The whole idea of cryptocurrency is still relatively new for a broad audience, and there is still confusion when it comes to how digital money is structured and works. As compared to fiat money in a bank account, digital money based on blockchain is both innovative and decentralized, which is why we want to discuss the most popular ways that lead to the creation of cryptocurrencies.
Alt-text: creating cryptocurrencies
What is a cryptocurrency?
At its core, cryptocurrency represents bits of information stored on a distributed ledger, also known as blockchain, that is transacted among retail or institutional entities. As with regular currencies, there are several ways digital money is created. To explain that better, it is imperative to talk about two important factors:
– Hashing algorithms
– Consensus mechanisms
These are the two pillars a cryptocurrency blockchain relies on and understanding them will help you get an in-depth view of how crypto works. Keep in mind that not all cryptocurrencies are equal and each blockchain has its own particularities. However, some basic principles apply with most of the popular tokens like Bitcoin, Ether, or Litecoin.
Creating a cryptocurrency
Cryptocurrencies are now treated like any other asset class (stocks, bonds, indices) and can be bought/sold through exchanges as well as brokerage houses. Cryptocurrency trading is now one of the main trends in financial trading, but even though traders are using cryptocurrencies to diversify their market exposure, there are some differences when it comes to how these tokens are being created.
As mentioned above, the hashing algorithm is one of the most important elements of smooth blockchain functioning. It represents a mathematical algorithm that can be used for applications such as verifying the integrity of messages/files, signature generation and verification, password verification, and many others. For cryptocurrencies, the main hashing algorithms are SHA-256, CryptoNight, and CryptoNote,
PoW, PoS, and minting
Second of all, the consensus mechanism will have a key role in determining how new cryptocurrencies are generated on the blockchain once each new block is created. In the case of Proof-of-Work (PoW), miners verify financial transactions and complete a mathematical puzzle using their computer processing power. Those who do that first will receive the reward associated with the specific cryptocurrency.
Proof-of-Stake (PoS) is currently gaining traction, with Ethereum, the second-largest cryptocurrency, projected to adopt it in 2021. The key difference is that in this case, there is no competition as the block creator is chosen by an algorithm based on the user’s stake.
Entities or individuals need to deposit tokens on the blockchain and receive rewards each time a new block is created based on that. It would be almost impossible to add a malicious block because that will imply someone holding 51% of all the tokens in existence.
When it comes to PoS, the process is no longer called mining but minting, and means the process of validating transactions, generating new blocks, and recording information on the blockchain. Validators are chosen pseudo-randomly and have the duty to secure the network and make it operate properly.