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What is cryptocurrency and how do they work

Cryptocurrency – what is it?

Cryptocurrency is a full – fledged payment system that exists exclusively in the global network. Unlike electronic money, which is only an "electronic representation" of ordinary money, it has no physical expression. It doesn’t use banks of any countries for issuing, storing or transferring from owner to owner.

To issue and receive cryptocurrency, you need to just connect to the online service. The connected computer needs high power to perform calculations. This process is called "mining". Accordingly, a user who is engaged in mining on their computer is called a miner. Earnings in this case are nothing more than a reward accrued by the payment system itself for using the capacity of the user's machine.

The currency is stored in cryptocurrencies and exchanged directly between users. All transaction data is stored in a kind of online database, having previously passed encryption to ensure security. Hence the "crypto" in the name.

The unit of cryptocurrency is a "coin". At the same time, unlike the usual money, each coin can be divided not only into hundredths (like cents), but also into smaller components.

Currently, there are about 1,500 active currencies. The most famous and popular among them are:

  • Bitcoin
  • Ethereum
  • Ripple
  • Litecoin
  • and others

How do they work?

At the core of cryptocurrency is the blockchain technology. It is used for data transmission and reliable storage. In fact, the blockchain is a database that has one extremely important feature: data can only be added to it and old information cannot be deleted.

First, let's look at the process of adding data. In simplified form, it looks like this:

  • the user's computer generates a transaction (the user pays the Internet, sending some coins from his account to seller account),
  • the transaction enters the network node is a distributed network of computers with equal rights
  • on the basis of a series of standard algorithms network nod confirmed user status and transactions
  • a series of confirmed transaction is formed in the block digital register, it gets additional data about how, where and what amount of transaction was done
  • the new unit joins the chain of existing blocks
  • the transaction is completed.

In this case, not only cryptography, encryption during storage and transmission, is responsible for data security, but also a distributed data storage structure. Instead of storing the entire database on a single server, the blockchain uses a system of distributed registries, the function of which is performed by computers participating in mining. Simply put, many duplicates of the "chain" are stored on different computers and even if one of them is damaged and the data is somehow changed (for example, it will lose its relevance due to the fact that the computer will not be connected to the network for the duration of a series of transactions), this will not affect the blockchain. In this case, the concept of "consensus" will work – the data will be considered correct if they are the same in most registries.

Consensus is also responsible for protecting against hacking. Even if the data of one or more registries is changed deliberately, for example, an attacker will add a couple of zeros to the amount in their own wallet and then the rest of the registries will indicate that this data is incorrect. They will not be counted.

The advantages of cryptocurrencies

  • Open source. All the algorithms used are known, so it is relatively easy to verify the correctness and "integrity" of the entire system.
  • Unlike regular money stored in a Bank account, data about the owner or recipient of the cryptocurrency cannot be tracked. You can only get the wallet number and partial information about the account amount.
  • Cryptocurrencies (with a few exceptions) and actions with them do not depend on the state, nor on a specific material good ("real" currency, oil, gold, and so on), nor on the Central Bank of a particular country, nor on the influence of governments and other factors that usually regulate the issue of funds.
  • The maximum number of cryptocurrency coins is strictly limited. For example, the maximum number of bitcoins is 21 million and not a coin more, which excludes inflation as a result of excessive issuance.
  • The use of cryptography and distributed storage makes it resistant to hacking.
  • No commissions. Payments and transfers between accounts, and even between countries, are devoid of the usual Bank fees.

Disadvantages

Despite the obvious benefits, is that of any cryptocurrency and a number of disadvantages:

  • The lack of guarantees. All responsibility for your own wallet lies solely with the user. In the case of hacking and theft of savings, which is extremely rare, but still occurs, you will not be able to collect evidence and return the money.
  • High volatility. The value of cryptocurrencies constantly fluctuates and depends solely on demand.
  • Certain difficulties in payment. In most countries, cryptocurrencies are not officially recognized as money, so you will not be able to pay with them in the nearest supermarket or online store. However, recently, some large companies still indicate on their websites the possibility of paying, for example, with ether.

Why do we need a cryptocurrency?

The impossibility of its widespread use as a means of payment at the moment leads to a logical question – why is it needed at all? Why delve into all these difficulties, if the practical application of this money is still not there? In fact, this is not the case, for at least two reasons:

  • Cryptocurrency can be used as an investment, and not only for storing your own funds, but also for earning – high volatility can bring higher income in comparison, for example, with storing funds in a Bank account. For example: the maximum interest on deposits in Sberbank in 2019 was 4.65% per annum, while inflation in Russia was 3%. At the same time, only in the first half of January 2020, bitcoin grew by 20%, and ether – by 25%.
  • Like other assets, it can be sold for dollars or euros, which, in turn, can be easily withdrawn to your Bank card.

How do I get cryptocurrency?

Currently, there are 3 ways to get it:

  • Bitcoin, ether, or other coins can be "mined" using your computer. On the one hand, it is quite simple – calculations are performed automatically, without requiring any actions on the part of the user. On the other hand, the computer must have high power so that the mining speed, which directly affects the income, is high and eliminates the cost of electricity.
  • Cloud mining. If your computer has little or no computing power, you can use cloud mining. In this case, the user pays a subscription fee for using a powerful remote server that mines cryptocurrency instead of a desktop PC.
  • Buying is the easiest way. If coins are sold, then you can buy them? This is true. You can do this through one of the special companies that provide users with easy access to cryptocurrency transactions. In this case, you can not only quickly get the necessary number of coins, bypassing the stage of long mining, but also fully use them as a means of payment, making operations to buy "ordinary" currency or shares all through the same company.
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