What is Bitcoin and how does it work?
You are most probably here in reference to our understanding the blockchain article. If not, please have a look at that article first before continuing with this one, as key concepts discussed in that article will be used and assumed mastered here. This article will give you as reader a broad overview on what Bitcoin is and how it works.
On its most basic level, the blockchain can be understood as an open database of any transaction involving value. What differs this database is the fact that it is decentralised and distributed. Creating a record whose authenticity can be verified by almost anyone.
Modern technology allows people to communicate directly. Voice, video calls, emails and pictures travel directly from A to B, maintaining trust between individuals wherever they are.
However, when it comes to money people need to trust a third party to be able to complete a transaction. Such as Banks and financial institutions.
Blockchain technology is challenging this status quo in a radical way, by using math and cryptography. The thing blockchain does that has never been done before is manufacturing truth and scarcity for virtual goods.
A Blockchain is a system in which a completely public record of transactions are registered and stored transparently across several computers internationally. The Bitcoin Blockchain is thus a public ledger that records and stores transactions that are in this case made in Bitcoins. In short, the Bitcoin blockchain is a chain of linked Bitcoin transactions between account holders which is maintained by multiple communicating nodes running Bitcoin software with the aim to maintain the Bitcoin Blockchain. For a more in-depth article on Blockchain visit starttrading.com.
Now that you understand the concept of a Blockchain you are ready to learn about Bitcoin and how it works.
Bitcoin is a protocol that runs on a network known as the Blockchain. Bitcoin is known as BTC is a virtual/ digital currency known as a cryptocurrency. Bitcoin can be seen as an online version of cash which can be used to buy products and services, if accepted by those sellers. What differs Bitcoin to other only payment systems is that fact that it is completely decentralised, global, little to no fees and transparent.
One of the major attributes of Bitcoin is that it has no central authority, meaning there is no one person or organisation which controls it.
Here are some key attributes of Bitcoin in accordance to its decentralized nature:
- Bitcoin has no central server controlling or storing its data and information. The Bitcoin network is completely peer-to-peer and controlled by different nodes world-wide.
- Anybody can store or view the Bitcoin ledger on their own machines, it is completely public and transparent.
- Anybody which has the necessary resources can become a Bitcoin miner, which we will discuss shortly, keeping the consensus across the Bitcoin Blockchain.
- It is not known which miner will create the new block to the Blockchain as this is up to chance and in some way processing power.
- Bitcoin Miners are awarded with Bitcoin when verifying transactions, which is the incentive to distribute to this decentralized system.
- Anybody can create a new bitcoin address, which is where you will send and receive Bitcoin from, without needing any approval from third parties such as governments.
- Anybody can also send a transaction to the network without needing any approval.
Even though the blockchain is a central record, there is no official authority tasked with updating the ledger, to keep track of money like a bank or the federal reserve.
The blockchain is a distributed system, meaning that there is no centralised organisation to maintain and verify the entries on the database.
This database is instead maintained by a large number of computers that are incentivised to provide computing resources by earning some form of tokens in exchange, known as Mining.
This is why the blockchain is decentralised, as their is no central authority tasked with keeping things in order.
If you have ever looking into Bitcoin before, you have most probably heard about the term Mining.
Mining is a process where individuals earn Bitcoin by performing certain actions to help maintain the Bitcoin Blockchain. This mining principle is one of the key attributes that makes Bitcoin so unique and valuable. Miners can be thought of as the decentralised authority enforcing the credibility of the Bitcoin network.
This might all seem confusing, but don’t worry its not as difficult as it seems.
Miners are all tasked with keeping track of the same ledger, ensuring that all transactions are accurate. Miners simply confirm that all transactions on the Blockchain are accurate and genuine. They do this by using a free software called a Bitcoin miner. Each of these so-called miner computers gets a complete copy of the Blockchain, which gets downloaded automatically upon joining the network.
When new entries (new transactions) into the database are made these changes are automatically broadcast across the entire network.
Mining computers on the network validate these new transactions, add them to the block their building and then broadcast the completed block to other nodes on the network, ensuring all nodes on the network have the new updated version of the database.
In order to make an entry onto the blockchain database, all the computers have to agree to the state of the entire chain, so that no computer can make an alteration without the consensus of the others.
Once completed a block will be added to the blockchain as a permanent record, each time a block is completed a new one is generated. There is a countless number of blocks in the blockchain, all intra-connected via links in a chain, in a linear, chronological order. This is why is is called a Blockchain, an enormous chain of blocks of data.
Without miners, people could do a plethora of fraudulent activities such as duplicating transactions to trick the system for personal gain.
Currently there are an estimated 100,000+ miners being run concurrently around the globe.
For every transaction on the network the following information must be announced/ broadcasted to the blockchain:
- Sending crypto address, similar to an Account Number at the bank
- Receiving crypto address, similar to an Account Number at the bank
- Amount of virtual assets or tokens sent
- Signature, meaning the transaction is signed using private key. This is not shared to the Blockchain
Miners use top of the range hardware and software to solve cryptographic problems created by the Blockchain in accordance to each set of transactions made. The miners’ computer uses its high computing power to guess an answer to the problem and the first miner to get the correct answer, is rewarded with Bitcoin. The reason this is done, is to ensure that a transaction is indeed valid and no double spending can occur.
It is important to note that new bitcoin is being released to the miners at a fixed, but periodically declining rate, such that the total supply of bitcoins approaches and will never be more than 21 million. Bitcoin are also released into circulation in this way.
As continuously more bitcoins are created, the difficulty of the mining process, the amount of computing power involved, increases.
On the Bitcoin blockchain, bitcoins are registered to bitcoin addresses. Creating a bitcoin address can be done by anyone, only requiring a person to pick a random valid private key and computing the corresponding bitcoin address. Not to worry, this computation can be done very quickly and is usually done for the user.
Users share their public bitcoin addresses without compromising its corresponding private key. To be able to use/ spend their bitcoins, the owner must know the corresponding private key and digitally sign the transaction using the private key which is not revealed to others.
Note: If a user loses their private key, the bitcoin network will not recognize any other evidence of ownership, thus the coins belonging to that address are lost and cannot be ‘recovered’.
7 facts about Bitcoin
- No one single entity controls this currency: Bitcoin is controlled by everyone who uses the bitcoin blockchain by making transactions on it. Consensus across the blockchain is made possible through the Bitcoin miners.
- There is and will always just be 21 000 000 Bitcoin in existence: There will only be 21000000 Bitcoin in existence ever, leading to the value of Bitcoin as a currency rising as time continues.
- All Bitcoin Transactions is completely transparent and available for everyone to see: One thing that makes Bitcoin so unique is that it is completely transparent. By stating this, we do not mean personal data, but instead with transactions and amounts.
- Anyone can mine bitcoins: As discussed earlier, anyone with the adequate computer hardware and software can join in mining Bitcoin and get paid out in Bitcoin by the blockchain itself.
- Transactions cannot be reversed: If you send Bitcoin to someone, you cannot revoke that transaction, so be very cautious when making transactions/payments.
- Bitcoin transactions have fees, but it is very small: With bitcoin, there are little to no transaction fees even when sending Bitcoin internationally. This fee is usually to pay the exchanges where these transactions take place on.
- You can buy things with Bitcoin: Bitcoins may be very new and there is a lot of scepticism around it, but it’s actually a real currency used to buy real things. There is a variety of merchants who accept bitcoins as payment for items, both online stores and physical stores.
After reading this article, we hope you as a reader have a better understanding of what Bitcoin is and how it works. Bitcoin is incredibly valuable and will continue to grow in value in the long run. Right now in this moment are a good a time as ever to start trading BTC and many of the other cryptocurrencies available in the market.
If you want to get started trading cryptocurrency and not sure where to go, our FREE trading academy is here to help.