how does cryptocurrency work

This tutorial explains how cryptocurrencies function, utilizing blockchain's decentralized ledger and consensus mechanisms like Proof-of-Work to secure transactions and manage digital currency creation, differing significantly from traditional banking systems.

Mar 20, 2025 at 02:06 pm

Cryptocurrencies are trading media created by using cryptography principles to ensure transaction security and control transaction units. They belong to the category of digital currency or virtual currency. Bitcoin, born in 2009, is the first decentralized cryptocurrency. Since then, many similar cryptocurrencies (commonly called "altcoins") have emerged one after another. The cryptocurrency system needs to meet a series of conditions: no central organization is required, and the state is maintained through a distributed consensus mechanism; the ability to record cryptocurrencies and their ownership; the way new currency is generated and the owner determines; ownership is proved only through cryptography; transactions are allowed to change ownership, and at most one change instruction for ownership of the same cryptocurrency at the same time shall be executed.

• Distributed ledger and blockchain : Cryptocurrencies rely on distributed ledger technology, where blockchain is the core. Blockchain is composed of many "blocks" connected in chronological order. Each block contains a certain number of transaction records, as well as the hash value of the previous block (a unique digital fingerprint generated by a specific algorithm) to form a chain structure. This structure makes it extremely difficult to tamper with the information of any block, because this will cause changes in the hash value of all subsequent blocks, thus ensuring the immutability and security of transaction records.

• Consensus mechanism : In a decentralized network, a consensus mechanism is needed to ensure that all nodes agree on transaction records. Taking the Proof of Work (PoW) adopted by Bitcoin as an example, nodes (miners) in the network need to compete for accounting rights by solving complex mathematical problems. The first miner to solve the problem will receive newly generated bitcoins as a reward and broadcast its packaged blocks to the entire network. After other nodes verify that the block information is correct, they will add it to their own blockchain. This mechanism ensures that the network can operate in an orderly manner without a central organization, preventing problems such as double payments.

• Encryption technology ensures security : Cryptocurrencies use asymmetric encryption technology, and each user has a pair of public and private keys. The public key is equivalent to the user's account address and can be shared publicly to receive cryptocurrencies; the private key is properly kept by the user, like an account password, used to sign the transaction and prove the authenticity and ownership of the transaction. When transaction information is spreading on the network, it is encrypted through a hash algorithm to ensure the integrity and confidentiality of the information.

• Blockchain native tokens : such as Bitcoin (BTC), are often used as a store of value and a means of hedging inflation; Ethereum (ETH), is the native token of the Ethereum blockchain, used to pay transaction fees, execute smart contracts, etc.

• Stablecoins : Designed to keep prices stable, usually pegged to stable assets or currencies (such as US dollars, euros). Including pegged stablecoins (such as USDT, USDC), algorithmic stablecoins and asset stablecoins (such as PAX Guld, Digix Guld Token).

• Platform coins : issued by specific cryptocurrency exchanges, with special functions and uses such as trading discounts, participation in platform activities, and voting, such as BNB (Binance Coin), HT (Huobi), OKB (OKCoin Coin), etc.