How do cryptocurrencies work?
We mentioned before that cryptocurrencies use cryptography for security purposes, but what does that really mean? In short, cryptocurrencies use advanced mathematical algorithms to ensure transaction security and protect data from unauthorized access or manipulation. These algorithms have two main functions: maintaining the privacy of user identities and verifying the authenticity of transactions.
Blockchain transactions are public, and addresses (public keys) are pseudo-anonymous (although not completely anonymous). In other words, while transactions are visible on the blockchain, the users behind the transactions are not easily identifiable. Cryptocurrencies achieve this by using cryptographic techniques such as hash functions and digital signatures.
Cryptocurrencies are self-managed through a distributed network of computers (collectively known as a blockchain), which is essentially a decentralized digital ledger that stores transaction data on many dedicated computers on the network.
Each such computer (also known as a node) maintains a copy of the ledger, and there is a consensus algorithm that protects copies of the blockchain by rejecting false or inconsistent copies. This distributed architecture improves the security of the network because criminals cannot exploit a single point of failure (such as a bank vault) to profit.
Cryptocurrencies allow individuals to transfer money directly to each other. In a typical cryptocurrency transaction, the sender creates a digital signature using a private key to initiate the transfer. The transaction is then sent to the network, where nodes ensure the validity of the transaction by verifying the digital signature and ensuring that the sender has sufficient funds. Once verified, the transaction is added to a new block and then to the existing blockchain. It sounds complicated, but miners handle these steps so users don't have to worry about it.