How Cryptocurrencies Use Cryptography

by Sandip Das from
How Cryptocurrencies Use Cryptography

Since cryptography is at the heart of all cryptocurrencies, this post on how cryptocurrencies use cryptography will strengthen your understanding of cryptos. With the introduction of Bitcoin in 2009, the world got a futuristic currency called cryptocurrency that can operate without an intermediary or any central authority. Cryptos are, secure, private, and decentralized. Have you ever wondered how cryptos achieve all these without being controlled by any governing body? Cryptography is the secret behind all these and much more.

1. The Specification of Crypto Environment

Cryptocurrencies operate in a trust-less environment. This means the crypto economy doesn't need a controlling central authority to manage it, unlike the traditional financial system. In a trust-less system, the users don’t need to know anything about each other.

Cryptography ensures that information is protected through codes and revealed only to the desired parties. Therefore, knowing about cryptography is essential to answer how do cryptocurrencies work. In this post on How cryptocurrencies use cryptography we are going to discuss:

  • What is cryptography?
  • How cryptocurrencies use cryptography
  • Cryptography methods
  • Crypto encryption
  • Purpose of cryptography
  • What are crypto keys
  • Cryptography vs. blockchain

2. What is Cryptography in Cryptocurrencies?

If you are wondering about what is cryptography in blockchains, this section will clarify all your doubts. The word ‘crypto’ in ‘cryptocurrency’ means secret in Greek. Cryptocurrency and cryptography go hand in hand.

In simple words, cryptography ensures secret communication. From WhatsApp messages to emails, cryptography is used in one form or another to enable users to communicate in secure ways. Since cryptocurrencies work in a peer-to-peer environment without any central body, cryptography is at the center of a cryptocurrency’s operations.

Cryptography uses sophisticated mathematical techniques to ensure the secrecy of communication. Cryptography ensures that all blockchain transactions remain secure and private, while no bad actor can alter blockchain data, and if you want to know more about blockachin itself, please check our blockchain for beginners guide.

In layman’s terms, cryptography converts an original message into an unintelligible message so that only the intended party can interpret it. Cryptography generally uses a two-step process involving encryption (in which information is made secret) and decryption (in which secret information is revealed only to the desired party). In cryptography, the sender encrypts the data and the receiver decrypts it.

The concept of cryptography is nothing new. It has been in practice in digital transactions for decades. However, cryptography’s application has been much more intensive in cryptocurrencies and continues to be in 2024. In cryptocurrencies, cryptography ensures that blockchain transactions are trustless, secure, anonymous, and private. Therefore, cryptocurrencies would hardly exist without cryptography.

3. Cryptography Methods Used in Crypto

There are mainly 3 cryptographic methods used in crypto in 2024, which are hash functions, symmetric key algorithms, and asymmetric key algorithms. These cryptography methods are heavily used in cryptocurrency algorithms or Bitcoin algorithms.

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3.1 Hash functions

The hash function doesn’t use any key for encryption, and it works in a one-way manner. Hash functions are heavily used in modern cryptography. The hash function transforms large random-size data into small fixed-size data. The output of the hash function is called hash value or digest. The hash function’s one-way operation ensures that we cannot calculate the input from the output.

The hash function creates a unique identifier, like a fingerprint, of data which helps in verifying the original data. Traditionally, hashing is used to index data and retrieve the same from a database in an efficient manner. Hashing is used to ensure data security. An entity without knowledge of the original message cannot decipher it from the hash alone.

3.2 Symmetric Key Algorithms

In Symmetric key algorithms, encryption, and decryption are done using a single cryptographic key. One cannot decrypt encrypted data without this cryptographic key. These cryptographic keys are securely generated and sent to senders and receivers of a message. The key remains unknown to other entities. So, if one entity compromises the key, the entire communication gets compromised.

3.3 Asymmetric-key Algorithms

In asymmetric key algorithms, the encryption and decryption are done by two mathematically related keys called public and private keys. In this cryptographic method, encryption is done using one key while decryption is done using the other one. The asymmetric key algorithm is also known as the public key algorithm.

In asymmetric-key encryption, the owner needs to keep the private key a secret because it can be used to decrypt information. The public key can be made available to the public as it acts as an address. For instance, your email ID is like a public key, which can be distributed to anyone. However, the password of your Email is the private key. You need this private key to access your emails.

While making crypto transactions, you need to share this public key to receive cryptos. Anybody having your public key can send your cryptocurrencies. However, you need your private keys to access those cryptos and use them.

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4. Key Cryptographic Functions in The World of Cyptocurrencies

In blockchains, the most commonly used forms of cryptography are hash functions and public-key cryptography. However, other forms of cryptography are also being tried and tested in blockchain encryption to ensure more security, scalability, and privacy.

Let’s look at some of the roles cryptography plays in cryptocurrencies and answer how does cryptography work:

4.1 Transaction Authentication

In the absence of any central authority, transactions in a blockchain are authenticated using public and private keys. Blockchain users need to have a public/private key pair and a blockchain address to submit transactions in the blockchain. The public key is generated using the private key, while the blockchain address is generated using the public key.

A blockchain address is similar to the name associated with your bank account. However, the only difference is that a blockchain address doesn’t use any real name or address. Rather, a blockchain address consists of a pseudo-anonymous string of numbers and letters. Users store their cryptos or execute their blockchain smart contracts in the blockchain address. The private key is like your Internet banking password, which is required to transfer funds or execute smart contracts.

When a user sends a transaction to the blockchain, they send a message for their blockchain address to the blockchain network. This message contains both transaction data and a digital signature. The transaction data shows what action the user wants to take, while the digital signature authenticates that action. The digital signature is formed by combining a hash of the transaction data and the private key.

The miners or validators of a blockchain verify the digital signature to validate transactions on the blockchain — more on how bitcoin mining works can be found in our related article. Transactions are authenticated and blocks are created after successful verification. This way, hashing and public-key cryptography make sure that only users having private keys can access the stored funds in the linked blockchain addresses.

4.2 Production and Finalization of Blocks

Block production and finalization are crucial for maintaining a blockchain. Blockchain data are contained in blocks connected chronologically. Blockchain miners or validators bundle pending blockchain transactions into blocks and propose the same to the blockchain. For a block to be accepted by the blockchain, miners/validators need to generate a valid hash for a block.

Under the Proof of Work (PoW) protocol, there is an open competition among miners to use brute force to generate a valid hash to get their blocks accepted by the network. When a block gets accepted by the network, the miners get rewarded for their work.

PoW blockchains also use hash functions to protect against Sybil attacks. Under Sybil attacks, bad actors get the majority of influence on a network to carry out their illegal activities by breaking the network’s rules.

Hashing is also used in PoS blockchains for block production. However, under the PoS system, there is no competition among the validators. Rather, a process of randomization is followed to select the validator who gets to complete a block. The odd of a validator to get a chance to complete a block is proportional to their staking weight.

Proof of stake and proof of work protocols are generally a very important part of cryptocurrency environment. If you want to find out more about the difference between PoW and PoS, just click on our related article.

4.3 Storage of data

A blockchain is a decentralized ledger to records all transactions in chronological order. All nodes in a blockchain keep a record of all the transactions recorded in the blockchain. As a blockchain runs longer and the size of the ledger goes up, it becomes costlier and more burdensome for the nodes to sync and store all the latest data.

Hash functions help blockchains store data efficiently. For secure and efficient encoding of data, blockchains use a data structure called Merkle tree. Under the Merkle tree, each transaction is hashed and then connected to another hashed transaction and hashed again. This hashing process continues until there is a single hash (called Merkle Root) for all the hashes. This way, Merkel tree uses the cryptographic hash function to free up disk space, maintain data integrity, and encode data in the blockchain ledger.

Therefore, as you can see from the above discussion, cryptography helps in authenticating transactions in a blockchain, protecting it against attacks, storing data, maintaining data integrity and security, and optimizing data storage. Moreover, cryptography helps blockchains achieve decentralization by doing away with the need for trust.

5. The Importance of Cryptography in Cryptocurrencies

Cryptography is what makes cryptocurrencies possible. Cryptocurrencies use the most sophisticated cryptographic methods to authenticate transactions, validate blocks, make the blockchain immutable, ensure decentralization, protect the blockchain against attack, and ensure efficient movement of the cryptos. So, why is cryptography important, and what is cryptography used for?

Let’s look at some of the end results of cryptography in cryptocurrencies:

  • Privacy and anonymity: In the traditional financial system, you cannot make transactions without revealing a range of personal data starting from credit card information to your address. The same is not true in cryptos. Cryptography makes a blockchain private and anonymous. The central idea behind cryptography is to ensure that information is revealed only to the intended parties. Also, cryptographic hashing ensures that crypto transactions can be efficiently conducted without revealing too much use data.
  • Balancing transparency and confidentiality: Cryptos use cryptography to achieve the right mix of transparency and confidentiality. While transactions in a public blockchain are transparent and visible to all users, the real identity of the users is protected using cryptography.
  • Security: Security is key to building trust in the blockchain technology. Cryptos use advanced cryptography to make a blockchain network secure by thwarting potential attacks.
  • Decentralization: One of the key promises of blockchain that sets it apart from traditional finances is decentralization. The decentralized nature of blockchains ensures that we don’t need any third parties to get financial transactions done. Cryptography ensures that peer-to-peer crypto transactions can take place seamlessly in the absence of any central authority.

6. How Cryptocurrencies Use Cryptography: Conclusion

Cryptography uses concepts from mathematics and computer science to ensure private and secure communication. Cryptography transforms an original message into an unintelligible message that can be deciphered only by the intended party.

In blockchains, cryptography is used for key functions such as transaction authentication, production and finalization of blocks, storage of data, protection of the blockchain against potential attacks, and ensuring decentralization. Moreover, cryptography helps a blockchain achieve privacy, security anonymity, and confidentiality.

Now when you are familiar with how cryptography works in crypto, you can start to familiarize yourself with other interesting concepts, such as high-frequency trading in crypto. As always, you can find all that information on our website — just clink on the link.

7. How Cryptocurrencies Use Cryptography - FAQs

7.1 ❔ How does cryptography help blockchains?

Cryptography ensures private and secure communication in a blockchain. Blockchain platforms can achieve the utmost security, privacy, anonymity, and confidentiality because of cryptography.

7.2 ❔ What is the difference between cryptography and cryptocurrency?

Many investors often get confused about cryptocurrency vs. cryptography. Cryptography is the mathematical technique of ensuring secure and private communication over a blockchain. Cryptocurrency is a digital currency that uses cryptography to ensure peer-to-peer transactions.

7.3 ❔ Do cryptocurrencies involve intermediaries?

Cryptocurrencies are decentralized in nature. This means they don’t have any intermediaries. They can operate in a peer-to-peer environment using cryptography. This post on how cryptocurrencies use cryptography, discussed the role of cryptography in decentralization and the purpose of cryptography.

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