How Cryptocurrency Transfers Work

The phrase “payment transfer system” sounds so technical, but it’s really just a way for one individual to make a payment to another individual or entity.

Imagine you’re living overseas and want to send some of your wages back to your home country. How do you accomplish this? Why through some payment transfer system of course.

These are known as remittances, but even when you buy something online (and who doesn’t) you’re using a payment transfer system.

That’s a pretty useful system, don’t you think?

It is, but it’s also a bit cumbersome. Payment transfers in fiat currencies can take several days, you need to provide detailed contact information, and it can be quite expensive. Here are the most common issues that have been identified in traditional payment transfer systems:

Fees: Bank transfers can be extremely expensive, especially for smaller transfers. Third-party services such as Western Union and Paypal aren’t much better either.

Exchange rate: If you’re sending fiat currency to a different country there’s a very good chance that the currency you’re sending will need to be converted to the local currency. This means an exchange rate will be used to convert the currency, and most banks will quote rates that are 5-8% more expensive than interbank rates.

Time: Bank transfers can take up to several days, which is frustrating if you need access to your money right away.

Access: It’s been suggested by the marketing of banks and money transfer agents that you will always have quick access to your money, but the reality is quite different. For those in developing countries it could mean a long journey to find an office or agent where they can collect their funds.

Legalities: Some countries have legislations governing money transfers that could mean that you’re subject to taxes or other penalties.

Thankfully a better system has been developed. That is the cryptocurrency system that emerged in 2009 when Satoshi Nakamoto released Bitcoin to the world.

Here’s how a cryptocurrency transfer works in the most simple terms:

If I want to send you some of my cryptocurrency I publish the intent to do so on the blockchain. The nodes then scan the network to verify that I actually have the cryptocurrency I’m intending to send you, and that I haven’t already sent it to another person.

After the nodes confirm both of those conditions the transaction gets added to the next block. That block is connected to the previous block in the blockchain and the transaction is completed. There may be a small transaction fee depending on which cryptocurrency I’m sending.

One huge benefit to this system is that transactions cannot be deleted or altered because all the following blocks would need to be reconfirmed as well, and the network would reject the change.

A more Complex Version

In fact, your cryptocurrency wallet doesn’t hold your actual coins. Instead it holds your address or public key.

Why is that important?

The address has a record of all your transactions, and your balance as well.

This address is a string of 34 alphanumeric characters. You might also know it as the public key. The public key is the address given to others when you need them to pay you.

There is also a private key that is matched to the public key. Even though they are matched, there is no way to figure out the private key from the public key. The private key is twice as long – 64 alphanumeric characters. It is crucial that you keep the private key a secret from everyone.

The private key is used to digitally sign any transaction you make from your address. Basically this is done by putting both the private key and the number of coins into your software along with the address of the person you’re sending the coins to.

Once  the software has these three pieces of information it can create a digital signature and send the transaction to the network for verification.

Here’s one of the genius parts of blockchain technology…

Any transaction can be validated by plugging the signature and the public key into a cryptocurrency wallet. As long as the digital signature was made with the private key that corresponds to the public key being used the network will be able to validate the transaction without knowing what the private key is.

That allows the network to confirm that the coins are available and haven’t been spent previously because it can use the public address to run through the complete history of the sending address.

Even more Complex

Once a transaction is validated it gets added to the current block, along with many other transactions.

At this point it’s important to explain what a hash is, because it’s needed in the remaining explanation.

A hash is produced by a “hash function,” which is a complex math equation that reduces any amount of text or data to 64-character string. It’s not random – every time you put in that particular data set through the hash function, you’ll get the same 64-character string. But if you change so much as a comma, you’ll get a completely different 64-character string.

This whole article could be reduced to a hash, and unless I change, remove or add anything to the text, the same hash can be produced again and again. This is a very effective way to tell if something has been changed, and is how the blockchain can confirm that a transaction has not been tampered with.

So, now that you know what a hash is we can continue.

On a blockchain every block contains a hash of the previous block as part of its data. This is what attaches the blocks to each other and creates the “chain” part of “blockchain”.

It’s important because if any small part of a previous block is changed in any way, the hash of the current block would also change.

So, any change in a previous block is going to be reflected in every following block as well. This makes changing anything on the blockchain incredibly difficult because of the number of blocks that will need to be changed and re-validated.

It’s these hashes that make cryptocurrencies virtually tamper-proof. It isn’t impossible of course, but is so difficult as to be incredibly improbable.

What makes Blockchain Transfers Better

Let’s first remind everyone of the high fees charged for international currency transfers in the currently accepted currency transfer system.

Why do you think it is so expensive to make currency transfers?

Well, first of all, any of the global money transfer systems (banks, Western Union, MoneyGram) all have costs associated with maintaining a global physical presence. All those offices and the staff to man them is very expensive, and the cost is passed along to customers in various fees.

Banks also have to bear the costs of conversions. In a recent study the World Bank determined that a traditional money transfer for private citizens costs over 7% of the payment amount.

Cryptocurrency transfers avoid the expensive real-world movement of currencies. This provides favorable transaction costs, speed and reliability in the network’s operation. Converting these cryptocurrencies to fiat currencies will then cost roughly 1.5-2% using most third-party cryptocurrency exchanges.

That’s a savings of more than 5% of the payment amount for most transactions.

While most blockchain projects are currently working on solving this more for corporations than individuals, there are still some cryptocurrencies looking to make global transfers less expensive, or even free, for the individual.

How Individuals Benefit from Cryptocurrency Transfers

There are several benefits of cryptocurrency transfers for the individual. The foremost in most people’s minds is of course the dramatically lower fees and costly transactions.

Additionally, cryptocurrency transfers are incredibly fast as a way to transfer value across borders. In some cases they can occur in just seconds.

Cryptocurrency transfers can be made without additional conversion or exchange costs.

In Conclusion

While cryptocurrencies haven’t been adopted by mainstream users yet, it’s inevitable that they will be. The cost savings, speed and reliability is simply too attractive.

All that’s needed is to make cryptocurrency transfers and withdrawals as simple as a traditional money transfer, and most people will quickly come on-board with cryptocurrencies.

It’s been said before, but I’ll repeat it. Cryptocurrencies are the future of money.

Featured image by Ghani Pradita