How Bitcoin Works

As a new user, you can get started with bitcoin without understanding the technical details of how bitcoin works. However, understanding how bitcoin works will make life even easier when interacting with bitcoin.

Whether you are looking to invest in Bitcoin or you just want to be ready for the new internet era of web 3.0, the need to understand how Bitcoin works at a technical level is important.

This knowledge is also important in sifting information, separating facts from fiction, which is crucial in the relatively young industry.

The way Bitcoin work is what differentiates it from all other currencies and payment systems. Bitcoin can be described simply as software that tracks and verify transactions on a public ledger over a peer-to-peer network. It does not need a central authority to protect it. Instead, it is protected through decentralization and cryptography. To achieve these features, bitcoin relies on blockchain technology.

The Blockchain Technology

Bitcoin blockchain is a decentralized distributed ledger. It is made of blocks that are linked with each other in a chain. The blocks contain transaction information. The blockchain is decentralized in that it does not rely on any central authority to operate. Instead, every computer on the network (as a full node) keeps a copy of Bitcoin’s ledger.

When any transaction occurs on the network, for instance when someone sends bitcoins from one wallet to another, the nodes broadcast the transaction to the network. Other nodes (miners) collect, verify, and record the transaction on the blockchain. The transactions are grouped and stored as a chunk of data called a block. The new block is announced to the rest of the nodes to update their copy of the blockchain record.

The blocks are stored in the blockchain in order from oldest to newest. Only new blocks can be added to the block. Existing blocks cannot be modified. This makes the transactions irreversible.

Bitcoin achieves immutability through cryptographic hashing. All new blocks contain a hash value computed from the last block in the blockchain. This links all the blocks within the blockchain, making it impossible to change data in one block without affecting all other blocks in the blockchain. This technique maintains order in the blockchain network and ensures the network is tamperproof.

Since bitcoin is decentralized, there must be a way to maintain the order of the blockchain and ensure that only legitimate transactions are included on the network that does not involve a central authority. Bitcoin uses cryptography and a concept called the proof-of-work consensus mechanism.

Bitcoin Uses Cryptography  

Bitcoin uses two cryptographic key pairs to facilitate the transfer of coins: The public key (Bitcoin address) and the private key. The private key is used to prove the ownership of bitcoins. A bitcoin sender signs the transaction using the private key. The digital signature proves the transaction details include the sender, the amount, and the recipient. Anyone on the Bitcoin network can verify the transaction cryptographically using the sender’s public key.

 Every signature for a Bitcoin transaction is unique and depends on the private key of the sender and the transaction details. Therefore, these signatures cannot be faked or counterfeited.

Also, a change in the transaction details such as the amount, sender address, or recipient address will invalidate the signature. Only private keys associated with Bitcoin addresses can create a valid digital signature for a particular Bitcoin address.

Any transaction without a valid, verifiable signature is rejected by the nodes on the Bitcoin network. Additionally, any new block containing transactions that lack a valid signature is entirely rejected. Therefore, fake transactions cannot be added to the blockchain network. This mechanism makes the network immutable.

Bitcoin Mining

Bitcoin mining is the process involving the creation of a new bitcoin. It involves the competitive use of computational power to calculate a unique solution. The solutions are cryptographically computed and verifiable based on the latest set of transactions and the last block of the blockchain. Therefore, the potential solutions to each competition are unique and unpredictable. This process is known as proof-of-work (PoW), and it prevents double spending on the network.

The first miner to find the solution receives a reward in the form of new Bitcoins and any recent transaction paid by other network users sending bitcoin.

The difficulty of finding a solution to the mining problem is automatically adjusted based on the network’s mining power. The mining difficulty increases with the increase in the mining power and vice versa. This mechanism maintains a stable rate of supply of new Bitcoin. Additionally, the amount of new Bitcoin awarded to a miner for confirming each transaction is cut by half after every four years. The process is known as Bitcoin Halvening and is intended to control Bitcoin inflation.

Besides creating new Bitcoins, the mining process aims to secure and synchronize the blockchain by confirming and adding transactions to the network.

Wrap Up

Bitcoin does not need a central authority to protect it. Instead, it is protected by decentralization and cryptography.