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What is Bitcoin: How do cryptocurrencies work?

Bitcoin’s price in 2012 was $13. Fast forward to 2017; a single Bitcoin is priced at $17,000. Bitcoin’s ever-risingvalue has made it a household name even among those who do not understand how it works. This article will try to explain what a Bitcoin is and how these cryptocurrencies work.

What is a cryptocurrency?

The word cryptocurrency is made of two distinct words, cryptography and currency. It is a form of money created by using sophisticated cryptography rules. Cryptocurrencyis created and managed by solving complex mathematical problems using specialized hardware. Unlike fiat currencies like a US Dollar or a Euro, there is a no physical component for this money. It livespurely in the cyberworld as zeros and ones, protected by unbreakable, unhackable cryptography.

Apart from Bitcoin, there areseveral other cryptocurrencies in circulation today. They are all called altcoins for the sake of convenience.Litecoin, Ethereum, Dash, Ripple and Zcash are some of thefamous altcoins available.

Most of the cryptocurrencies share a few similar characteristics with regular currency and so have become popular, Bitcoin being the leading example. But not all cryptocurrencies were created to be a replacement for money.
For instance, Ethereum’s tokens‘Ether’was not created to be a currency alternative. The primary aim of Ethereum was to developdecentralized applications (DApps) and smart contracts.

On the other hand,Monero wanted to be a digital currency but offerscomplete anonymity to its blockchain and the money it holds.

What is aBitcoin?

Bitcoin is the world’s first cryptocurrency created as a proof of work for the concept of currency created by using complex mathematics. It was first proposed as an idea by Satoshi Nakamoto in a cryptography mailing list in 2008. He published the proof of work in Jan 2009.After 2010, he handed over all Bitcoin websites and source code to other developers and vanished from the scene.

By design, Bitcoinis decentralized in nature, i.e.  There is no central authority that issues or regulates the currency. Thus, it is free from any political, banking or regulator’s clutches and constraints, making it ideal for border-free transactions.

How does cryptocurrency work?

Bitcoins and altcoins function in the same way. Some altcoins are ‘pre-mined,’ i.e.  All tokens are created before being published. Some coins like Ether do not have a limit on the number of coins that can be created. So there are variations in thebehaviour of different altcoins although most of them follow the similar path while transacting and recording thetransactions on a blockchain. For the sake of simplicity, all the examples here will be focused on Bitcoin.

To help understand the process of creating Bitcoin and how its transactions work, consider the following example.

A buyer wants to pay a seller using bitcoins. The buyer scans the seller’s Wallet QR code, enter the amount, the transaction fee and clicks send.  This transaction is broadcast to the entire network, and based on a series of filters, a miner picks up such transactions and adds it to the permanent record ‘the Blockchain’. For his efforts, the miner is paid a certain amount of Bitcoin, plus he gets to keep the transaction fee sent by the buyer. Once the transaction is recorded on the blockchain, it is irreversible and is consideredto be ‘confirmed’. Depending on the value of thetransaction, a seller may wait for low, a medium or a highlevel of confirmation.

Theseare the typical confirmation codesafter a successful transaction.

0 – Safe only with trusted senders.These payments can be reversed, and the codeissuitedonly for very low-value transactions.

1 – Reliable (Suggested for <$1000).

3 – Highly reliable (Suggested for <$10000)

6 – Minimum score for high-value BTC transactions (For transactions > $10000)

Howto store cryptocurrencies?

 

Paper money is stored in wallets, purses, and vaults. Cryptocurrencies are stored in a digital wallet. To be precise, the private keys used to approve a Bitcoin transaction are stored in the wallet. Thesewallets come in different forms and offer different levels of security;

Mobile wallet:  The easiest way to storeBitcoin is in a mobile wallet. An app loaded on to a smartphone can hold the private keys and can be used for smaller transactions.

Desktop wallet: A wallet created on a PC offers better security than the one on a mobile. However, if the PC crashes, or is destroyed, there is no way to retrieve your private keys.

Paper wallet: When storing amore substantial number of coins, a paper wallet is ideal as it cannot be accessed via the internet.

Hardware Wallet: These are gaining popularity now. A digital wallet on a USB stick can store a lot ofBitcoin. It is portableand can be offline,providing better protection from hackers and thieves.

While most wallets can hold a majority of the cryptocurrencies, some networks offer their ownwallets to use with their digital currency. So check which one is best based on the cryptocurrency owned.

It is an exciting time for cryptocurrencies. Bitcoin has doubled its price in justtwo weeks. Many others like Ethereum have grown 36 times in the last year. Instead of getting carried away by the big numbers, use caution, research and invest in a cryptocurrency that works best for you.