Introduction to Cryptocurrency

What is Cryptocurrency?

A digital currency that is secured by cryptography and is, typically, used as a medium of exchange within a peer-to-peer (P2P) digital economic system. The use of cryptographic techniques is what ensures that these systems are completely immune to fraud and counterfeiting.
The first cryptocurrency to be ever created was Bitcoin, introduced by pseudonymous developer Satoshi Nakamoto, in 2009. Nakamoto’s goal was to create a novel electronic payment system that would allow digital financial transactions to occur between users without the need for intermediaries, such as banks or governmental institutions.
Most cryptocurrency systems work through a decentralized framework that is collectively maintained by a distributed network of computers. Each computer (or device) that joins the network is referred to as a node. In simple terms, a node is any physical device that is connected to a network and that is able to send, receive and forward information. Each node is categorized according to the functions it performs within the system. For instance, the Bitcoin network is made of, at least, seven different types of nodes, and the nodes that perform all available functions are known as full nodes.
Cryptocurrency systems are considered decentralized because they don't rely on a centralized point of authority. The network nodes are widely distributed around the world and the issuance and management of cryptocurrency units are based on pre-programmed algorithms and mathematical proofs. However, each cryptocurrency works in a particular way, which results in varying degrees of decentralization. In other words, some cryptocurrencies may be considered more decentralized than others, depending on the network structure and on how the nodes are distributed.

Most cryptocurrency systems rely on a public distributed ledger known as a blockchain, which is basically an ever-growing list of records that are highly resistant to modification. As the name suggests, a blockchain is made of a linear chain of blocks and, in the context of cryptocurrencies, it is responsible for keeping a permanent record of all confirmed transactions (and related data) - all secured by cryptography. Generally speaking, every cryptocurrency works on top of a blockchain that works according to a predefined set of rules (i.e. an underlying protocol). The protocol is what defines how the blockchain and the cryptocurrency system should operate.

What is Cryptography

Advances in computer technology have made data more accessible, and although this may offer a huge advantage, it has a downside as well. Online data is exposed to many threats, including theft and corruption. Cryptography (or cryptology) is one solution that has made it possible to protect information from some of the risks associated with data storage and distribution. It is not to say that the concept of encrypting data is new. Even before the digital era, people have been masking messages to prevent unintended audiences from reading them. But the increased use of computing devices brought the science of encryption to a whole new level.

In a few words, cryptography is the science of hiding information. More specifically, modern cryptography makes use of mathematical theories and computation to encrypt and decrypt data or to guarantee the integrity and authenticity of the information.

In a basic process of text encryption, a plaintext (data that can be clearly understood) undergoes an encryption process that turns it into ciphertext (which is unreadable). By doing this, one can guarantee that the information sent can only be read by a person in possession of a specific decryption key.
By using specific cryptographic techniques, one is able to send sensitive data even over unsecured networks. The level of encryption will depend on the degree of protection that the data requires. For instance, the type of security used on regular personal files (like contacts) is not the same as the one used on cryptocurrency networks.

Learning how cryptography works is critical to understanding its importance within cryptocurrency systems. Most blockchain systems, such as the one of Bitcoin, make use of a particular set of cryptographic techniques that allow them to function as a decentralized and public ledger, through which digital transactions can take place in a very secure way.

How does cryptography work?

The modern cryptography consists of various areas of study, but some of the most relevant are the ones that deal with symmetric encryption, asymmetric encryption, hash functions, and digital signatures.
The Bitcoin protocol makes use of cryptographic proofs in order to secure the network and to ensure the validity of each transaction. Digital signatures guarantee that each user is only able to spend the funds of his own wallet and that these funds can't be spent more than once. For instance, if Alice sends 2 bitcoins to Bob, she creates a transaction that is, essentially, a message that confirms the addition of 2 bitcoins to Bob’s wallet, while removing the coins from Alice’s wallet. However, she is only able to do so by providing a digital signature.
Another important element of the Bitcoin Protocol is the Hashcash function, which defines the Proof of Work consensus mechanism and the mining process (responsible for securing the network, validating transactions and generating new coins). Hashcash makes use of a cryptographic function called SHA-256.
Cryptography is an essential part of the blockchain technology and, therefore, is crucial for any cryptocurrency. Cryptographic proofs applied to distributed networks enabled the creation of trustless economic systems, giving birth to Bitcoin and other decentralized digital currencies.