How Does Bitcoin Work?

Dec 06, 2023

byNDAX Labs

Like actually, for real for real. To illustrate how Bitcoin works, let’s journey through a concise description of the lifecycle of a Bitcoin transaction, from uncensorable payment to immutable public ledger… But first! Wouldn’t that be a little more enlightening with a couple of core concepts for context? Indeed!

I. Core Concepts for Context

Bitcoin operates on a decentralized network using a technology called blockchain. Here's a simplified explanation of how Bitcoin works:

1. Blockchain Technology

Bitcoin transactions are recorded on a public ledger called the blockchain.
The blockchain is a chain of blocks, where each block contains a pack of transactions. (One can think of this as a “time chain”; since time is immutable.)
These blocks are linked and secured using cryptographic hashes.

2. Decentralized Network

Bitcoin operates on a peer-to-peer network, meaning there is no central authority like a bank or government overseeing transactions.
Nodes on the network, known as miners, validate and add transactions to the blockchain through a process called mining.

3. Transactions

When someone initiates a Bitcoin transaction, it is broadcast to the network.
The transaction includes information such as the sender's and recipient's addresses and the amount of Bitcoin being transferred.

4. Mining

Miners compete to solve complex mathematical problems based on the transactions in a block.
The first miner to solve the problem is awarded the right to add a new block to the blockchain, and is paid new bitcoins for this work.
This process, known as proof-of-work, adds security to the network.

5. Consensus Mechanism

The decentralized nature of Bitcoin relies on a consensus mechanism to agree on the state of the blockchain.
Consensus is achieved through the majority of nodes accepting the longest valid blockchain, making it very difficult (impossible) for one entity to control the entire network.

6. Cryptography

Cryptography plays a crucial role in securing transactions and controlling the creation of new units of Bitcoin.
Public and private keys are used to sign and verify transactions, ensuring only the rightful owner can initiate a transfer.

7. Limited Supply

Bitcoin has a capped supply of 21 million coins to control inflation. This scarcity is programmed into the code to mimic the scarcity of precious metals like gold.

8. Wallets

Users store their Bitcoin in digital wallets. A wallet consists of a private key (for the owner's use) and a public key (for receiving Bitcoin).

9. Decentralized Development

The development of the Bitcoin protocol is open-source and community-driven. Changes and improvements require broad consensus.

II. Lifecycle of a Bitcoin Transaction

When a Bitcoin payment is initiated, the transaction details, including sender and recipient addresses and the amount, are pushed (broadcast) to the decentralized network. Miners verify and bundle these transactions into a block through cryptographic computations called mining. Once a miner successfully adds a block to the blockchain (approx. every 10 min), the transaction becomes a permanent part of the immutable ledger. Those satoshis (fractions of a bitcoin), which existed at your public address, under your control, now exist at another public address, under yoru recipient’s control. The decentralized nature of Bitcoin ensures transparency, security, and consensus, making each transaction a securely recorded and unalterable entry in the blockchain, accessible to anyone on the network.

Wrap

So, as we’ve seen, Bitcoin is a decentralized digital economy/currency backed by a physical network/protocol that operates an open, transparent blockchain, which, at time of writing, is over CA$1T secure. It is tethered to the physical world by its proof-of-work consensus mechanism, and leverages cryptography to ensure the integrity and security of its ownership and transactions. Users control their funds via private keys, and the finite supply of Bitcoin adds a deflationary aspect to its economic model. What else would you like to learn about Bitcoin or Crypto?

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Disclaimer: This article is not intended to provide investment, legal, accounting, tax or any other advice and should not be relied on in that or any other regard. The information contained herein is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of cryptocurrencies or otherwise.