Cryptocurrencies have only existed since 2009, when Bitcoin was first released. Satoshi Nakamoto, the creator of Bitcoin, intended to invent a decentralized digital cash system that could operate without any central entity (such as a government) supporting it. Many groups had attempted to create a digital cash system that relied on a centralized system before, but Nakamoto discovered that their reliance on a central entity was tied directly to their failure.
Let’s start with the basics — in order for a digital cash system to work, there must be a network that continually tracks all accounts/balances and facilitates any transactions. In order to work effectively, this network must be able to prevent any account from spending the same amount of money twice (double spending).
Before the advent of the Bitcoin, all digital cash systems would try to hold all of their balance data on a central server that verified transactions. With cryptocurrencies, this job is relegated to every entity using the network — any individual who holds that currency. This means that each member of the network must have a record of every balance and transaction occurring throughout the network in order to validate future transactions. This information must be consistent throughout every entity within the network, or else the entire system could become tainted with forged transactions/inconsistent.
For this reason, centralized networks — wherein a central authority would declare the correct balance of each account — were believed to be the only way to establish a functional digital cash system. But using blockchain technology, cryptocurrency networks are now able to provide each peer on the network with an accurate history of every transaction to ever occur within the system. Therefore, each peer can correctly identify the true balance of every account.
When spending, purchasing, or trading cryptocurrencies, a file representing that transaction is sent across the peer network to every other user for confirmation. This is how it works:
The blockchain is the term used to describe these blocks of data after they have been compiled. Because the data cannot be changed once entering the blockchain, it is impossible to falsify records within a blockchain network.
Because cryptocurrency networks are designed to operate without any centralized authority, a secure system is needed to prevent any entity from abusing the power to confirm transactions. Satoshi decided that the best way to achieve balance would be by forcing miners to use a computer to solve an extremely complex cryptologic puzzle before they could confirm transactions. This makes miners arguably the most important component of a cryptocurrency network, as they are the ones responsible for confirming each transaction.
While the exact details of the puzzle Satoshi used are not important, you should know that the solution to this puzzle is a hash that connects newly created blocks to the block that precedes it in the system. Basically, once the computer solves the puzzle, a block is built, confirmed, and added to the blockchain. In exchange for confirming transactions within the network, the miner who solves the puzzle is granted a specific amount of cryptocurrency as a reward. This is the only way to create valid Bitcoins, and a wide majority of all cryptocurrencies operate using similar systems.
The full scope of how blockchain technology and cryptocurrencies will affect the global marketplace are yet to be seen. Still, the economy is slowly shifting towards coins, like Bitcoin, being an acceptable form of payment for a wide range of purchases. Now that you know the basic components of how cryptocurrency works, you can decide whether you want to enter into this constantly evolving market.
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