Cryptocurrencies, through their operation, have taken over the world's thoughts and revolutionized the concept of money, transactions and digital assets. At the core of their operation lies a complex web of technologies that guarantees security, transparency and decentralized activity. This article is about the core technologies on which cryptocurrencies are built, discussing what each one of them includes and how they interact with each other to create new digital value.
Introduction to Cryptocurrencies
We live in a digitized, highly connected world whereby, at present, we can get access to almost everything online: be it online shopping, live casino, virtual gaming, or any other activity one might want to engage in. With this in mind, there is no wonder that currencies have moved into the digital domain as well.
Cryptocurrencies are digital or virtual currencies that make use of cryptography to verify their transactions. Crypto, unlike traditional flat currencies being issued by, for example, governments and their central banks, functions from a centralized framework. Their transactions are verified over a decentralized open framework using blockchain technology. The first and most famous of all cryptocurrencies is Bitcoin, put forward in 2009 by an anonymous individual or group of individuals under the pseudonym Satoshi Nakamoto. Since then, alternative forms of cryptocurrencies, often described as unique, other than Bitcoins, have cropped up in the thousands; each has special features and use cases.
Probably the most popular characteristics of cryptocurrencies are their decentralized nature and the fact that they do not rely on any central authority, such as a government or a financial institution. This is made possible by what is called nodes—a network of computers scattered all over the world, all of which cooperate to hold up the integrity of the system. The transactions that follow with cryptocurrency coins or tokens are recorded on a public ledger called a blockchain for maximum transparency and immutability. Parallel proliferation in smartphones and internet connectivity have then made online transactions more accessible and more convenient than ever whilst also making sure users feel safe and protected.
Blockchain Technology: The Backbone of Cryptocurrencies
At the centre of any cryptocurrency, exists at least Blockchain technology. A blockchain is simply a decentralized platform keeper of records of all transactions that have or are occurring between a given network of computers. Each chain of their blocks carries a hash of a series of transactions, a time-stamp of a given date and time of transaction and a cryptographic hash of the previous block, that maintains an unbroken secure decentralized chain.
Blockchain technology is vital for the existence of cryptocurrencies due to a number of reasons:
Decentralization: Traditional models of financial systems had to rely on a central authority, but with blockchains, no single entity could control the network. This makes them more secure and less open to corruption and manipulation.
Transparency: All blockchain transactions are accessible to each one of the participants in the particular system, which establishes transparency and trust. Here lies the major one why people consider this as one of the highly secure forms of technology.
Immutability: This means that once a block is added to the blockchain, it can't be modified or erased. This immutability makes the record of transactions indisputable and tamper-proof, thus enhancing the security further.
Blockchain technology also allows for the implementation of smart contracts, which are self-executing contracts with the terms of the agreement directly written into code. Important ecosystems, such as decentralized applications (DApps), are used with smart contracts.
Cryptographic Foundations
Cryptography lies at the foundation of cryptocurrencies and their security. It uses a few complex mathematical encryptions to secure data so that only selected recipients can read or alter it. There are two basic kinds of techniques applied to the majority of cryptocurrencies: public-key cryptography and hashing.
Public-Key Cryptography: In cryptocurrency, this type of cryptography enables secure transactions of digital currency between entities.
Each user has two full parts of a cryptographic key pair: the public one and the private one. The public one is shared with other parties for the purpose of deposit, while the private one is kept secret and is therefore used for transaction signing—it rightfully proves its ownership properties against the funds in its account. This guarantees that only the rightful owner can approve their transactions, meaning there is no fraud or illegal access.
Hashing: Hash functions are the other critical component of cryptocurrency security. A hash function generally takes an input and forms a fixed-size string of characters, usually a hash code. In cryptocurrencies, hashing secures transactions as it codes the information contained in every single block within a blockchain. A change in transaction data would mean a change in this block's hash, thereby signaling the network of tampering. Hash functions also play a role in mining: a process through which new blocks are added to the blockchain.
Smart Contracts and Decentralized Applications (DApps)
Smart contracts can perhaps be one of the most pure disruptions made by blockchain technology. In a smart contract, a self-executing program is made where the terms are directly written into lines of code. Once the conditions laid down within the contract are, by their nature, satisfied, the contract itself executes the agreement. Just-in-between middlemen are not required and the chances of human mistakes or malfeasance decrease.
Smart contracts effectively allow DApps – decentralized applications. They run their operation not on central servers, as traditional apps do, but rather on a set of interconnected and non-centralized nodes. There are several advantages to doing that:
Autonomy: DApps run with very little interference from central authority, thus they afford minimal likelihood of being censored or controlled by a single entity.
Transparency: Since DApps are built on Blockchain technology, their operations are transparent to users and each user can verify the authenticity and integrity of the application.
Security: DApps are effectively more secure than their centralized counterparts because, with no one point of failure, hacking or disastrous data breaches are minimized. Examples of potential use of smart contracts and DApps cover almost all fields, ranging from finance and insurance to the supply chain. For example, in the financial sphere, the potential application of smart contracts is to automate the complexities of loan issuance and loan repayment. Supply chain management makes goods transparent and traceable from production to delivery.
There is a disruptive and complex technology at the base of cryptocurrencies. The term also suggests a change in paradigm to most people—how we are generally raised to think about money, financial transactions, or even digital assets is considered from a different point of view. Such foundational technologies are blockchain, cryptography, smart contracts and decentralized applications working in union with each other for the safety, transparency and decentralization of the financial system. If the group of technologies constituting cryptocurrencies continue to evolve as they have been into this ecosystem, it is likely that it will someday play the most important role in determining the future, finance being part of it.