How does a cryptocurrency work?

It is basically the blockchain network and the technology behind it that makes it possible to conduct decentralized transactions. The network of a cryptocurrency runs 24/7, this is because it is decentralized with nodes/computers all over the world.

The transactions that take place in the network consist of different information, but a common denominator is that they contain information about the recipient, sender and the amount that is transferred. This information is distributed to all nodes in the network, which together confirm the transaction by checking with the main public transaction book. If everything is in order, the transaction is approved and executed. The extraction of new blocks used for transactions takes place by means of an algorithm that must be solved by a node in the network. This node gets paid by the sender of the transaction to extract the block. Nodes are also paid to confirm transactions that have taken place on the network.

In addition to confirming transactions, the nodes help secure the network. This is done by having updated versions of the transaction ledger, as well as adding new blocks to the chain using hashes.


The specific process for how this is done depends on the algorithm of each cryptocurrency.

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Different algorithms

The algorithm of a cryptocurrency is like the foundation of a house. This is the data code that determines how a cryptocurrency should work on a daily basis. It is especially important in deciding how new blocks are extracted and added to the blockchain.

To extract a new "block", one of the nodes, also called a miner/staker, must solve a cryptographic problem, ie a mathematical problem. This requires a lot of computing power. There are different protocols for how to solve this. The two most used and well-known algorithms are:

  • Proof of Work (Bitcoin, Dodgecoin, Litecoin, and more)

  • Proof of Stake (Ethereum, Solana, Cardano, Algorand, and more)

Proof of Work (PoW) means that the one with the most computing power (CPU) has the greatest chance of extracting a new block. You can think of it as a lottery, the one with the greatest computing power has more tickets to win.

Proof of Stake (PoS) works in such a way that the one with the most currency units in their wallet has the most tickets to win the lottery. That is, how much money are you willing to invest to secure the network and approve transactions.

In recent times, there have been several algorithms that try to improve or have other methods than the algorithms mentioned above. But PoW and PoS are still the largest and most widely used.

In order to make the extraction more profitable and fair, it has gradually become more normal for several nodes to extract blocks together, in so-called "pools". Here you get your share of the total income from the pool you are part of based on what percentage you contribute of computing power or currency units. When you are in larger pools, there is also a greater chance that the pool you are in will win the extraction of new blocks.

There has been some criticism regarding the decentralized aspect of using such pools. One of the biggest objections to the use of a cryptocurrency is whether some players become larger than 50%.

You then in theory have the opportunity to control the network which involves stopping new transactions or payments between selected players. In such an attack, you can in theory also reverse transactions that happened when you were in control of the network, which means that you can, for example, use the currency twice. As you can see, it is therefore very important that the decentralized part of a cryptocurrency is maintained. The more nodes and actors the network is divided into, the more secure the blockchain will be against such attacks.

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