What is Cryptocurrency and How Does it Work? 

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Lesson 4: What is Cryptocurrency and How Does it Work?

Lesson Intro:

The world’s largest crypto exchange, Binance, entered into a collaboration agreement with our nonprofit, the Prison Professors Charitable Corporation. With this collaboration, we’re able to provide justice-impacted people with a great resource they can use to learn about cryptocurrency, decentralized finance (DeFi), Web3.0, Artificial Intelligence, and other topics that relate to the digital economy. The agreement is part of our nonprofit’s ongoing efforts to help people prepare for success after prison.

• See agreement with Binance
• See our Certificate with Binance

Some people have access to our videos, others do not. If a staff member in your prison will authorize videos, invite them to contact Prison Professors for information on how we can send DVDs with additional educational materials to help people learn–and potentially an in-person presentation in your facility.

Each lesson includes critical thinking questions and a glossary. We encourage participants to use these lessons, and to memorialize their learning path by building a profile on Prison Professors Talent. More information on how to build a personal profile at the end of this workbook.

4. What is Cryptocurrency and How Does it Work?

TL;DR 

Cryptocurrency is a decentralized digital currency secured by cryptography, allowing transactions without intermediaries. Accessed through wallets or exchanges, the currency remains on the blockchain. Bitcoin, created in 2009, is the first cryptocurrency. They serve as a medium of exchange and support smart contracts, DeFi, and NFTs.

Cryptocurrencies use cryptographic algorithms for security and privacy. Blockchain technology records transactions on a decentralized ledger maintained by nodes, ensuring authenticity and security.

Key Takeaways

• Cryptocurrency is a digital currency based on blockchain technology that enables peer-to-peer (P2P) transactions
• Bitcoin, ether, BNB, and USDT are notable examples of the top cryptocurrencies by market capitalization.
• Cryptocurrencies are accessed through crypto wallets or exchanges. Though people often say they are “stored” in wallets, they are actually stored on a blockchain.
• They have specific characteristics, including decentralization, transparency, and immutability.

What Is A Cryptocurrency?

Cryptocurrency is a decentralized digital currency that uses cryptography for security. It can operate independently of intermediaries such as banks and payment processors.

This decentralized nature facilitates peer-to-peer (P2P) transactions directly between individuals. But instead of physical wallets and bank accounts, people access their cryptocurrency through unique crypto wallets or crypto exchanges.

You may have heard people saying that crypto is “stored” in wallets. However, cryptocurrencies don’t actually exist in crypto wallets or exchanges — in reality, they always remain on the blockchain. In the case of a crypto exchange, it holds the private keys that allow users to access those funds.

The first and most well-known cryptocurrency is Bitcoin, which was created in 2009 by an individual or group under the pseudonym Satoshi Nakamoto. Since then, thousands of cryptocurrencies have emerged, each with unique characteristics and purposes.

Like traditional fiat currencies, cryptocurrencies can be used as a medium of exchange. However, the use cases for cryptocurrencies have expanded significantly over the years to include smart contracts, decentralized finance (DeFi), stores of value, governance, and non-fungible tokens (NFTs). 

How Does Cryptocurrency Work?

We’ve mentioned that cryptocurrency uses cryptography for security purposes, but what does that really mean? Simply put, cryptocurrencies use advanced mathematical algorithms to secure transactions and protect data from unauthorized access or manipulation. These algorithms serve two primary functions: maintaining the privacy of user identities and verifying the authenticity of transactions.

Blockchain transactions are public and addresses (public keys) are pseudonymous, though not completely anonymous. In other words, while transactions are visible on the blockchain, the users behind them are not easily identifiable. Cryptocurrencies achieve this through the use of cryptographic techniques such as hash functions and digital signatures.

Cryptocurrency achieves autonomy through a distributed network of computers collectively known as a blockchain, which is essentially a decentralized digital ledger that stores transaction data across many specialized computers on the network.

Each of these computers — also called nodes — maintains a copy of the ledger, and a consensus algorithm preserves the blockchain’s by ensuring fake or inconsistent copies are rejected. This distributed architecture increases the network’s security because there is no single point of failure, such as a bank vault, for malicious actors to exploit.

Cryptocurrencies allow individuals to transfer funds directly to one another. In a typical cryptocurrency transaction, the sender initiates the transfer by creating a digital signature using their private key. The transaction is then sent to the network, where nodes validate it by verifying the digital signature and ensuring the sender has sufficient funds.

Once verified, the transaction is added to a new block, which is then added to the existing blockchain. While this may sound complicated, miners take care of these steps so the user doesn’t have to worry about them.

What Makes Cryptocurrency Unique?

Cryptocurrencies have impacted various ecosystems, from finance to technology, by introducing innovative features that distinguish them from traditional protocols and currencies. Some of the unique aspects of cryptocurrencies include:

1. Decentralization
   • Cryptocurrency’s decentralized architecture eliminates the need for a central authority. This allows for greater autonomy, as well as less vulnerability to manipulation or control by a single entity.
2. Transparency and immutability
   • Blockchain technology records all transactions on a transparent and tamper-proof ledger. Therefore, once a transaction is added to the blockchain, it can be viewed by anyone and cannot be altered or deleted.
3. Programmability
   • Many cryptocurrencies, such as ETH, are programmable, allowing developers to deploy smart contracts to create decentralized applications (DApps) and other innovative solutions on top of blockchains. Additionally, because permissionless blockchains are open-source, anyone can start deploying code on top of a blockchain and create their own DApps.
4. Borderless
   • Cryptocurrencies are easily transferred and exchanged globally, allowing people to use them for international transactions and remittances.
5. Predefined supply of coins
   • Many cryptocurrencies have a limited supply of coins, meaning the teams behind them will only ever create a finite number of coins. This deflationary aspect of cryptocurrencies can potentially be positive over time, as scarcity drives demand.In contrast, fiat currencies are often inflationary because central banks can print more money. However, with a limited supply, crypto inflation can be better controlled because the total number of coins is predetermined.

Types of Cryptocurrency

Among the myriad cryptocurrencies, four notable examples include Bitcoin (BTC) and popular altcoins ether (ETH), Binance Coin (BNB), and Tether (USDT).

Bitcoin (BTC)

BTC is the most popular cryptocurrency. It uses a consensus mechanism called proof-of-work (PoW), where miners compete to validate transactions and keep the network running. In addition, BTC’s limited supply of 21 million coins makes it relatively scarce and helps maintain its value over time.

Ether (ETH)

Ether (ETH) is the second most popular cryptocurrency, launched in 2015 by Vitalik Buterin and his team. In addition to transfers of value, it enables programmability through smart contracts. 

Like BTC, ETH initially used a PoW consensus mechanism but has shifted to the more environmentally friendly and energy-efficient proof-of-stake (PoS) model. This shift has allowed users to validate transactions and secure the network by staking their ETH rather than through nodes using computing power.

BNB

Formerly known as Binance Coin, BNB (which stands for Build and Build) was introduced in 2017 by the cryptocurrency exchange Binance as an ERC-20 token on the Ethereum blockchain. In 2019, it migrated to its own blockchain, BNB Chain, as a BEP-2 token.

Later, Binance Smart Chain (BSC; now named BNB Smart Chain) was created and today, the BNB cryptocurrency exists on both BNB Chain as a BEP-2 token and BSC as a BEP-20 token. It’s also worth noting that BNB Chain consists of two chains: the EVM-compatible BSC, as well as BNB Beacon Chain (previously called Binance Chain), which covers governance, staking, and voting.

BNB Chain provides an environment for creating smart contracts and DApps, and features lower transaction fees and faster processing times than many other blockchains.

BNB has various use cases, some of which include paying transaction fees on BNB Chain and trading fees on Binance, participating in token sales, and staking for network validation on the BNB Chain. Binance also uses a periodic token burn mechanism, which limits the overall supply of BNB.

Tether (USDT)

USDT is a USD-pegged stablecoin launched in 2014 by Tether Limited Inc. Stablecoins are cryptocurrencies designed to maintain a consistent value relative to a reserve asset, such as a fiat currency. In the case of USDT, each token is backed by an equivalent amount of assets held in the company’s reserves. As a result, USDT offers the benefits of a cryptocurrency while minimizing price fluctuations.

What Is Crypto Market Cap?

The term “crypto market cap is” short for “cryptocurrency market capitalization”, which is a metric used to determine a cryptocurrency’s relative size and value. You can calculate it simply by multiplying a coin’s current price by the total number of coins in circulation. However, you may not even need to do so as many cryptocurrency platforms calculate it for you.

Crypto market cap is often used to rank cryptocurrencies, with a higher market cap generally indicating a more stable and widely accepted cryptocurrency. Conversely, a lower market cap usually signals a more speculative or volatile asset.

Do note, however, that this is just one of the many factors to consider when evaluating a cryptocurrency’s potential. Several other factors, such as technology, team, tokenomics, and use cases, should also be considered when researching cryptocurrencies.

How to Safely Invest in Crypto

Like other financial assets, investing in cryptocurrency can be risky and may result in financial loss. Here are five essential tips to make buying and selling cryptocurrency safer:

1. DYOR
   • The acronym DYOR stands for “do your own research”. It’s important to understand the basics of blockchain technology — such as the different types of cryptocurrencies and market dynamics — before investing in any cryptocurrency.Books, blogs, podcasts, and online courses are all good places to start. You should also learn about the projects, teams, and technology behind different cryptocurrencies in order to make informed decisions.
2. Start small and diversify
   • The crypto market can be volatile and unpredictable, especially when it comes to less popular coins. Therefore, starting with small investments that won’t hurt your pocket is wise. This approach enables one to gain experience and develop a better understanding of market trends without risking significant financial loss.Diversification can also be useful when investing in cryptocurrencies. Instead of focusing on a single cryptocurrency, investing in different cryptocurrencies can reduce your overall risk and increase your holdings’ chances of long-term growth.
3. Stay involved
   • As the cryptocurrency landscape is ever-changing, one should stay abreast of news, technological advancements, and regulatory updates in order to be able to make timely decisions. Joining a crypto community is an excellent way to do this.
4. Choose a reputable cryptocurrency exchange
   • Choosing a well-known and secure cryptocurrency exchange for your crypto investments should be your top priority in terms of security measures. The right crypto exchange can be found by researching different options and comparing their fees, customer support, interface, and available cryptocurrencies.
5. Practice risk management
   • Before investing in any cryptocurrency, it’s essential to implement some risk management techniques. For example, investors should only invest what they can afford to lose. In addition, setting stop-loss orders to limit potential losses and taking profits at predetermined levels to secure gains can make a big difference.

What Is a Crypto Whitepaper?

A crypto whitepaper is a document that explains the details and technical specifications of a blockchain project. It typically includes information such as the project’s goals, how it works, the technology behind it, the team involved, the tokenomics of the project, and the roadmap for development and implementation.

Cryptocurrency whitepapers serve as a comprehensive guide to the project, explaining its purpose and potential benefits. Investors and community members often review and scrutinize whitepapers to evaluate the legitimacy and potential of a cryptocurrency project before investing or getting involved. As such, whitepapers are essential for transparency and accountability in the cryptocurrency industry.

However, there are no standards or regulations for whitepapers, and they could be misleading or inaccurate. Cryptocurrency projects can write anything they want in their whitepapers. Therefore, the responsibility to verify the truthfulness of the claims in the document falls on the users.

Closing Thoughts

The cryptocurrency ecosystem represents a revolutionary approach to finance and technology. However, the future of cryptocurrency depends on whom you ask.

Some believe bitcoin will replace gold and disrupt the existing financial system, while others argue that cryptocurrency will always be a secondary system and niche market. There are also those who believe Ethereum will become a decentralized computer that will serve as the backbone of a new Internet.

Though there are numerous possible outcomes, it’s simply too early to determine what will happen even a year from now. Still, we can’t deny cryptocurrency’s already visible impact on various industries, which is likely to further develop in the coming years.

Further Reading

• What Is an NFT?
• What Is the Metaverse?
• What Is Blockchain and How Does It Work?

Critical thinking questions

1. How does the deterministic nature of hash functions ensure data integrity and reliability in blockchain technology?
2. What are the implications of collision resistance, preimage resistance, and second-preimage resistance for the security of cryptographic hash functions?
3. Why is it important for hash functions used in cryptocurrencies like Bitcoin to be one-way functions, and how does this property enhance security?
4. How does the adjustment of mining difficulty in Bitcoin mining ensure the stability and security of the blockchain network?
5. In what ways can the properties of cryptographic hash functions be applied to secure digital identities and authenticate data in various applications? 

Advocacy Initiative:

We encourage participants to begin memorializing the ways they are using time in prison to prepare for success upon release. I encourage participants to create a personal profile by:

1. Writing a simple biography
2. Writing a daily journal to show all that you’re learning
3. Writing book reports that memorialize the books you read
4. Writing a release plan to show the ways you’re preparing for success upon release

These strategies helped me immensely once I got out. By using my time wisely inside, I was able to raise capital, build businesses, and succeed in ways that few people would think are possible for someone who served multiple decades in prison. Anyone can do the same—if they prepare first.

If you’d like to follow in the same footsteps, I encourage you to begin building your personal profile. Get started by sending an email message to our team at:

Prison Professors Talent
[email protected]
32565 Golden Lantern, B-1026
Dana Point, CA 92629

Our interns will accept your email invite. You may then send the interns a message such as:

Dear Interns,  

My name is xxx, and I am in prison. I would like to begin showing the strategies I am using to prepare for success upon release. Please send me a Release Plan Workbook, and any other books that will help me prepare for the job market. After receiving those workbooks, I will begin building my profile to show others how I am using my time inside to prepare for success outside.  

Sincerely,
[Your Name]

Glossary

• Algorithm (noun): A step-by-step procedure or formula for solving a problem or performing a task.
• Bitcoin (noun): A decentralized digital currency that uses cryptography for secure transactions on a blockchain.
• Block (noun): A unit of data containing transaction information, which is added to a blockchain.
• Blockchain (noun): A decentralized digital ledger that securely records transaction data across many specialized computers on the network.
• Collision (noun): The occurrence when two different inputs produce the same hash output.
• Cryptographic Hash Function (noun): A hash function that uses cryptographic techniques to ensure data integrity and security.
• Data Integrity (noun): The accuracy and consistency of data over its lifecycle.
• Deterministic (adjective): Producing the same output from the same input every time.
• Hash (noun): The fixed-size output generated from input data using a hash function.
• Hash Function (noun): A mathematical formula that converts input data into a fixed-size output (hash).
• Hash Rate (noun): The measure of computational power used in cryptocurrency mining.
• Immutability (noun): The characteristic of being unchangeable once recorded.
• Merkle Tree (noun): A data structure used in blockchain to efficiently verify the integrity of data.
• Mining (noun): The process of performing complex calculations to validate transactions and add them to a blockchain.
• One-way Function (noun): A function that is easy to compute in one direction but difficult to reverse.
• Output Size (noun): The fixed size of the hash produced by a specific hash function.
• Preimage (noun): The original input data that is hashed to produce a specific hash.
• Resistance (noun): The difficulty of performing a certain action, such as reversing a hash function.
• SHA-256 (noun): A cryptographic hash function that produces a 256-bit hash, used in Bitcoin.
• Zero (noun): The leading character in a hash that meets the difficulty criteria in Bitcoin mining.