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What Is Encryption in Blockchain and Its Impact on Cryptocurrency?

By Samuel Becker · November 19, 2021 · 4 minute read

We’re here to help! First and foremost, SoFi Learn strives to be a beneficial resource to you as you navigate your financial journey. Read more We develop content that covers a variety of financial topics. Sometimes, that content may include information about products, features, or services that SoFi does not provide. We aim to break down complicated concepts, loop you in on the latest trends, and keep you up-to-date on the stuff you can use to help get your money right. Read less

What Is Encryption in Blockchain and Its Impact on Cryptocurrency?

Encryption is the technical process that prevents sensitive or private information from falling into the wrong hands. When it comes to cryptocurrency messages and transactions, encryption and decryption between two parties means that a third party can’t make sense of it or misuse it.

When it comes to blockchain technology, however, encryption is a bit more complicated than password-protecting a file, or adding two-factor authentication to a platform. Encryption is one of the features that makes blockchain such an exciting technology for different types of users.

Encryption is an important part of crypto transactions, and it’s helpful to have a basic understanding of how it works. Here’s what you need to know:

How Is Encryption Used in Crypto?

You may have noticed that the words “encryption” and “crypto” share a common root: “Crypt.” Instead, it relates to cryptography, or the practice of anonymizing and protecting sensitive data.

Broadly speaking, cryptocurrencies use encryption methods to make transactions anonymous and secure. Proponents of crypto cite its security as one of its major benefits.

Using blockchain cryptography, two parties can complete a transaction without sharing their own information or having to use a middle man such as a bank or government. Different types of cryptocurrencies use different types of encryption.

Recommended: A Brief History of Cryptography

What Type of Encryption Does Blockchain Use?

There are a few ways that a system might encrypt data: Symmetric encryption, asymmetric encryption, and hashing.

Symmetric Encryption

If the users employ the same key for both encrypting and decrypting the data then the system uses symmetric encryption. This is also sometimes referred to as “secret-key encryption.”

The key used in this sort of cryptographic system may be called a “common key,” as it’s used to both encrypt and decrypt data. Such a system, however, has greater potential for a security breach.

Asymmetric Encryption

Conversely, an asymmetric system uses two keys — a public key, and a private key. The Bitcoin network is an asymmetric system, since it issues users a private key which then generates a public key. It may also be called “public-key encryption.”

The way that an asymmetric encryption system would work then, is that the public key can be used for encrypting or encoding data, but the users would need a private key to decrypt or decode the data. In other words, the public key turns plaintext into ciphertext, but a user’s private key turns the ciphertext back into plaintext.

Hashing

Hashing does not utilize keys at all. Instead it uses an algorithm that generates a “hash value” based on the plaintext input. Hash functions are very secure, and the hash value generated often makes it difficult, if not impossible, for users to recover the plaintext to once encrypted.

The actual technical process behind hashing is fairly complicated, and because of that, can be used as a method of mining for some cryptocurrencies. The computational resources being expended on a network to contribute to the hashing process is referred to as the hash rate, and a good hash rate generally means that the network is secure.

The Importance of Plaintext and Ciphertext in Blockchain Encryption

Blockchain encryption is the process of securing and obscuring data, systems, or networks, making it difficult for unauthorized parties to gain access. The technical process behind encrypting data usually requires a crypto algorithm to convert “plaintext” into “ciphertext.”

What Is Plaintext?

Plaintext is what you type into your phone when you send a text or even the words that you’re reading right now. Plaintext is found everywhere and can contain sensitive information — like the password to your crypto wallet.

What Is Ciphertext?

Ciphertext is encrypted text. The encryption process converts into ciphertext — it’s turned into a code, in other words — by a program or algorithm called a cipher. In order to decrypt a message in ciphertext, a second party needs an algorithm or cipher to turn ciphertext back into plaintext. Decrypting is the opposite of encrypting.

The Role of Blockchain Encryption Algorithms and Keys

As mentioned, systems and networks that incorporate encryption use algorithms, and sometimes keys to do it. For instance, the Bitcoin encryption issues users a private key or a seed phrase, which generates a public key, too. That public key is like a Bitcoin address, and anyone can access it. It is what you would give to other people in order to execute a Bitcoin transaction.

Recommended: What Is a Bitcoin Seed Phrase?

Many cryptocurrencies use asymmetric encryption to ensure that the transactions on their network are secure. So, those “keys” are a user’s encryption tool — they can encode or decode encrypted data. Again, a network (like Bitcoin) may incorporate both public and private keys, so that transactions can occur, and so that users can ensure that their holdings remain secure (by never sharing their private key).

Algorithms do the actual encrypting and decrypting. There are several methods through which this can occur, but on a basic level, cryptographic algorithms scramble data or information, turning plaintext into ciphertext. Users then employ keys to turn unreadable or scrambled data back into something readable.

The Takeaway

The technical side of cryptocurrency networks — including encryption and security — can be a lot to digest. There are numerous methods to encrypt data, and different blockchain networks may incorporate different types of cryptography, which are more or less secure than others.

When you start buying crypto through SoFi Invest, the app takes care of the security on your behalf. That way, you can focus on building a portfolio that includes cryptocurrency, stocks, and exchange-traded funds.

Photo credit: iStock/Olemedia


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Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
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