How Cryptocurrencies Work: Transactions and Consensus Mechanisms

Hello, learners! Now that we’ve explored what cryptocurrencies are and looked at some
examples, it’s time to delve deeper into how they work. In this section, we’ll explore how
transactions are made and how consensus mechanisms ensure the security and integrity of
these transactions. Let’s get started!
Cryptocurrency Transactions
When you send or receive cryptocurrencies, you’re essentially signing off ownership of the
coins to a new digital wallet. The transaction information is recorded on the blockchain, but
how does the system ensure that the transaction is legitimate? This is where public and private
keys come in.
Public and Private Keys
In the world of cryptocurrencies, your wallet doesn’t actually hold your coins. Instead, it holds a
pair of cryptographic keys: a public key and a private key.
1. Public Key: This is your wallet address. It’s like your email address – you can share it
with others so they can send you cryptocurrencies.
2. Private Key: This is like your email password – you use it to access and manage your
funds. You should never share your private key with anyone.
When you send cryptocurrencies, you’re essentially creating a message, called a transaction,
that says, “I am transferring ownership of my cryptocurrency to the public key of another
wallet.” This transaction is signed with your private key and broadcasted to the network.
Consensus Mechanisms
But how does the network agree that your transaction is valid and should be added to the
blockchain? This is where consensus mechanisms come in. These are protocols that ensure all
nodes in the network agree on the contents of the blockchain.
There are several types of consensus mechanisms, but we’ll focus on two of the most common
ones: Proof of Work (PoW) and Proof of Stake (PoS).
Proof of Work (PoW)
PoW is the consensus algorithm used by Bitcoin. In PoW, miners compete to solve complex
mathematical problems. The first one to solve the problem gets to add a new block of
transactions to the blockchain. The miner is then rewarded with a certain amount of
cryptocurrency. This process is known as mining.
Proof of Stake (PoS)
PoS is a different type of consensus algorithm used by cryptocurrencies like Ethereum. In PoS,
the creator of a new block is chosen in a deterministic way, depending on its wealth, also
defined as stake. There is no reward for creating a new block. Instead, the creator gets the
transaction fees.
Why Understanding Transactions and Consensus Mechanisms Matters
Understanding how transactions and consensus mechanisms work is crucial to understanding
cryptocurrencies. It helps you understand the security and integrity of the system, and why
cryptocurrencies hold value.
In our next section, we’ll explore how to buy and sell cryptocurrencies. Stay tuned!
Remember, every step you take in learning brings you closer to understanding the complex
and fascinating world of cryptocurrencies. Keep going!