How Cryptocurrencies Really Work – Popular Mechanics

Money is changing. Just a few years ago saw the invention of Bitcoin, the world's first cryptocurrency, and today there are thousands of these cryptocurrencies being used by people all around the world including variants like Ethereum and Litecoin.

But what is a cryptocurrency? How does it work? There has been no shortage of explainers during Bitcoin's rise, but this new one from Youtuber 3Blue1Brown explains the whole process from the bottom up to give you an understanding of cryptocurrency as if you had invented it yourself:

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In a typical currency, such as U.S. dollars, transactions are handled either through exchanging cash or via electronic transfers. These electronic transfers are managed by large banks that we trust to keep our money safe and our transactions honest.

To create a cryptocurrency like Bitcoin, we first have to take the responsibility of keeping track of transactions away from banks and manage it ourselves. The first step is to create a ledger of everyone's payments to everyone else. This ledger will keep track of who owes money to who and records everyone's payments to each other.

The next step is to prevent people from cheating by adding transactions that one party much not agree on. One easy way to solve that problem is by requiring both people in the transaction to sign off on the payment. Each participant can add their "digital signature" using public/private key encryption so that everyone knows the transaction is legitimate.

But there's one last problem: Who owns the ledger? In a traditional currency system a bank would maintain it, but we're supposed to be building a currency that doesn't need banks. Instead, everyone has their own ledger, and all transactions are made public so everyone updates their ledger at the same time.

In this way, everyone can safely exchange money without worrying about whether the people handling it are trustworthy. Instead of trusting a central bank or a government to insure our transactions, we can simply use cryptography to force everyone to play fair. While cryptocurrencies are still in the early stages, in a few years they might be the preferred way to make payments all over the world.

Source: 3Blue1Brown

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How Cryptocurrencies Really Work - Popular Mechanics