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How Does A Cryptocurrency Work? [Simplest Guide For Beginners]

How Does A Cryptocurrency Work [Simplest Guide for Beginners]

Cryptocurrency is a virtual, numerical, and electronic form of currency that is created, transacted, and verified by cryptography (thus called Cryptocurrency). The value of any Cryptocurrency is simply related to the utilization and paucity of that particular cryptocurrency.

Alright! I’ll make it simpler for you. Consider Cryptocurrency is software. All the units (coins or tokens) of that Cryptocurrency are the programmed codes upon which that software works.

Now the value of that software (Cryptocurrency) will be determined by the number of people having access to that software, the number of people selling and buying that access, and the limit of how many people can access that software. There are some other aspects that determine the value of Cryptocurrencies, but this is the majority part.

I hope you got the basic concept. In short, Cryptocurrency is the numbers encrypted and decrypted by cryptography for transactions and other procedures involving Cryptocurrency. The code numbers of most Cryptocurrencies are public.

You might be wondering all the cryptocurrencies are numbers, then why don’t people make copies of that and create as many copies as they want. Well, it’s not quite possible, here’s why:

Each cryptocurrency has a unique code, and that code is not the only thing that is involved in the verification of an actual unit of cryptocurrency being transacted. There are many other systematic orders of authentication the transaction has to go through to be verified.

But let’s say you can make as many copies as you want by just replicating that code. You still can’t do it, because for each transaction the code is randomly shuffled, and the possibility of you guessing that code for your transaction is 1 in a billion.

Not to mention the hurdles in a single guess of that code. To guess these highly complex different combinations of numbers, you need supercomputers for computation.  These supercomputers are not only expensive but they also require extensive power to operate and heavy-duty cooling systems for the disposal of heat from that machinery. So basically nobody has ever tried it yet, and probably no rationally thinking human ever will!

Some Terminologies Associated To Cryptocurrency

Here are some very simple definitions of terms you might come across wherever cryptocurrency is mentioned.

1. Bitcoin

Bitcoin is the first-ever cryptocurrency created in 2009. The technology of Bitcoin and the currency itself was created by a person named Satoshi Nakamoto who is completely unknown and unidentified to the world. Bitcoin is currently the most expensive and valued Cryptocurrency.

2. Blockchain

It is a decentralised, continuously relocating technology which has all the information about the origin and the new location of Cryptocurrency. The Blockchain uses computers of each individual to process means there is no way a single person has control to regulate things. The Blockchain is simply a network with no permanent or centralised server. The transactions on the Blockchain provide complete anonymity which is why no real identity of sender and receiver is required.

3.  Mining

Cryptocurrency mining is the verification of any transaction on the Blockchain by using the computing power of devices of miners. As a reward or fee, miners are provided with a quantity of that virtual currency. It is very important for the working of Blockchain. According to the latest stats, the amount (in USD) raised by the mining of cryptocurrency worldwide in a single day (14 Feb 2021) was about 51 million. (Source: Statista)

4. Crypto Exchange

Just like stock exchange, crypto exchange is a platform that allows the users to trade Cryptocurrency for other forms of assets, paper currencies, or another Cryptocurrency.

There are numerous platforms that provide such services, but you should always use the verified ones otherwise you might end up in the trap of scammers.

5.  Market Capitalisation

Market capitalization can be defined as the net worth of a cryptocurrency. In other words, the total numbers of certain crypto in circulation based on the price per unit (coins or tokens).

In other words, you can say that the market cap. shows the amount of money you need to purchase every single unit of that cryptocurrency.

Functional Process/Working Of Cryptocurrency

1. How Does A Cryptocurrency Launch?

The launching of Cryptocurrency requires a lot of digital legwork and programming. You have to gain the faith of everybody on the Blockchain that the currency you are launching is real. This is the most basic way to get the idea in your mind, otherwise, it is much more technical than just coding.

2. How Does A Cryptocurrency Get Value?

Now the value of Cryptocurrency in general terms depends on the dynamics of supply and demand and the involvement of that currency in transactions. The macro perimeters like issuance rate, mining, and the amount of attention, etc altogether provide value to a certain digital currency.

It’s almost like Fiat currency, in which a particular currency has a value just for the reason that people believe it has that value because of the foundation behind that currency. The foundation can be an organisation, a corporation, or a government. Similarly, People on the Blockchain who are interested in Cryptocurrency believe that it has that value because people are willing to pay that value in exchange for that cryptocurrency. And because of this highly volatile and delicate value system, the value of Cryptocurrency is extremely speculative.

3. ICO And Its Role In Raising A Cryptocurrency

ICO stands for initial coin offering. The fundamental concept of ICO is to convince investors or funds to invest in your cryptocurrency, promising that it will provide high returns.

It is like raising money for a start-up or buying shares of a company.

Convincing the investors to put in their money in a speculative asset can be quite difficult. A proper theoretical explanation and white papers need to be prepared to present the future performance and goals of your digital currency or the organisation related to it. Explanation of how the investment will be spent and how it will provide returns. If your strategy and business structure are impressive to the investors, you will get money for your Cryptocurrency.

ICO investments are used for many purposes. Buying coins, improving the technology and security of your coins and if the cryptocurrency is related to an organization, such as a social media platform or a tech company, then the money may also be used for the betterment of marketing of that organization.

4. How A Transaction Takes Place And What Is The Role Of Miners?

Transactions of cryptocurrency take place on Blockchain. Here is an explanation for you to understand the transaction and the part of miners in crypto transactions

Consider a person A sends a person B 100 coins of a Cryptocurrency. Now this information will be converted into a code incomprehensible to humans and will be broadcasted on the stream. When the miner gets this information, he provides an authentication code in combination with the code which was broadcasted. If he is willing, and when a satisfactory number of miners do their authentication of the same transaction, therefore the transaction is verified.

Miners are responsible for the verification of transactions of Cryptocurrencies. And as a reward they are provided with the currency they verify the transaction of. Keep in mind that in normal procedures, no fees for miners are deducted and the reward given is a new unit of that virtual currency.

This is how a cryptographic currency gains its volume. As soon as the currency gains attention and more and more miners are interested in that particular crypto, the competition results in the halving of miner’s rewards. This reward may also reduce periodically. This halving method is also responsible for the coordination between the supply and demand of a Cryptocurrency.

Also remember that as more miners enter the Blockchain, the computing power required for mining also increases, which will result in more expensive hardware and more energy consumptions, so the miner has to keep a balance between the expenditures on the mining machinery and the return he gets through mining.

And that is how Cryptocurrency works. Many people don’t have faith in cryptocurrency. They don’t see it as a productive asset.

Warren Buffett, business tycoon and one of the most successful investors while a conversation with CNBC’s anchorperson says

“It’s not a currency…. Imaging people selling their homes to buy some tulips……… there’s no quantitative limits, if you buy a stock you say, I will buy 15 times earnings but I won’t buy 20 times earnings, but when you buy something that doesn’t produce anything, there’s no checkpoint, there’s nothing to refer to ..”

Whereas some people do believe that it has a very prominent future of successful penetrations as a legal tender.

Elon Musk, CEO of Tesla and SpaceX and a successful industrialist says

“So where I see crypto as respectively is as a replacement of cash”

On the other hand, many people have made lucrative amounts from it irrespective of its form or legal value. So in the end it’s all that you believe.

Elon Musk tweets about the worth and the future of Cryptocurrency. “That said, BTC & ETH do seem high lol,” he said.

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What do you think?

Written by Huzayfah Habib

Huzayfah Habib is a blog writer, newsletter, and article writer. He is also a Book Editor. He is a medical student. He likes to travel, read books, watching movies and he is much obsessed with time-traveling

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