Unless you have been living under a rock, you will have at least heard of the term cryptocurrency. You may have no clue what it is, and indeed many people who buy and use it don’t really understand it either! A cryptocurrency is a medium of exchange, typically viewed as a digital currency.
Cryptocurrency has no physical form and has no centralized control. This means that it is not controlled and distributed in the same way that a fiat currency is by a central bank. Examples of cryptocurrencies include Bitcoin, Ethereum, Litecoin, Dogecoin and Monero, but there are hundreds more.
But how do cryptocurrencies work? This is a complex subject. In the article below, we will look at the main technology behind cryptocurrencies – blockchain technology. This is what most cryptocurrencies are built on, and a major reason that they have such great potential.
Blockchain technology explained
Blockchain is the backbone of most cryptocurrencies. It is the underlying technology that makes them tick. Without blockchain, people would not be able to buy, sell or use most cryptocurrencies. Indeed, they wouldn’t exist and websites like https://cryptology.pl/ wouldn’t have a purpose.
The technology behind cryptocurrencies in its simplest form is a public distributed ledger. A distributed ledger is used for record keeping. It is distributed because there is no single central system or computer where the records are updated. Instead, distributed blockchain ledgers use multiple computers called nodes.
Nodes are responsible for storing, approving and verifying data in the blockchain ledger. Any information that is added to the ledger is done so in a block or group of data. This is done in a continual string, which is why the ledger is called a blockchain.
Still confused? Let’s look at a simple example. A person wants to buy some Bitcoin from an exchange. When they make their request, it is added to the blockchain by a node. The exchange then responds to the request and accepts the funds. This information is added to the blockchain. The exchange then sends the Bitcoin in return and this process is also added to the blockchain. It’s a continual process that adds publicly viewable information that provides proof of purchase and non-repudiation of data.
At the core, you have individual nodes that are approving and verifying information and transactions. The concept is revolutionary, and it has many potential applications outside of cryptocurrencies. Cryptocurrencies just happen to be the first major solution that uses blockchain technology.
The benefits of blockchain technology
Blockchain technology has the potential to change the way we see finance. The following are the main benefits:
- No single point of failure: As mentioned, the blockchain operates with hundreds of individual nodes. This means that if one node fails, there are still plenty of others to continue approving transactions.
- Reduces fraud: All information is stored on the blockchain ledger, so anyone can see it. This essentially eliminates the potential for fraud as you literally cannot deny that a transaction was made or spend currency you don’t possess.
- Transparency of transactions: The blockchain also means that cryptocurrency transactions are 100% transparent. This differs from traditional fiat currency and payment providers where you can’t see exactly what is happening, or who is involved.
- Greater security: The hash sequences required for nodes to approve transactions and do anything on the blockchain mean that the underlying security is fantastic. Of course, there have been many security incidents with cryptocurrencies, but these have largely been to do with the inadequate security of exchanges – not the underlying blockchain technology.
- Enhanced privacy: While literally anyone can access the distributed ledger and view your financial dealings, they require your wallet id to do so. Provided you keep this information private, your financial dealings are private as well.
The potential drawbacks of blockchain technology
Although blockchain technology has many benefits, it is not without its drawbacks:
- Scalability: One of the main issues is scalability. Currently the way that blockchain technology works limits the number of transactions that can be processed per second. Compared to traditional payment providers, this means that many cryptocurrency transactions simply can’t be processed quickly until a scalable option is found. Some cryptocurrencies possess better scalability than others.
- Energy consumption: Running the nodes that are essential for blockchain technology takes an incredible amount of energy. This means that currently, blockchain technology is not particularly environmentally friendly. Some cryptocurrencies are moving from using the proof of work protocol to the proof of stake protocol, which is anticipated to significantly reduce energy consumption.
We hope you have found this article interesting. You should now have a clearer idea of the technology behind cryptocurrencies and how blockchains work. As mentioned, blockchain technology has the potential for many other uses, and we can expect its scope to evolve past cryptocurrencies in the future.