How Does Bitcoin Work?

Last Updated: 26 March 2023

We explained what Bitcoin is in our bitcoin basics series; if you have not already, read that article as well.

Bitcoin’s operation is based on cutting-edge technology, cryptography, the utilization of tremendously powerful computers, and the internet.

Bitcoin transactions are verified and recorded in a public distributed ledger known as a Blockchain since no single administrator is responsible for maintaining or supporting the cryptocurrency.

Whereas one’s preferred bank might keep a copy of the ledger that reflects the flow of financial transactions through one’s account, the Blockchain is a type of ledger shared among Bitcoin ‘miners’ and ‘nodes’ all over the world, rather than being retained by a bank.

What Is Blockchain Technology and How Does It Work?

The name “Blockchain” comes from the fundamental data structure, which comprises 1-megabyte files called “Blocks,” which are effectively ledgers. A complicated mathematical proof is used to ‘Chain’ the blocks together.

The Blockchain is referred to as a decentralized public ledger that supports the entire Bitcoin network. All network nodes (computers running Bitcoin software) can observe authorized transactions on the Blockchain because the Blockchain does not display the names of individuals but instead gives an alphanumeric identification, as the transacting parties are somewhat anonymous.

Rather than relying on a bank’s trustworthiness to validate a ledger’s integrity, the Blockchain uses cryptography (the art of solving codes or writing) as its evidence.

Bitcoin Wallets

When transacting in Bitcoin, parties use what is known as a “Bitcoin Wallet” to trade Bitcoin denominations (BTC). A Public Key (the address used for transferring or receiving Bitcoin) and a Private Key are provided by Bitcoin Wallets to its customers.

The term ‘Wallet’ is a wrong selection; a more realistic name would be a ‘Keychain,’ where users can duplicate both of their keys rather than just one.

A Bitcoin Private Key

A Private Key is a vital ‘signature’ for Bitcoin users. It is used to authenticate pending transactions by providing mathematical proof that they came from the Wallet owner.

When a user looks for a Bitcoin transaction, they submit a signed transaction with their private key to the Blockchain. The bitcoin network next checks if the to and from addresses are correct, the private key is correct, and sufficient funds to complete the transaction. Within the next 10 minutes, the transaction is generally verified on the network.

Cryptocurrency Mining

Mining is validating pending transactions and consolidating them into a block for inclusion in the Blockchain. “Miners” are computer users who use extremely powerful hardware to solve complex mathematical problems cryptographically sign a block of transactions and link it to all previous transactions in the Bitcoin network.

Miners protect the Bitcoin network, which benefits the Bitcoin community. The process of solving a block’s cryptographic proof consumes a lot of resources. Miners obtain a ‘bounty’ or ‘reward’ in Bitcoin for winning the race to mine 1-megabyte ‘blocks’ of transactions.

Because a fraudulent transaction necessitates so much computing (and hence electricity), it is almost always more economical to employ that same compute power to safeguard the network and earn the block reward instead. This keeps bad actors off the network and prevents malicious or fraudulent entries from being recorded on the Blockchain.

Mining gets its name from the idea that miners obtain Bitcoin as a reward in the same way as rare goods like gold are extracted from the ground.

What do I require to know about Bitcoin?

While Bitcoin is a fascinating technology that has the potential to be both a lucrative store of value and a method of exchange, the Bitcoin network is fundamentally different from the existing financial system and has some significant differences.

While Bitcoin is unhackable in the sense that the Bitcoin network is built on complex mathematical proofs – and even a single transaction would require enormous resources. The Bitcoin wallets share similar vulnerabilities as traditional wallets that are only as secure as their users leave them.

Bitcoin Wallets are an obvious target for computer hackers looking for a quick way to steal digital currency because Bitcoin can be easily transferred anywhere in the world. One should choose a reputable Wallet provider with caution and keep their Wallet secure at all times.

Bitcoin Storage

Custodial services or exchanges, which frequently participate in the storing or transaction of bitcoin, are two more prominent storage options. Because these entities typically handle large quantities of bitcoin and other digital money, they are tempting targets for internet hackers, and caution should be exercised while using them.

Bitcoin is also easy to steal because Bitcoin payments are irreversible without the entity’s aid who got the funds in error.

Even though the Bitcoin network can identify typos and will not enable users to send Bitcoin to an invalid address, confirmed transactions must be viewed as final because they are safeguarded by cryptography. As a result, when exchanging Bitcoin, transacting parties must be able to trust one another.

Bitcoin Transparency

Finally, Bitcoin isn’t completely anonymous. Whereas a bank may be trusted to keep the privacy of a customer’s bank account, all computers on the Bitcoin network have the ability to examine the Blockchain and, in most cases, can see each Wallet’s balance. Every transaction is also viewable on the network. Even though the names of transacting parties are not revealed on the network when exchanging Bitcoin, practical blockchain analysis could allow third parties to track bitcoin’s path across the network.

We’ll go through how Bitcoin mining works in greater detail in part three of our Bitcoin Basics series.


  • Luke Handt

    Hello, my name is Luke Handt; I am a successful Bitcoin trader, financial analyst, and researcher. I have been studying the market trends for the conventional stock exchange system globally since I was in college.

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