How Does Bitcoin Work?

Last Updated: 19 September 2023

If you’re new to the world of cryptocurrencies, you might be wondering about the technology behind Bitcoin, the most well-known and widely used cryptocurrency. In our Bitcoin Basics series, we’ve already covered what Bitcoin is. Now let’s dive deeper into the technology that makes Bitcoin possible, starting with the Blockchain.

Understanding the Blockchain

At the heart of Bitcoin’s operation is the Blockchain. This is a public, distributed ledger that records all Bitcoin transactions. Unlike traditional banking systems, where a single entity maintains a ledger of transactions, the Blockchain is shared among Bitcoin ‘miners’ and ‘nodes’ around the world. This decentralized nature of the Blockchain ensures transparency and trustworthiness, removing the need for a central authority.

How Blockchain Technology Works?

So, how does this Blockchain work? The term “Blockchain” is derived from its structure, which consists of 1-megabyte files called “Blocks”. These Blocks, which are essentially ledgers, are linked together using complex mathematical proofs, forming a ‘Chain’. Hence, the name ‘Blockchain’.

The Blockchain is a public ledger that supports the Bitcoin network. All nodes in the network can view authorized transactions recorded on the Blockchain. While the Blockchain doesn’t reveal the identities of the transacting parties, it ensures their anonymity by using an alphanumeric identification.

Instead of relying on a centralized authority like a bank, the Blockchain uses cryptography to ensure the integrity of the ledger. This makes the Blockchain a secure and reliable platform for Bitcoin transactions.

Bitcoin Wallets and Private Keys

When it comes to transactions, Bitcoin users use something called a “Bitcoin Wallet”. This Wallet provides a Public Key, which is the address used for sending or receiving Bitcoins, and a Private Key. The Private Key is essentially a digital signature that validates transactions, proving that they originated from the owner of the Wallet.

It’s important to note that despite its name, a Bitcoin Wallet is more like a ‘Keychain’. This is because users can duplicate both their keys, not just one.

What You Need to Know About Cryptocurrency Mining

Mining is a crucial part of the Bitcoin ecosystem. It involves validating pending transactions and consolidating them into a block to be added to the Blockchain. Miners, who are users with powerful hardware, solve complex mathematical problems to cryptographically sign a block of transactions and link it to the rest of the transactions in the Bitcoin network.

Miners play a vital role in protecting the Bitcoin network, and they are rewarded with Bitcoin for their efforts. This process, aptly named ‘mining’, is similar to how precious materials like gold are extracted from the ground.

Key Points to Remember About Bitcoin

While Bitcoin offers a unique and potentially profitable way of storing value and conducting transactions, it’s important to remember that it operates differently from traditional financial systems. Bitcoin Wallets, like physical wallets, are only as secure as their users make them. They can be targets for hackers, so it’s crucial to choose a reputable Wallet provider and keep your Wallet secure.

Storing Bitcoin Safely

When it comes to storing Bitcoin, there are a few options to consider. Custodial services or exchanges are often used for storing or transacting Bitcoin. However, these entities can be targets for hackers, so it’s important to exercise caution when using them. Also, keep in mind that Bitcoin transactions are irreversible, so it’s crucial to trust the other party in a transaction.

Transparency and Anonymity in Bitcoin

While Bitcoin offers a degree of anonymity, it’s not completely anonymous. All transactions and wallet balances can be viewed on the Blockchain. However, the identities of the transacting parties are not revealed. This means that while Bitcoin transactions are transparent, they also offer a certain level of privacy.

In the next part of our Bitcoin Basics series, we’ll delve into how Bitcoin mining works in more detail. Stay tuned!