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What is cryptocurrency

Author: Milan Cutkovic
22 jan 2024
Cryptocurrency is a word that has entered our everyday life over the past few years and has become an integral part of the modern digital era. It is a new form of money that is completely digital and has no physical expression in the form of coins or banknotes. Since its inception, cryptocurrencies have generated a wide range of reactions – from distrust and skepticism to full acceptance and integration into the financial systems of many countries.

The very concept of cryptocurrency grew out of the need to create a secure, anonymous way to conduct transactions over the Internet. In the era of universal digitalization of data, a new approach to the handling of value transfer media is required, which has led to the emergence of technologies such as blockchain and the use of cryptography to protect transactions.
Blockchain is a decentralized distributed ledger technology that allows transactions to be recorded in multiple copies of a database that is simultaneously stored on different computers. Data blocks (blocks) containing information about transactions are interconnected and protected by cryptographic methods.
The main difference between cryptocurrencies and traditional monetary systems is their decentralization. This means that the system is managed collectively by its users without a single control body or intermediary - for example, a bank or government. This radical change allows people to send values to each other directly without third parties involved.

The key role is played by the use of complex mathematical algorithms and computer power to ensure data security: since each operation is verified by network participants through a process called " mining”, this makes double spending or fraud almost impossible.

Since the beginning of its existence, the number of different cryptocurrencies has increased exponentially; at the moment there are hundreds of active options to choose from-from the well-known Bitcoin to less well-known alternatives such as Litecoin or Ripple.

The importance of this asset class continues to grow as more and more people recognize the potential benefits of using decentralized digital currencies: open accounting records (blockchain), increased transparency of operations, and the ability to make quick transfers around the world without having to pay extra for intermediary fees.

So, to understand the significance and potential impact of cryptocurrencies on the future of finance is to realize the profound changes that are happening right in front of us. This is exactly the meaning of this introduction: we will try to understand what these mysterious “crypts” are and what kind of future they are building in front of us.
One of the key aspects that distinguish cryptocurrency from traditional financial systems is the use of cryptography to ensure the security of transactions and control the creation of new units of currency. Cryptography is the science of protecting information using encoding, which allows only the sender and recipient to unravel the content of a message.

Every transaction on the cryptocurrency network is encrypted using sophisticated algorithms. The key element of this process is the so-called cryptographic keys. There are two types of keys: public and private. The public key can be compared to a bank account number – it is visible to all users on the blockchain and is used to send money to your wallet. The private key is similar to the PIN code of a bank card – it is known only to the wallet owner and is used to sign transactions, confirming the right to dispose of the invested funds.

This system provides a level of security that makes it almost impossible to fake or modify a transaction that has already been made without access to the corresponding private keys. What happens when a transaction is executed? User A wants to transfer money to user B. It creates a message (transaction) that contains the public addresses of the sender and recipient, as well as the amount of cryptocurrency transferred. This message is then encrypted using User A's private key.

After that, the encrypted information is distributed to all participants of the blockchain for verification (this is done through the mining process or other consensus algorithms). Miners or nodes verify the authenticity of a transaction by checking it against a list of all previously performed operations (the history of the blockchain). If the majority is convinced of the legitimacy of the operation, it is added to the new data block.

This technique not only prevents double spending of digital coins, but also preserves the anonymity of users to a certain extent; although all transactions are recorded in an open register (blockchain), the identity of users is not disclosed - only their wallet addresses are known.

However, you should keep in mind the potential risks: if the private key is lost or stolen, then access to the corresponding assets may be lost forever; if an attacker gets it, they may perform unauthorized operations on your behalf.

The use of cryptography makes the system very secure in nature; at the same time, it requires users to take a high level of responsibility for the security of their cryptographic keys.

The use of cryptography to ensure the security of transactions.

Cryptocurrency is not only a new form of digital money, but is also based on the principles of decentralization. To understand its uniqueness, it is important to consider this aspect in more detail.

Traditional financial systems are built on centralized models, where a single organization or institution, such as a bank or government, controls the currency. These central authorities are responsible for issuing money, regulating supply, and ensuring the stability and security of the payment system. This model has its advantages: it facilitates the regulation and monitoring of financial transactions; however, it also creates a point of failure – if a centralized resource is attacked or a technical failure, the entire system can be undermined.

In contrast, cryptocurrencies use a decentralized approach. This means that no single organization or individual controls the entire network. Instead, cryptocurrency systems rely on a distributed database known as a blockchain – a chain of data blocks that is stored on multiple computers around the world. Each block contains a record of a certain number of transactions, and when a new block is added, all devices on the network must check and approve it.

This process makes cryptosystems extremely resistant to manipulation; to change an entry in an already existing block, you need to gain control over most of all computer power in the network – a task that is close to impossible in its complexity.

This structure also contributes to the creation of more inclusive financial systems: anyone from all over the world can join the network without the permission of the central authority. Users interact directly with each other through P2P (peer-to-peer) data transfer without the need to involve third parties

The decentralized nature of cryptocurrencies.

P2P (peer-to-peer) — is a term describing a distributed network architecture in which each participant (peer) of the network is both a client and a server, communicating directly with each other. Such networks do not have a centralized server that controls the entire process; instead, data is transferred directly between users. This allows you to efficiently allocate resources and data, improving scalability and resilience to failures. P2P technologies are widely used in file sharing, communication, and financial applications.

How Cryptocurrencies Work

Cryptocurrencies work on the basis of blockchain technology, which is a distributed database that functions as a public register of all transactions. In this registry, entries are arranged in blocks, and each new block contains information about the previous ones, creating a chain. This structure is called a blockchain, because it is actually a chain of data blocks.

Thanks to the use of cryptographic algorithms and decentralization-placing copies of the database on multiple computers (nodes) around the world-a high level of security and reliability of the system is ensured. If you try to change information in one block, you will need to change data in all subsequent blocks and on all copies of the database, which is almost impossible without the coordination of most nodes.

The entire system works as follows: to perform a transaction, the user sends a request to the network. The transaction is verified using network algorithms; after verifying its validity (for example, that the sender has enough coins to transfer), this information is added to a new” block " of transactions. This process is called " mining”, in which miners use high computing power to solve complex mathematical problems and confirm transactions.

When the problem is solved, the result is passed to other nodes for verification. If the majority of nodes confirm that the results are correct, the block is added to the chain. For their work, the miner receives a reward – a certain number of new cryptocurrencies (this is also one of the ways to issue new units).

It is important to note that each cryptotransactions has two keys: a public key (wallet address) and a private key (equivalent to an electronic signature). The public key is available to all users of the network to perform operations; the private key should remain only with the user – it serves as a guarantee of secure access to their assets.

The technical basis of cryptosystems makes the process transparent: anyone can track all transactions with certain wallets throughы the blockchain explorer - special services for viewing information about the status of the addressee's or sender's account. This does not mean a lack of privacy – the identity behind the wallet addresses is not disclosed until the user himself wants it.

The principle of operation of cryptocurrencies changes the idea of money and financing radically: there is no need to trust third parties or the banking system; all operations are performed directly between users; and the speed of transactions around the world significantly increases without significant transfer fees.

How transactions are recorded and verified

The blockchain underlying most cryptocurrencies is a distributed and reliable database that stores all transactions carried out. A transaction is a transfer of value between wallets or accounts. In the context of cryptocurrency, every transaction must be properly recorded and verified by the network.

When a user sends a certain amount of cryptocurrency to another address, they create a digital signature using their private key. This signature is a mathematical proof that the operation was initiated by the owner of the wallet. After that, the transaction is transferred to the network and gets into the memory pool, a special storage for all unconfirmed transactions.

Then the verification process begins: miners (network participants with high computing power) take a group of such unconfirmed transactions from the mempool to form a new block. They start solving the cryptographic task of finding the so-called block hash that meets the current protocol requirements (proof-of-work).

Each new block contains information about previous blocks via a unique hash of the previous block in the chain, which creates a consistent link between all blocks (hence the name "blockchain”). This ensures that the recorded data remains unchanged: if an attacker tries to change the information in one of the blocks, he will have to recalculate all subsequent hashes, which is almost impossible due to the huge amount of work.

After creating a new block, it must be approved by other network participants. If the majority of confirming devices (”nodes") reach a consensus on the correctness of all transactions contained in this block and the process of its formation, then it is added to the general chain on all computers of the system.

Only after adding a new block to the chain can we talk about the completion of the verification process: all previously contained” hanging “or” incomplete " operations will receive the status of confirmed. Recipients of these transfers have the ability to dispose of the received assets after 1 confirmation from the network for most transactions; however, for large or particularly significant transfers, more confirmations may be required.
Creating new units of cryptocurrency, a process known as "mining” or” mining," is a key element of most cryptocurrency systems, especially in the likes of Bitcoin. Mining is a decentralized way to maintain and develop the blockchain, as well as a way to distribute new coins among network participants.

Cryptocurrency is usually mined using the computing power of computers. Miners solve complex mathematical problems that require significant computational resources. These tasks are related to verifying transactions and adding them to the blockchain block. Each time a miner successfully joins a block to the blockchain, they are rewarded with a certain number of cryptocurrency units.

The mining process not only creates new coins, but also encourages strengthening the security of the entire network. The more computational work spent on maintaining the system (i.e., the higher the "hashrate” - the total computing power of all mining devices), the more difficult it is to become a victim of attacks or fall under the control of one person or group of people.

Traditionally, central processing units (CPUs) of a computer have been used for mining, but over time, graphics processing units (GPUs) have been shown to be more efficient in performing this task due to their better ability to process data in parallel. In recent years, specialized mining hardware has emerged - ASIC (Application-Specific Integrated Circuit), which is an integrated circuit designed specifically for the running hashing algorithm.

Механизм вознаграждения за The mining reward mechanism is often referred to as a Proof-of-Work (PoW) system or "Proof of Work". Along with PoW, there are other consensus algorithms used in various crypto platforms, such as Proof-of-Stake (PoS), Delegated Proof-of-Stake (DPoS), and Proof-of-Authority (PoA), each with its own unique method for verifying transactions and issuing new units.

It is important to note that each cryptocurrency has a limit on the number of units available for mining: for example, Bitcoin provides for issuing only 21 million bitcoins. This means that over time, the reward for adding a new block will decrease until it reaches zero; this phenomenon is known as халвинг (“halving.

Creating new units of cryptocurrencies through Mining

Halving — from the English "halving" — halving) — is an event in the world of cryptocurrencies, in which the reward for mining a new block is halved. This is a mechanism built into some cryptocurrencies, such as bitcoin. Halving occurs after a certain number of blocks or a period of time and is part of the cryptocurrency's monetary policy aimed at controlling inflation. This event affects the economy of cryptocurrencies, as it reduces the number of new coins entering circulation, which can affect the price.
Bitcoin, Ethereum, Litecoin, and Ripple are four of the most popular cryptocurrencies to date. Each of them has unique characteristics and offers that distinguish it in the market.

Bitcoin (BTC) is the first cryptocurrency created in 2009 by an unknown person or group of people under the pseudonym Satoshi Nakamoto. Bitcoin is built on the blockchain – a distributed database that is supported by a network of miners. These miners use high processing power to process transactions and secure the network. The main goal of Bitcoin was to create a peer-to-peer (P2P) electronic money system that does not require trust in a third party.

Ethereum (ETH) is a platform for creating decentralized online services based on the blockchain through the use of smart contracts. Smart contracts are software algorithms for automating contracts and transactions. Ethereum was launched in 2015 by Vitalik Buterin and a team of developers. The main difference between Ethereum and Bitcoin is its functionality: in addition to transactions in ETH, the platform can be used to launch applications and create new cryptoassets.

Litecoin (LTC) is one of the first altcoins (“alternative coin” in relation to Bitcoin), founded by Charlie Lee in 2011 as “silver” in relation to the “gold” of Bitcoin. Litecoin appears to be a lighter version of Bitcoin with a block generation rate of approximately every 2.5 minutes (four times faster than that of BTC), which contributes to faster transaction processing.

Ripple (XRP) is both a payment system and a cryptocurrency created by Ripple Labs Inc., aimed at providing instant transfer of large amounts of money with minimal fees. An important feature of Ripple is that it uses a unique consensus algorithm that does not require mining; as a result, operations are performed much faster and more efficiently compared to standard blockchains.

These four cryptocurrencies were of great importance for the development of the entire digital asset market; they paved the way for a new type of economic relations without being tied to individuals or legal entities as a determining factor, even when conducting large-scale financing or investment projects.

Popular Cryptocurrencies

Cryptocurrencies have evolved in recent years into a significant financial instrument that can be used for both everyday transactions and long-term investments. The scope of cryptocurrencies is constantly expanding due to their main characteristics: a high degree of security, anonymity, ease of transfer of assets and lack of binding to centralized financial institutions.

Transactions using cryptocurrencies have become popular because of their efficiency – they can be performed faster and cheaper than traditional bank transfers, especially in the case of international transfers. Fees for sending cryptocurrencies are usually lower than in banks or when using payment systems such as PayPal. In addition, users have full control over their transaction without having to disclose personal information to third parties.

The use of cryptocurrencies in investments is also growing due to the possibility of obtaining high returns. Although this involves a lot of risk due to the high volatility of crypto asset prices, many investors see this as a chance to make significant profits. The growing interest is also explained by the emergence of various financial products based on cryptocurrencies, such as ETFs (exchange-traded investment funds), which make investing available to a wide range of market participants.

However, buying and using cryptocurrencies is not without its difficulties. An important part is choosing a reliable and secure wallet for storing assets – this can be a software wallet on a computer or mobile device, a hardware wallet, or even a paper wallet. Users should also be prepared to face the possibility of losing all their assets due to hacker attacks or user errors (for example, forgetting the wallet password).

Use of cryptocurrencies in transactions and investments.

Cryptocurrencies have certainly become a significant part of the modern financial world. They offer new opportunities for transactions, investments, and even the creation of a digital identity system. However, along with opportunities come challenges such as regulatory uncertainty, price volatility, and security issues.

In terms of cryptocurrency regulation, most countries are just beginning to develop a legal framework. Although some states have already taken strict measures to control the circulation of cryptocurrencies or even completely banned their use, other countries remain open to innovation and allow the crypto industry to develop with minimal interference.

Volatility is another key aspect to consider when dealing with cryptocurrencies. Significant price fluctuations can lead both to the rapid enrichment of investors and to the loss of all capital in a short time. This makes investing in cryptocurrencies a high-risk business and requires deep knowledge of the market.

Transaction security remains one of the most pressing issues in the cryptocurrency market. Although blockchain technology is inherently secure, user wallets and exchanges are subject to hacker attacks.

Despite all these difficulties, there is still a promising future for cryptocurrencies. Technology continues to evolve: there are more and more DeFi (decentralized finance) projects offering alternative financing without intermediaries; NFT (non-fungible tokens) is changing the approach to digital asset rights; blockchains are becoming more scalable and eco-friendlier.

Prospects for cryptocurrencies

NFTs (non-fungible tokens), or non , - fungible tokens, are unique digital assets that use blockchain technology to verify authenticity and ownership. Unlike regular, fungible tokens (like Bitcoin), each NFT is unique and cannot be replaced with another identical token. NFTs are often used for digital works of art, collectibles, media content, and other unique digital objects, providing a way to verify their authorship and ownership.
At the moment, we can confidently say that we are only at the beginning of the path to realizing the full potential that blockchains and related technologies carry. Mining is no longer the only form of generating new units; concepts such as Proof of Stake, which requires significantly less electricity than Proof of Work, are beginning to gain popularity.

In conclusion, it can be noted that although no one can predict the future exactly one thing-interest in this area will only grow both from innovative companies and from states that want to have control over this new form of assets or the desire to be part of this new step in the evolution of finance.