Cryptocurrencies are also called decentralized currencies because central financial authorities like banks are not involved in the transactions carried out by users. In order to prevent people from misusing these currencies, a few security systems are in place and these systems are what we will talk about today.

As discussed in the previous blog, our identity is going to be a set of 10-digit numbers. When a transaction is taking place, it will look like 1234567890 has given 30 coins to 6789043567. These numbers don’t reveal your identity, therefore, act as pseudo-identity.

Let’s start with an example say Alice has a hypothetical number (1234567890) and Bob has a hypothetical number (678904356750). Alice wants to transfer some bitcoins to Bob. Imagine this transaction as an entry in a ledger.

Now in a transaction between Alice and Bob, she will give her own 50 coins and get 32 deducted as a result of the transaction with Bob. Keep in mind, crypto coins are not like cash where you can give the exact change, instead,  think of 50 as a currency note which you will need to give to get the change.

And since Alice has decided that she wants to give 30 to Bob,  when she gives 50, 18 is returned to her. Why not 20? That’s because 2 coins are the cost of the transaction which will be deducted.

Once she has had paid from her end, she creates something called the digital signature which is nothing but a transaction id. She will broadcast this digital signature to people in the peer-to-peer network called Nodes. These nodes are basically all the people that are doing the same type of transaction and will help Alice validate the details of this transaction to Bob. Basically, nodes assure Bob that she gave him the money and there is no funny business associated with it.

And why do you think these nodes help? Remember the two coins which were deducted as the cost of the transaction, well, they act as an incentive to the nodes. So, imagine these nodes are basically all people in the network and they have a job to not say yes to a faulty or inaccurate transaction. This minding is important for nodes because if they want to keep making a profit, they will need to disagree in consensus if a faulty transaction is before them, otherwise, that block in the blockchain will collapse.

The peer-to-peer network is basically a network of individuals that collectively agree on different aspects of how a protocol is implemented and used, and that’s how they mind the network.

After getting the coins from Alice, Bob will also check if the math works out. Now, there is something we have to worry about when we have virtual currencies, and that is when someone can try to copy the numbers that identify this transaction and try to use them elsewhere.

To reduce the risk of this, specific nodes in the peer-to-peer network called bitcoin miners are employed. They take all the transactions in the whole system, not just Alice and Bob’s transaction, but all, and compile them into what’s known as a transaction block. If one transaction is an entry in a ledger book, the block is an entire page in that ledger book. These miners include a specially crafted sequence of numbers associated with these transactions is known as proof of work into the transactional block. It is called proof of work as it is very hard to generate as it requires a lot of effort to do and that makes it hard for just anybody to get involved with Bitcoin mining simply. It is required that they exhibit or exert some computational effort to get the extra reward promised to them after mining. This incentivizes these miners to do what they do and it mainly comes from the deducted coins from transactions between Alice and Bob and others.

Each transaction block is connected to its previous block and so on so forth forming a chain of blocks. So imagine we have a chain of 5 blocks and assume if an attacker wants to mess with the 4th block, then the code for the 4th block will change, and if the 4th block changes, the code of the last 5th block also changes. so even if one block in the middle is messed with, the attacker has to change the code of all the subsequent blocks after that middle block to preserve the integrity of the chain. This can take a lot of time and by this time people in the network can take notice and prevent this from happening.

To know more, check out our blog next week.

Cryptocurrency is making a lot of noise in the media today. Carisma solutions had started working towards our accounting readiness for Cryptocurrency and Bitcoin in the year 2017. We have executed client accounting work in cryptocurrency.  

Rishika Gupta is a passionate digital marketer. She loves 80’s music and is a hardcore anime fan. If you like what she writes about, send your feedback at PurpleQuay builds Enterprise software products and Learning management products for the education industry, screening, and testing software for non-Communicable diseases and rare diseases in the health care industry, and productivity solutions for the accounting industry.