What is a cryptocurrency?

The digital currency known as cryptocurrency uses a decentralized network to verify transactions rather than a centralized authority. Thanks to this device, the participation of banks in financial transactions is excluded. Cryptocurrencies, first introduced to the market with the invention of bitcoin in 2008, have become a replacement for traditional payment systems.

All cryptocurrencies are decentralized, should be free from government regulation, built on blockchain technology. They are divided into two categories depending on their purpose. Coins, like bitcoin, are a currency designed to replace fiat money. Tokens, like ether, are programmable assets that exist exclusively on the blockchain. All of these cryptocurrencies can be purchased on cryptocurrency websites called cryptocurrency exchanges.

The three main components of cryptocurrencies are the blockchain, the blockchain network, and the network cryptocurrency. Blockchain is the core technology of cryptocurrency networks. It is a distributed ledger that records and maintains transactions using cryptography, which is the practice of encoding and decoding data.

Data is stored in groups called blocks. When a block reaches its maximum capacity, it is closed and attached to the previously filled block, thus forming a data chain.

There are different types of blockchains. Public blockchains allow anyone to join, explore and transfer data through a peer-to-peer network of computers and data centers around the world. Private blockchains run on private databases and require an invitation to participate. Some companies, such as Facebook from Meta Platforms (META), have opened their own blockchain divisions to fight competition from new technologies, but their networks tend to be private. Permissioned blockchains are a hybrid of public and private blockchains where anyone can join the network as long as they meet certain criteria.

The blockchain network includes the blockchain ledger and all the people who contribute to the ledger. Most cryptocurrencies use public blockchains with decentralized networks. They are not kept in one place and are not issued by a central authority. Because of this, the ledger update method depends on the blockchain consensus protocol.


What is the blockchain protocol?

The blockchain consensus algorithm, also known as the blockchain protocol, is a method for verifying data and updating the ledger. In general, there are five types of consensus protocols. But the two most widely used are Proof of Work and Proof of Stake.

The Bitcoin network was the first cryptocurrency payment system built on blockchain in 2008. It was created by an anonymous individual or group known as Satoshi Nakamoto. The goal of Bitcoin is to become an international currency. It has a limited reserve of 21 million coins, which are allocated through mining. Mining is the process of verifying blocks and verifying transactions on the blockchain.


Bitcoin: proof of work

Bitcoin uses a proof-of-work consensus algorithm, which means that only verified miners can update the ledger. Proof-of-Work protocols reward miners for processing and verifying transactions, which is achieved by solving complex mathematical problems that require huge computing power.

Computing nodes combine and store transaction data in blocks. Each block is encrypted with a hash function that assigns a specific hash value to it. Miners compete to be the first to discover the correct hash value, thus validating the block. As soon as other nodes in the network confirm the decision, the block will be added to the registry. The winning miner receives a transaction processing fee or a bitcoin reward in the case of newly minted coins.

Transaction fees vary depending on network congestion, and bitcoin fees can be as low as a few cents. The reward for a new coin block is currently 6.25 BTC. This figure is halved every four years to slow down supply and help boost demand in a process called “halving.”

The fierce competition for bitcoin mining has led to an increase in demand for computer components called GPUs. This has led to a global shortage of these devices in 2021. Bitcoin mining operators like Marathon Digital Holdings (MARA) use their systems 24/7, which wears out GPUs. This has been a big boost for component vendors like Nvidia (NVDA) and Advanced Micro Devices (AMD), whose share prices hit all-time highs last November.

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