How Does Bitcoin Work?

Bitcoin (BTC) is a revolutionary digital currency that functions independently from banks or centralized entities. It was created by the pseudo-anonymous Satoshi Nakamoto as a decentralized alternative to traditional financial systems, enabling transactions directly between users. This brief guide will explain how Bitcoin works and the underlying technology powering it. 

Looking Under The Hood

Bitcoin is a decentralized payment system and currency operating without a financial system or the involvement of financial institutions. At the center of Bitcoin’s success is its protocol that ensures secure, transparent, and trustless transactions. 

The Bitcoin Blockchain 

The Bitcoin blockchain is a publicly available, distributed ledger containing a record of every Bitcoin transaction. When a transaction is initiated, it is signed with a secure digital signature and broadcast to the Bitcoin network. Anyone can download a copy of the blockchain and trace previous transactions between users. While anyone can view the transactions, once transactions are added to the Bitcoin blockchain, they become immutable. This means they cannot be altered in any shape, way, or form. 

Another thing to remember is that while the blockchain maintains a record of every Bitcoin transaction, these transactions may or may not be linked to real-life identities. This is why Bitcoin is considered pseudo-anonymous. Some features of the Bitcoin blockchain are: 

• Transparency:  The Bitcoin blockchain allows anyone to view the history of all Bitcoin transactions. Transparency ensures trust and security.

• Decentralization: The Bitcoin blockchain is decentralized, meaning it is not controlled by a single entity. Instead, it is maintained by its network of nodes that verify transactions and secure the blockchain. 

Blocks 

A block is a set of Bitcoin transactions from a specific time period. Blocks on the blockchain are “stacked” so that each block is dependent on the previous one, creating a chain of blocks, hence the term “blockchain.” Blocks are created by Bitcoin miners in return for BTC. Whenever a miner solves a block, they earn a predetermined quantity of BTC. Bitcoin miners play a crucial role in securing the network, and the BTC acts as a reward for their efforts. This system ensures all transactions are valid and protects the network from fraud. 

A block contains the following information. 

• Current software version: The current Bitcoin client version

• Previous block hash: The hash of the block before the current block 

• Block height number: How numerically far the block is from the first block

• Merkelroot: A 256-bit number that stores information about the transactions within the block

• Timestamp: The date and time the block was opened

• Target in bits: The network target

• Nonce: A 32-bit number added to the block hash 

Bitcoin Mining 

Bitcoin mining is the process through which the Bitcoin network releases new BTC into circulation. But how does it work? Bitcoin mining is carried out by a very specific type of user. These users, called miners, use specialized hardware to solve cryptographically difficult puzzles using real-world computational resources. When a miner solves the puzzle, they get to add a block containing pending transactions to the Bitcoin blockchain. This process is also called Proof-of-Work. 

In return for adding the block to the blockchain, the miner wins a “block reward.” The first Bitcoin block had a block reward of 50 BTC. Since then, Bitcoin has gone through several “halving” events. These halving events occur every four years, or 210,000 blocks, and slash the block reward by half, ensuring BTC’s limited supply does not run out and creating a supply crunch. The most recent Bitcoin halving occurred in April 2024 and slashed the block reward from 6.25 BTC to 3.125 BTC. The next halving will take place in 2028. 

Bitcoin Transactions 

You don’t need to go through a financial intermediary to complete a Bitcoin transaction. All you need is a Bitcoin wallet. Bitcoin wallets contain your public and private keys. The public key acts as your bank account and helps store your BTC. On the other hand, your private key acts like an ATM pin, allowing you to access your BTC. You can share your public address with anyone. However, your private key must be kept secure at all times. Below, we will oversimplify the transaction process. 

• If you want your friend to give you BTC, send them your public address.

• If you wish to send your friend your BTC, use your private key. 

In Closing 

This guide has explained the workings of Bitcoin in a very brief and simplified manner. It has also explained how the process of mining works. In the next part, we will look at some of the hard and soft forks of Bitcoin.

Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.