How do cryptocurrencies work?
Cryptocurrencies are digital or virtual currencies that operate independently from the traditional financial systems we use in our daily lives. Also referred to as being decentralised, cryptocurrencies are not run by a central authority such as a bank or financial institution.
Instead, these digital currencies are traded on peer-to-peer networks that are secured by cryptographic systems, with each transaction recorded on a public ledger using blockchain technology.
While the data of these transactions can be viewed by anyone, the sender and receiver of the cryptocurrency are not. In this way, transactions can be verified independently preventing fraud or double spending and ensuring anonymity for the people transacting on the network.
How are cryptocurrencies created?
To understand how cryptocurrencies are created, you must first understand the technology that underpins it – blockchains. As the name suggests, blockchains contain a number of blocks that forms a digital ledger with a record of every transaction that has taken place similar to what is used by traditional banks.
Each block contains transactions that have been verified by participants who are connected to the blockchain network. Each new block that is added to the chain has to be verified in the exact same way to ensure against any kind of forgery.
While the process of verifying new blocks is common among different blockchains, the incentives and methods through which they are verified differ by what is known as consensus protocols. These are essentially the way in which each participant connected to the network via their own computer equipment collectively agrees upon whether each set of transactions is valid and how it is then added to the chain via a process called “mining”. Popular consensus protocols include Proof of Work and Proof of Stake.
While there are thousands of cryptocurrencies around today, the most popular and valuable cryptocurrency is Bitcoin, introduced in 2008 by a whitepaper authored by an anonymous person or collective known as Satoshi Nakamoto.