What Is Bitcoin and How Does It Work? | A Simple Guide

Share on facebook
Share on google
Share on twitter
Share on linkedin

What Is Bitcoin?

Bitcoin is an open-source, peer-to-peer digital currency. It was created in 2009 by an unknown person (or group) going by the pseudonym Satoshi Nakamoto. At its core, Bitcoin enables you to send money around the world without needing a trusted intermediary like a bank.

Before continuing, though, we should clear something up. Bitcoin with a capital “B” refers to the blockchain network that facilitates transactions of bitcoin, the cryptocurrency. You can think of bitcoin (lowercase “b”) as similar to dollars, euros, etc. You’ll commonly see the currency referred to as “BTC.”

People find Bitcoin valuable because it’s censorship-resistant, trustless, and secure. Let’s break down each of those benefits.

Censorship-Resistant

Bitcoin is censorship-resistant meaning that no one can stop you from using the network. It doesn’t have a central authority with the power to freeze accounts or block transactions. The network doesn’t care where you send your money or from who you receive it.

Trustless

Trustlessness isn’t the attribute it appears to be at first glance. It’s not that you can’t trust anyone when using Bitcoin, it’s that you don’t need to.

When you send or receive bitcoin, you participate in a direct, peer-to-peer transaction. Through mathematics and cryptography, you can be confident that the transaction will go through successfully without any funny business. Once again, Bitcoin cuts out the middlemen of our traditional financial systems.

Secure

Bitcoin operates on a blockchain that stores redundant copies of its transactions on computers around the world. If one or even several of those computers go offline, there are thousands of others to keep the network alive. One of the few ways to disrupt the Bitcoin network is through a 51% attack. To perform this attack, though, you need to control 51% of Bitcoin’s hash power — a feat that currently costs over $600,000 per hour. So, it’s not really worth the cost, unless you’re an evil billionaire.

What Bitcoin Isn’t

Censorship-resistant, trustless, secure — those are the three benefits to remember. Sure, there are some other pros, like its 21 million coin supply cap to prevent hyperinflation. But those are the big three.

Contrary to popular belief, a Bitcoin transaction isn’t inherently fast. And it most definitely isn’t anonymous. We’ll save that conversation for a different time, though.

How Does Bitcoin Work?

You’ve probably heard all about the complexities of Bitcoin. We want to put your mind at ease with a simple explanation.

The heart of Bitcoin is its blockchain, a public record of transactions. A blockchain simply connects groups of transactions, or blocks, together into a chain. Each block is connected to the previous block through a type of cryptographic hash, called a hash pointer. Manipulating the hash pointer of one block changes the hash pointer of every subsequent block.

Therefore, as more blocks append to the chain, earlier blocks become increasingly difficult to change. Transactions become like a “fly trapped in amber” in that each additional block (layer of amber) further cements the immutability of an earlier transaction (the fly). It’s near impossible for a malicious party to change blockchain records or fudge the numbers of previous transactions without the entire network knowing.

Bitcoin block information
A Bitcoin block includes a lot of information. | Source: Blockchain

How Does a Bitcoin Transaction Work?

As we mentioned earlier, bitcoin transactions are peer-to-peer and secured through cryptography. There’s a significant amount of work going on under the hood, however.

The Bitcoin network is operated by thousands of computers around the world, called nodes and miners. Nodes maintain a record of the entire blockchain while miners create new blocks.

When you attempt to send bitcoin, you broadcast the transaction to every node on the network. (Don’t worry, the wallets handle this for you automatically). The nodes then check for two things:

  1. You are who you say you are, and
  2. You have enough currency to cover your transaction

They confirm your identity through the private key with which you sign your transaction. Your private key is a string of letters and numbers akin to a password.

You should never reveal your private key to anyone. On the flip side, you also have a public key (or public address). Telling someone your public key isn’t an issue and is necessary if you want to receive funds.

Remember how every node keeps a copy of the blockchain? Well, because they do, they can easily check to see if you’re trying to send more bitcoin than you own. Once nodes validate your transaction, a miner combines it with other transactions in a block and then adds that block to the blockchain.

“Which Miner Creates the Block?”

Great question! Miners compete with each other to solve a mathematical puzzle. The first to solve it earns the right to create the block. Miners effectively solve this puzzle through brute force guessing, so the more hash power (i.e., computing power) a miner dedicates to solving it, the better the chance of it beating out the competition.

Bitcoin’s difficulty level for this puzzle varies over time so that miners end up creating new blocks every ten minutes, on average. In return for creating a block, the winning miner receives a bitcoin block reward. The block reward started at 50 BTC and halves about every four years until all 21 million bitcoins are in circulation. It’s currently at 12.5 BTC and will decrease to 6.25 BTC in May 2020.

Chart of bitcoin mining difficulty over time
Bitcoin’s mining difficulty has been correlated with its price since creation. | Source: Blockchain

Just Scratching the Surface

Congratulations — you now have a better understanding of Bitcoin than the majority of the world. Of course, there’s plenty more for you to learn, but you’ve got a great foundation that you can now build on. Now that you know the basics, check out why investing in bitcoin could be right for you.

Want to learn more?

Join our community to stay up-to-date with the latest Coin Clear news, updates, and educational resources.

Bitnami