There’s Bitcoin, there’s Litecoin, there’s Ethereum and there’s alternative coins. So just what is cryptocurrecy and how does it work? Essentially, it’s digital money that’s bought and sold online. There are no bills or coins, it’s not based on another asset like gold and it doesn’t go through traditional financial institutions like banks.
Instead, these currencies operate in a completely decentralized systems using so called blockchain technology to track transactions, to see how this works, let’s look at how you buy something with cryptocurrency.
Say that Alice want’s to buy a bike from Dan using Bitcoin, her cryptocurrency of choice.
Alice begins by logging into her Bitcoin wallet with a private key, a unique combination of letters and numbers. With a traditional financial transaction, the exchange gets sent to banks on each side, who record the money subtracted from one account and added to another, but remember, in this scenario, there are no banks or middle men.
Instead, Alice’s transaction is shared with everyone in the Bitcoin network. These network computers add Alice’s transaction to a shared list of recent transactions, known as a block. Every 10 minutes, the newest block of transactions is added on, or chained to all of the previous blocks.
How Does Cryptocurrency Work?
That’s how you get a blockchain. To ensure each block of transactions on the chain is verified, a subset of Bitcoins network joins a race to solve a very difficult math puzzle. And, if they solve it first, their record of the block of transactions becomes the official record. They’re rewarded with Bitcoins of their own and the network gets a new block on the chain. This entire process is known as mining, but instead of chipping away at rocks, you’re solving complex puzzles.
The fact that many computers are competing to verify a block ensures no single computer can monopolize the Bitcoin market. To ensure the competition stays fair and evenly timed, the puzzle becomes harder when more computers join in. The Bitcoin protocol says mining will continue until there are 21,000,000 Bitcoins in existence. That’s set to happen around 2140.