How does bitcoin work?

Bitcoin is a decentralized digital currency. It thus means that it is intangible and has no central control. This digital currency was developed by Satoshi Nakamoto in 2009 in a bid to solve the challenges that people face while sending and receiving money. The big question is, how does bitcoin work?

Remember that no one owns this currency and either does it have a central authority for control. 

Bitcoin is an open-source cryptocurrency. In layman’s language, all the information is public and displayed on a public ledger. Some people may argue that this feature may open the network up for manipulation. However, Bitcoin applies cryptography to secure the transactions. 

What is a full node?

It is worth noting that transactions are verified through consensus. It thus means that different players have to agree on the validity of a specific transaction before they add it to a block. For the validation of these transactions and blocks to happen, one requires a full node. It is the work of the full node to download every transaction and block and check them against the consensus rules laid down by the Bitcoin network. Some of these consensus rules include:

  • Every transaction has the right signature
  • There is no double spending on a single blockchain
  • Every block can only release a given number of bitcoins (the number is 12.5 BTC for every block currently)

What is a block?

Several blocks will form a blockchain. A block is where several transactions are kept on a permanent basis. After the miners make the consensus on the transactions, they group them into blocks, and a sequence of them forms the blockchain. You have to understand bitcoin mining to understand this concept on a deeper level.

What is bitcoin mining?

When most people hear about mining, all that can come to their minds is physical products such as oil and gold. However, in this case, we are not dealing with physical or tangible products. An important point to note when it comes to this virtual currency is that the supply is limited at 21 million bitcoin. 

Bitcoin mining is merely the process of validating transactions. For example, if person A sends two bitcoins to person B, it is the work of the miners to verify this transaction and add it to a block. The miner will in return get a reward for the effort. It thus means that mining does create new bitcoins but releases those in the fixed supply.

Mining is not a manual task.

You have to dedicate your computing power to solve mathematical problems. Most miners share their computing powers with mining pools to become competitive in this area. When your pool generates a block, the reward will be split among all the participants based on the amount of computing power that you have dedicated. 

A block is created after every 10 minutes roughly. This block is connected to the previous block. The result is a chain of blocks which essentially make the blockchain. You have to run a full node for you to become a miner. All the information on the bitcoin network is stored in the nodes.

Bitcoin mining farm.
Bitcoin mining farm.

Anonymity

One of the main features that make people fall in love with bitcoin is its anonymity feature.

You cannot tell who owns a particular address unless he or she decides to link a name on it.

In simple terms, the bitcoin network keeps track of addresses where the money is instead of the users of the network. You cannot understand how bitcoin works before you know what a bitcoin wallet is.

How a bitcoin wallet works

Most of us store our physical cash in a wallet. However, in this case, we are storing a digital currency which calls for a digital wallet. Once you buy bitcoin, you will store them in a wallet. There are many types of wallets where you can store your bitcoin. We can use the analogy of an email account to explain how a bitcoin wallet operates. A bitcoin wallet has two keys namely private and public keys.

Public key

It is accessible to everyone on the bitcoin ledger. It is like your email address which is public. Anyone with your email address can send you a mail. It contains between 26-35 characters. This is an example of a public key;

39TqSdRnj1ov4dUyeqyMQnQDYbqMNjrqJV

It is worth noting that anyone on the network can tell the number of bitcoins on every public key. 

Private key

This compares to the password to your email account. Anyone with your public key can send you bitcoins, but no one can access the coins unless he or she has the private key. You have to combine the two keys, which is equivalent to a digital signature, to transfer bitcoins from your address to another user.

A private key is longer than a public key and can have like 60 characters. An imaginary private key looks like this

UB2312AjsUhsUaHsjKWkL1JjE9s1AgdXqfRKr7wxKJU76Gsy7yH4sGs892HgXBNqW71Q3mg1SnK1Gast&5shGfFsY62Kis9Uiw.

Peer to peer technology

If you want to send money to someone else, you will most likely use your bank or international money transfer service. These middlemen will charge a commission and even at times cause delays. Bitcoin transactions work differently as they eliminate the need for intermediaries by allowing you to send money directly to another person. Once the miners validate the transaction and add it to a block, then the deal is marked as complete and that is simply how bitcoin works. 

Public Ledger

To answer the question ‘what is bitcoin and how it works,’ you have first to understand a public ledger. Regular banks have a database where they keep all their records. However, some people can manipulate the entries and even decide what to show to the public. Bitcoin has a public ledger which shows all the transactions once they undergo verification. Every member of the network can trace every transaction and see the movement of the coins within the network. The public ledger is distributed to many computers all over the world. Failure of one machine will thus not affect the network

Conclusion 

The blockchain network is secure and transparent. Several countries are already banking on blockchain in the voting process. If you want to change information in a particular block, it will also affect the rest.

A good example is a blockchain with 1000 blocks. If you’re going to manipulate data on the block 50, you will have to change the other 900 blocks which is impossible. As already stated, all decisions are reached through consensus which makes manipulation hard.

Do you still have doubts about how does bitcoin work? Let us know in the comments section.

Nica Tudor

Blockchain, Smart Contracts, and cryptocurrencies enthusiast.

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