s
The cryptocurrencies are based on the blockchain, i.e., a decentralized database in which transactions made by users are stored. Each cryptocurrency has its own blockchain or works thanks to the blockchain of another cryptocurrency. From a technical point of view, talking about cryptocurrency means talking about blockchain.

We’ll see a few key information on blockchain and cryptocurrency in more detail:

– What are cryptocurrencies used for?
– How can I use a cryptocurrency?

– How are transactions validated?
– Cryptocurrencies and inflation
– Is the blockchain anonymous?
– How can I get cryptocurrencies?

What are the various cryptocurrencies used for?

The first cryptocurrency, Bitcoin, was used as a virtual currency: it gave people the possibility to exchange value among themselves in a free, borderless, and cheap way. This is the first application of the blockchain, but not the only one: the possibility to manage an anonymous and decentralized database is useful for many purposes.
Another possible application for the blockchain to facilitate transfers of traditional currencies or other values, in a decentralized way – i.e., payment systems where I can use not only cryptocurrencies but also, for example, dollars or euros. The perfect example of this is Stellar.
A third application is the creation of “smart contracts”, i.e., computerized transaction protocols that execute terms of a contract . Smart contracts allow you to create applications of all kinds (notarial deeds, decentralized markets, and lot more than this). Today the most used crypto for smart contracts is Ethereum. (See here for more data)
In addition to these three categories, there are countless other applications, too many to list in this article.

How can I use cryptocurrencies?

To use a cryptocurrency, you first need to create an “online wallet” that can store, send, and receive cryptocurrencies. To do this, you need to download it and install the appropriate program or contact the dedicated service that allows you to create it.
Each wallet is associated with a sort of “password” (the private key). With this password, it’s possible to authenticate and authorize cryptocurrency movements to other wallets. To obtain cryptocurrency, you can validate transactions or purchase them (check the end of the article).

How are transactions validated?

Transactions executed using the blockchain are publicly validated by a series of independent individuals. The users who validate the transaction also guarantee that the database (the blockchain) is not manipulated.
Transactions are validated by recording them in “blocks” that are interconnected with each other, thus creating the blockchain.
There are several validation methods, the main two are “Proof-Of-Work” (POW) and “Proof-Of Stake” (POS).
In the Proof Of Work process, validators (called miners) are users who exploit their computing ability to solve a cryptographic problem. The solution to this problem allows finding the “block” in which to store transactions awaiting to be validated. Solving a block is easier with a higher computational power: the higher the computational power of a miner, the more he contributes to the mining process.
Miners are rewarded for this work in cryptocurrencies. The first coin that adopted this method was Bitcoin, where miners are paid in Bitcoin. Another important coin based on mining is Litecoin.
In Proof Of Stake process, validators are users who hold a certain amount (“stake”) of the cryptocurrency and contribute to the validation in proportion to how many cryptocurrencies they have. They are usually paid with a percentage of their stake.

In some cases these people can delegate their validation to others, “voting” them according to the size of their stake: this is the so-called Delegated Proof Of Stake (DPOS).
See here for a deeper understanding of POW and POS

Cyptocurrencies and inflation

Cryptocurrencies are usually emitted as a reward for those who validate a cryptocurrency’s blockchain.
This passage is crucial for coins based on Proof of Work (POW), such as Bitcoin. In fact, a very interesting property of Bitcoin is that it exists in limited quantities. New Bitcoins are issued as a reward for miners, but this “reward” is halved every 4 years (the so-called “halving”). There will never be more than 21 million Bitcoins: Bitcoin and many other POW based coins exist in limited quantity. So, if their use will increase, the price will rise too.
Coins based on Proof-of-Stake (POS), on the other hand, have a constant inflation rate in percentage terms. This inflation consists of the rewards received by those who hold the stakes.
In general, inflation in cryptocurrencies is set in the code itself and is extremely difficult to change, giving greater security than traditional coins, which can lose value if inflation increases. This has made them an interesting investment in recent years.

Is the blockchain anonymous?

The blockchain is a public register: transactions are publicly recorded among users. Each user has a “wallet” which is usually identified externally as an “address”, i.e., a sequence of numbers and letters. Anonymity is given by the fact that nobody knows to whom these numbers and letters correspond.
In recent years, anyway, various techniques have been used to identify the owners of addresses, making bitcoins and other cryptocurrencies less anonymous. When we talk about “bitcoin and dark web”, we are talking about the past. Many of the major cryptocurrencies are no longer the best choice for anonymity, even if they’re less “transparent” than traditional payment methods (except cash).
However, some crypto were created to specifically protect the anonymity and privacy of users. These are the so-called “privacy coin” or “anonymous coin”: the oldest one is Dash.

How can I get cryptocurrencies?

You can obtain Cryptocurrencies in two ways: by downloading a program and validating transactions, or by purchasing them. To buy them, the easiest choices are platforms similar to traditional financial markets: the Exchanges. There are thousands of cryptocurrencies and hundreds of exchanges.
To buy cryptocurrencies, you have to pass through an Exchange that allows you to deposit dollars or other traditional currencies, convert your funds into Bitcoin or other cryptocurrencies, and then transfer them to other Exchanges. The most important exchanges to deposit dollars, euros, or similar are:

COINBASE via Visa or Mastercard, SEPA Bank Transfer or International Bank Transfer;
BINANCE JERSEY via SEPA Bank Transfer or International Bank Transfer;
BITSTAMP via Visa or Mastercard, SEPA Bank Transfer or International Bank Transfer;
KRAKEN via SEPA Bank Transfer or International Bank Transfer;

More Stories
How to trade cryptocurrencies? How they work? If you're a beginner, read this guide!
Cryptocurrencies for Beginners