Cryptography plays a critical role in many contemporary financial technologies, underpinning a wide range of financial applications from secure cash transfers to blockchain. Therefore, it is important for financial professionals to understand the basics of modern cryptography.
Blockchain technology has found an increasing number of applications in finance. While cryptocurrencies such as Bitcoin remain the most well-known use of blockchain, the technology is increasingly used in areas such as trade finance, investment banking, and elsewhere.
Blockchains and distributed ledger technologies can be used for various purposes. Among these is the creation of digital assets with certain unique features. Known as crypto assets, these are applications of distributed ledgers that are designed as a medium of exchange or store of wealth, although their infrastructure may be used for other purposes. The most prominent of these is Bitcoin, but there are many other examples.
Cryptography is not a new phenomenon. It simply means encoded writing or secret writing. The first instances of cryptography date as far back as 1900 BC from an inscription in the main chamber of the tomb of the nobleman Khnumhotep II in Egypt.
The aim of cryptography is to protect messages from attacks by outside parties, so only the sender and receiver can understand the meaning behind the communication.
There are three different types of modern cryptography:
- Secret Key Cryptography
- Public Key Cryptography
- Hash Functions
The most basic type of cryptography is secret key cryptography (SKC) which uses a key to encode a message. That same key is then used to decode the message. Both parties involved in the exchange must know the key and that knowledge must not be shared with anyone else for the message to be secure.
Public key cryptography (PKC) is a way for two parties to communicate privately and securely across an insecure network without sharing a secret key beforehand. PKC users create key pairs – a public key and a private key – that are used to encrypt and decrypt messages. The public key can be widely shared, while the private key must be kept secret.
The third form of cryptography is known as hash functions and is used to provide a guarantee of the integrity of a message.
Hashes are one-way encryptions: they encode a message but cannot be decrypted. However, any alteration to the message will cause its hash to change. Hashes can be thought of as data “fingerprints”.
Hash functions make it possible to verify passwords with a database, without the risk of the password being stolen. If we store the hash of a password, we can verify whether an attempted password has the same hash, without knowing what that password is.
Blockchain has become an increasingly important financial technology, thanks to the publicity surrounding Bitcoin, a cryptocurrency based on blockchain technology.
In general terms, a blockchain is a database or ledger composed of a timestamped and immutable chain of records, that grows as new records – or blocks – are added to it.
Each block contains some type of record – transaction data, for example – as well as a timestamp and cryptographic information that includes a link to the previous block.
Blockchains reside on multiple computers at the same time, rather than on a single, centralized server. Thus, blockchain technology is sometimes known as distributed ledger technology.
Blockchains and distributed ledger technologies can be used for various purposes. Among these is the creation of digital assets with certain unique features. Known as crypto assets, these are applications of distributed ledgers that are designed as a medium of exchange or store of wealth, although their infrastructure may be used for other purposes.
Crypto assets are part of the wider set of digital assets, which are assets that do not exist in any physical sense.
A balance at PayPal, for example, is a digital asset, as is the balance of tokens in an online game – they are assets in the sense that they appear on the asset side of the "balance-sheet" of those entities.
Crypto assets, sometimes known as cryptocurrencies, are digital assets that share specific characteristics, such as their ledgers generally being decentralized and their using of public key encryption algorithms.
In conclusion, cryptography, blockchain, and crypto assets are key areas of financial technology both budding and progressive financial professionals need to understand.
The information in this article is taken from Intuition Now’s Crypto and Blockchain online, one-demand course.
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