What is Cryptocurrency, and How does it Work?

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What are cryptocurrencies, and how do they work? A complete guide on the role of digital currencies, increasingly popular and appreciated all over the world.

Two legitimate questions, especially in light of the recent performances of Bitcoin, Ethereum, and Litecoin, just to name a few.

In the midst of the virtual boom, understanding what cryptocurrencies are and how they work is something of fundamental importance, especially because, critics aside, they could really represent the future.

A cryptocurrency represents in all respects virtual money, which therefore we cannot touch with our hands, but which bases its operation on the principles of cryptography. We are talking about open-source digital tools that go beyond the concept of traditional money owned by governments and allow operations to be carried out safely and anonymously.

The information underlying cryptocurrency transactions are stored and transmitted, but only the recipients of the same can read it. To understand what cryptocurrencies are but above all how they work, we need to imagine them as tools rich in data to be decoded.

The aforementioned cryptography is used to verify transactions and control the entry of currency into the system through mining. The process makes the system itself more robust but, above all, safer.

What are cryptocurrencies

Cryptocurrency is defined as a virtual currency, in the sense that it does not exist in physical form, but is exchanged exclusively electronically, whose transactions are carried out directly between two subjects in peer-to-peer mode, or directly between two devices, without the need of intermediaries (i.e., banks) to purchase goods and services.

As already mentioned, cryptocurrencies are virtual means of payment that correspond in all respects to digital money, designed to carry out any type of transaction.

Traditional centralized systems involve intermediaries who, very often, influence the value of the currency. The financial institutions, in fact, have the power to determine inflation-producing real currency.

Virtual currencies were designed to avoid all this, and, as such, they are highly decentralized and free from the control of the same governments and financial institutions – which is why many still struggle to accept them.

Cryptocurrencies are, therefore, virtual, decentralized, and cryptocurrencies, which are transferred between peers, that is, through peer-to-peer (p2p) technology – a technology in which the nodes are not hierarchical but equivalent.

How does cryptocurrency work?

Now that we understand what cryptocurrencies are, it will be quite helpful to understand how they work and what principles they are based on. Currencies, or at least most of them, have by definition a digital origin and derive from an operation called mining, a term that comes from gold mining, i.e., the activity of gold mining.

In this process, computers tend to solve complex mathematical problems, which in turn generate digital coins. Users can also choose to buy cryptocurrencies from brokers and then enter or spend them through digital wallets.

Compared to traditional coins, cryptocurrencies have a virtual value for those who own them and are registered in the blockchain, the technology that supports cryptocurrencies. If a user wants to transfer cryptocurrencies to another user, they can make a transaction on the recipient user’s wallet. The transaction ends after verification and registration in the blockchain through a process known as ‘mining.’ In this way, cryptocurrency tokens are also created.

Cryptocurrencies, or at least most of them, are designed to introduce new currency units into the system but with quantitative limits imposed to avoid inflation and to increase their value. In the case of Bitcoin, for example, mining will stop when 21 million units are reached.

The mining activity is free, which means that anyone can produce cryptocurrencies, always within limits mentioned above. In other words, and through certain algorithms, it is necessary to make the payment and avoid duplication of money. We refer to the problem of double-spending; double-spending, whereby the currency pays for the service but remains in the wallet, doubling itself.

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Are cryptocurrencies “real” money?

Believe it or not, the answer to this question can be either ‘yes’ or ‘no.’ Money, or “currency,” to use the right term, is defined as an accepted “medium of exchange.” The national currency of the country you live in is defined as legal by law (suppliers of goods and services, with very few exceptions, are obliged to accept payments in that currency). If you are employed, you expect to be paid in that currency by your employer. If you have a debt or are presented with an account, you can always repay it in your national currency: it is a real “medium of exchange.” With cryptocurrencies, the situation is very different, as most goods and services cannot be purchased with digital currency. This may change in the future, but that’s the way it is for now.

In other words, if you have a digital currency such as Bitcoin, you can exchange it for dollar money whenever the market is open and accessible, but you cannot go out and spend it in most shops, at the market, or supermarket in your neighborhood (although some online stores accept the major cryptocurrencies as a payment method, with Bitcoin). in that sense, owning digital currency is like owning stocks or commodities like gold.