A Beginner's Guide to Cryptocurrency

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A cryptocurrency is a form of digital cash that enables individuals to transmit value in a digital setting.

You may be wondering how this sort of system differs from PayPal or the digital banking app you have on your phone. They certainly appear to serve the same use cases on the surface – paying friends, making purchases from your favorite website – but under the hood, they couldn’t be more different.

There are several moving pieces crucial to the functioning of cryptocurrency. In the following article, we’ll try to break those concepts down into manageable pieces, before tying them together in the end.

What is cryptocurrency?

Cryptocurrency serves as a catch-all term for a range of digital money systems. They rely on robust cryptography to enforce ownership rights and to ensure secure transactions. These are not operated by any single party, but rather by a distributed network of participants that coordinate around a shared set of facts.

Cryptocurrency: cutting out the middleman

The financial system, as we know it, is overrun with middlemen. Any transaction you make that isn’t a face-to-face cash payment will set off a chain reaction in your bank’s database. Though it may appear outwardly that you’re simply tapping your card to purchase a coffee, what’s really happening is that the merchant contacts your bank, which ensures that you have the authorization (and balance) to make the payment. The funds don’t even exist in your account: the bank just keeps a ledger that says it owes you the money. 

To cut a long story short, the backbone of our financial infrastructure is incredibly centralized – at the touch of a button, a few key players could make your life savings disappear. In a cryptocurrency network, this backbone doesn’t exist. Well, it does, but in a different way. 

Consider a country where there are 10 banks serving 1,000,000 people. Each bank is heavily-regulated and must pass innumerable checks before it can begin to serve its customers in the fiat currency system. The customers have certain guarantees under the law, but fundamentally, they have no control over the money they store in the banks. 

In a typical cryptocurrency setup, we make no distinction between the ‘banks’ and ‘customers’ – every user is their own bank. There are regulations, but instead of being enforced by middlemen, they’re enforced by software. To launch their own bank (what we call a node), it’s really as simple as downloading a program and running it on a computer – most of the time, a low-end device will suffice. 

This software connects to the internet and reaches out to discover other computers running the same program to form connections with them. All of the banks connect with a number of others in this manner, creating a peer-to-peer network. 

comparison of a centralized network and a decentralized network

This makes it so that there is no central source of information: as soon as one node creates new information (or receives it from another node), it will broadcast it to all those it’s connected to. They will do the same, ensuring that information is rapidly propagated around the network and that all participants can stay up to date.

What information is shared by nodes?

The nodes share information on transactions. You’ll often hear people speak of a distributed ledger because each node stores what is effectively a very long list. The list is updated on a frequent basis, with a batch of transactions appended every time (for an in-depth discussion on this, see What is Blockchain Technology?).

Since there’s no single bank, or even a trusted party that can be relied upon to maintain records, each node must do it themselves. When a new batch (called a block) of transactions is propagated, the software automatically verifies that it has been created within the rules of the system. If the entity that produced the block has attempted to spend funds that they do not own, the network will automatically reject it. 

Anyone can create a block. The most popular method for doing so (seen in cryptocurrencies like Bitcoin) is through a process called mining, but other methods are increasingly gaining traction. There’s no need to worry about the specifics – all you need to know is that a good cryptocurrency will make it expensive for a participant to attempt to cheat, and reward them for acting honestly.

How does cryptocurrency work?

It’s perhaps unsurprising given the name, but cryptography lies at the heart of any cryptocurrency network. It prevents other users from spending your money, ensures you can receive coins without sacrificing your privacy, and keeps the entire ecosystem secure.

At the user level, your point of entry into the network is a private key. This is a tremendously large number that would be feasibly impossible for anyone to guess, even with an abundance of high-powered computers. In many ways, it’s like a password, but with the very important distinction that it cannot be changed, and once it’s lost, you can never recover it (for a guide on how to properly store your keys, check out Keeping Your Private Key Secure).

Once you generate a private key (which can be done on virtually any device), you can now derive from it public addresses – strings of characters that you can hand out to other users, so that they can send cryptocurrency to you. There’s no risk of anyone reverse-engineering the addresses to get the private key.

A neat feature of this so-called public-key cryptography is that users can easily prove that they have the right to spend coins, and others can easily verify that this is the case. Conversely, if malicious actors attempt to move funds that don't belong to them, their transactions won't be relayed by other nodes.

Tying it all together

We’ve only just scratched the surface of cryptocurrency, but hopefully, we’ve touched on enough to gain a good overview of the system. Let’s talk through how a typical debit card transaction works, followed by how a cryptocurrency one works, by drawing on an example with our friends Alice and Bob.

Alice wishes to purchase a coffee from Bob’s establishment:

  1. Bob registers the order on his point-of-sale device, and Alice inserts her debit card.
  2. If all looks good, the information is transmitted to the acquirer (the bank that accepts card transactions on Bob’s behalf).
  3. The acquirer taps into an overarching network with Alice’s request, which will then query Alice’s bank to make sure the transaction is valid.
  4. Alice’s bank will run some checks (is this transaction likely to be fraudulent? Does she have the funds for it?).
  5. Alice’s bank informs the network that everything is good (or that there’s a problem, if that’s the case).
  6. The network relays the information to the acquirer, which finally passes it onto Bob.

Alice leaves with her purchase. The day goes on, and she finds herself craving caffeine once again. She makes her way back to Bob’s café, and sees that Bob has put a Bitcoin Accepted Here sticker on the window. Eager to try it out, she enters and places her order:

  1. Bob opens his wallet (a piece of software that holds his public/private keys and allows him to create transactions). He generates a public address and presents it to Alice. For convenience, he can display this as a QR code.
  2. Alice opens her own wallet, and scans the QR code. Her wallet automatically decodes it, and she is asked to input the sum she wishes to send.
  3. She enters the price of the coffee (a small fee is added to incentivize the network to accept the transaction), and presses ‘send’.
  4. The transaction is broadcast to the network of nodes running Bitcoin.
  5. It will be collected by someone attempting to create a block.
  6. If the block is accepted, the transaction is confirmed, and Bob will be notified that he has received a new payment. 

comparison of traditional banking and cryptocurrency

Et voilà! As you can see, the Bitcoin transaction involves considerably fewer middlemen. In fact, we don’t consider there to be any: even if some nodes refuse Alice’s valid transaction, others will accept it. Cryptocurrency is the closest we can get to physical cash transfers in a digital setting.

It should perhaps be noted that, when it comes to speed, the card network may be faster – it can take anywhere from minutes to hours for a cryptocurrency transaction to settle. In the grand scheme of things, however, settlement time is much faster than that of banks, which often take days to actually reallocate funds in their backends. And with numerous innovations in the cryptocurrency space, it’s likely that the difference between card and crypto speeds will soon become negligible.

Where to buy cryptocurrency

There are many ways to acquire cryptocurrency. You could earn it for selling goods or services, attempt to mine it, or simply buy it outright. We believe that the future of finance lies in this nascent field of digital money, and have made it our mission to drive its adoption worldwide. Binance supports hundreds of coins, and we’re constantly striving to make it as easy as possible for you to get ahold of them.

To get started, simply head over to our Buy and Sell Cryptocurrency gateway, where you’ll be prompted for the amount you wish to spend and the coin you wish to buy. From there, either log in or register, confirm your identity, and enjoy your first step into the new financial paradigm!

Closing thoughts

When Satoshi Nakamoto first published his proposal for Bitcoin in 2008, he set into motion a chain of events that would forever change how we perceive, hold and transmit value. In an age where our privacy is increasingly harder to safeguard, and our security relies on trusting third parties, cryptocurrency has emerged as a means to truly be your own bank.