How Cryptocurrency Work

What is Cryptocurrency ???
1.It is a virtual medium of exchange .
It is used to purchase goods and services and exchanged for conventional currencies .
It is virtual and exists only as ledger entries in the peer to peer network .

2.Cryptography is used to
a. secure transactions - Transactions are put through a function into hash values which makes it almost
impossible to invert.
b. control the creation of new units - Coins are created through a mining process using cryptography .

3.Cryptocurrencies are decentralized (currently)
The government cannot produce units of cryptocurrencies

4.Cryptocurrencies provide privacy to its users .
Some effort is required to protect your privacy. All cryptocurrency transactions are stored publicly and permanently
the peer to peer network. However, identity of the user behind an address remains unknown until information is
revealed during a purchase or in other circumstances.

*Transacting in Cryptocurrency
Let’s illustrate with an example how a transaction works. Alice wishes to buy a shirt from Bob’s online shop Total
costs including shipping is USD $30 Suppose current exchange rate is 0.0026BTC to 1 USD Thus, Alice needs to pay
Bob 0.078BTC This transaction gets broadcasted into the peer to peer network

*What is in a transaction?

There are three elements in the transaction: 1. An input. Alice’s public address 2. The amount being sent 3. An output. Bob’s public address Alice signs the transaction with her private key for verification

There are no actual bitcoins: What you store are the secure digital (private) keys used to access your public bitcoin addresses and sign transactions.

*What happens in the peer-to-peer network?

Alice sends a message that she is transferring bitcoins to Bob into the network. Nodes pass the message along in the peer-to-peer system.

Inside each node: Each node holds the entire ledger of transactions that have taken place in Bitcoin history This is checked to ensure that Alice owns 0.078 BTC

A node does the following: *Holds the public ledger *Verifies transactions *Updates the ledger as new ledger pages (blocks) are created *Optional: the node can also create new blocks through the mining process

A node that is also a miner: Takes a group of verified transactions and attempts to put them in a page of the ledger (block in the blockchain). This is done by solving a cryptographic puzzle

*Solving the puzzle:
Each block takes approximately 10 minutes to mine. Solving the cryptographic puzzle is akin to guessing the number on a combination lock. There is no “smart” way to solve the puzzle; it can only be done by brute force. Thus, it is referred to as mining because effort is needed to gain the reward.

The difficulty of the puzzle is adjusted to adapt to changes in computing power in the network, such that each block takes approximately 10 minutes to mine.

*Mining Rewards
A miner is rewarded for solving the puzzle. The reward structure is as follows for Bitcoin: It starts at 50 coins per block and is halved every 210,000 blocks. Current reward is at 25 coins, this is expected to be halved in September 2015 (approximation).

The miner can also collect any transaction fees attached to the transactions in the block. Similar to physical mining, one exchanges effort for a reward. In this case, one gets coins for solving the cryptographic puzzle. The puzzle solver adds a transaction transferring coins to himself to the block he created. This usually appears as the first transaction in a block (as seen in the example below).

**Verifying a transaction **

A new block is appended to the Blockchain in historical order. To ensure that Alice does not double-spend her coins, Bob waits for a few blocks to be added to the chain. The industry standard is 6 confirmations or blocks. After waiting for 6 blocks, Bob is sure he has received the money. He then sends Alice her shirt and the transaction is complete.