How Does Bitcoin Work: A Comprehensive Guide to Bitcoins

FIRST, What is a Bitcoin?

Bitcoin is the first ever decentralized digital currency. It is simply a digital form of money that can be sent or received using the internet.

The decentralized part of bitcoin is quite simple. It just means that it doesn’t have a single centralized authority like a government or a central bank controlling it. So, instead of using a bank or some other payment service provider, you and I can directly send the money to a friend, a shop or for anything else we can imagine. 

The best part about using a decentralized currency is that you don’t have to rely on a bank for non-cash transactions.

Think of credit cards. Credit cards are extremely convenient but we have to pay a fee to the card’s issuer. Similarly, we pay fees for withdrawing money from an ATM machine and also pay fees for making online bank transfers.

Since using bitcoins doesn’t involve a bank, we can make payments or transfers without having to pay an intermediary. An important caveat to keep in mind. 

Bitcoin


Aside from the fees, there are other benefits of using bitcoins:

  • Since bitcoin is not directly associated with a country or a government, it can be used as it is in literally any part of the world.
  • Since no government controls bitcoin, bitcoin accounts or wallets cannot be frozen as opposed to a bank account.
  • There are no arbitrary requirements or limits for opening an account, sending money or anything else involving money.
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    Transactions in bitcoins are not completely free. However, transaction fees for bitcoins are negligible compared to those charged by banks.

How To Store Bitcoin?

There are a number of ways to store bitcoins: 

Type of a wallet

Simple description

How it looks?

A digital wallet is a simple computer or smartphone app, which can be used to store bitcoins on our computer or smartphone.

Digital wallet for Bitcoin

Hardware wallets are specially designed storage devices dedicated for storing bitcoins.

Hardware wallet

A paper wallet is simply a document that contains all of the necessary information to form a bitcoin wallet.

Paper wallet

How To Send Bitcoins?

Four Simple Steps for Sending Bitcoins:

  1. Open your bitcoin wallet and click on the “Send” tab.

  2. In the “Send To” box, enter the recipient's wallet address.

  3. Enter the amount of bitcoin (or dollars) you want to send in the “Amount” box.

  4. Click “Send” to complete the transaction.

If you need more information, follow our guideline to Bitcoin wallet. 

How Do Bitcoin Transactions Take Place?

As you can see above, sending bitcoins is pretty much as simple as sending an email. It is, after all, completely virtual. To send money, we use an app called a bitcoin wallet. It is also where our bitcoins are stored.

So, in order to send money, we have to either enter the recipient’s bitcoin address or account number, or scan their account QR code and enter the amount we’d like to send. The recipient would then see the money appear, almost instantaneously, in their wallet.

What Bitcoin Address and Private Keys look like

What Bitcoin Address and Private Keys look like

How Does Bitcoin REALLY Work?

You must be wondering how transactions can take place without a bank? Well, at the most basic level, bitcoin is simply a permanent ledger with account numbers and transaction figures recorded in it. The ledger or blockchain literally does everything that a bank does. It validates, verifies and records every single transaction involving bitcoins.

For example, when I send you 1 bitcoin, the transaction is recorded on the ledger as minus one bitcoin with my account number and plus one bitcoin with your account number. Since the ledger is permanent, once I’ve sent you the money, the money belongs to you and there is no way for me to get it back unless you agree to send it back to me. This prevents fraud and provides a guarantee without the need for trust or a middleman such as a bank or an escrow.

Let's look at this infographics: 

How Bitcoin works?

Source: Medium.com


Since all transactions recorded on the ledger are identified by account numbers instead of names, there is a degree of anonymity to using bitcoins. Obviously, none of us wants the world to know how much money we have or the amount we’re spending. So, this ensures a greater degree of privacy than banks usually offer. But more importantly, the ledger does not record account balances as a bank does. Instead, it merely records transactions. This way, even if someone knows your account number, it is impossible for them to determine how much money you have in bitcoins.

Security and Privacy of Bitcoin

Let’s move on to the security aspect of bitcoins. Every time we use bitcoins to send money, information on the transaction such as the account numbers and the amount transferred is relayed by the bitcoin wallet to the public ledger. So, in order to ensure that no one else can send or receive our money, the blockchain utilizes a signature mechanism, which is similar to signatures used on a check.

The difference is that the signature is based on mathematics instead of handwriting. This signature or math comes from cryptography, which is the science of encryption for hiding information.  However, in the blockchain network, cryptography is used for authentication purposes rather than encryption of messages.

Why are bitcoins so safe?

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    Each and every bitcoin account or bitcoin wallet has a unique key that only the owner of the wallet would know. 
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    ​​​​This unique key is used by the system to create unique and random signatures for every single transaction.
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    The information regarding the transaction would be sent to the network as an encrypted message.
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    Since the signature is unique for each and every transaction and there is a time limit for decrypting the message, it is absolutely impossible for someone other than the receiver to decrypt the message and fraudulently receive the money.

How Does Bitcoin Mining Work?

What is bitcoin miner and what exactly do miners do? It doesn’t involve pickaxes, I can assure you that much.

Miners dedicate computing power or processing power to the blockchain. What does that mean, you ask? Well, every computer has a certain amount of processing power it uses for different tasks.

Miners install an app that contains their personal copy of the blockchain and it uses the computer’s processing power to solve mathematical problems that ultimately verifies individual transactions based on its transactional signature and bitcoin addresses.

Basically, they run a mining app, which tries to verify transactions for the blockchain along with hundreds of thousands of other miners around the globe. The mining computer would only be used for bitcoin mining, as all of its processing power would be dedicated to solving these cryptographic based mathematical problems.

Cryptocurrency mining farm

Cryptocurrency mining farm

Bitcoin miners or maintainers of the blockchain don’t do this out of the goodness of their heart. There is a financial incentive for those dedicating their computing power to maintain the blockchain ledger. These miners receive newly generated bitcoins as a financial incentive for powering the blockchain and validating future bitcoin transactions.

Start Mining in Six Simple Steps:

  1. Fist, you’ll need to purchase dedicated mining equipment.
  2. For security purposes, use a local bitcoin wallet such as Armory. You will connect your wallet to a mining pool’s user account.
  3. Download a mining software. CGminer and BFgminer are two of the most popular mining software.
  4. You’ll need to join an established mining pool. Pools allows miners to share their resources as well as the rewards.
  5. Begin mining.
  6. Keep an eye on the temperature. Mining programs are designed to maximize the use of your hardware. Ideally, you should get a temperature monitoring software as well.

How Much Miners Earn?
BLOCK REWARD

Initially, the block reward consisted of 50 bitcoins, meaning 50 new bitcoins were generated every 10 minutes. In order to slowly reduce the supply of new bitcoins, the block reward halves every 210,000 blocks. Since 144 blocks are mined or added to the blockchain in a day, it takes around four years to mine 210,000 blocks. In 2012, the block size was halved for the first time from 50 bitcoins per block to 25 bitcoins per block. The most recent halving took place in 2016 and now miners receive 12.5 bitcoins per block. The next bitcoin halving will take place in 2020, when the block reward will be further reduced to 6.25 bitcoins per block.

Conclusion: Today it’s not profitable for average persons to mine bitcoins. Now only specialised companies and pools can generate profits.

The “average” miner earns no more than $100-200 minus their electricity cost per month.

Now It Is Your Turn: START With Bitcoin Today

If you’ve come this far, I am sure you’ve learned a great deal about bitcoins and how bitcoin works. But as you can see, this is more of an introduction to how bitcoin works. if you’re interested in using bitcoins and personally benefit from the digital currency, you will definitely need more information on how to use bitcoins, especially relating to cybersecurity.

+ GLOSSARY

Altcoins

Altcoin is an abbreviation of “Bitcoin alternative”. It, basically, means all crypto currencies other than Bitcoin.

Address (payment address)

It is the most common way to exchange payment information, similar to using a bank account to transfer money.

Block

The blockchain consists of two kinds of records: transactions and blocks. Transactions are the actual data to be stored in the blockchain, and blocks record and confirm when and in what sequence transactions are added to the blockchain. 

Blocks within the blockchain connect various transactions together into a coherent manner. Various transactions are combined into single blocks and are verified every ten minutes through mining, which also prevents multi-transactions or double spending.

Block reward

Block reward is the amount of bitcoins a miner receives for processing transactions in a given block. 

Bitcoi​​​​n Price Index (BPI)

CoinDesk Bitcoin Price Index represents an average of bitcoin prices across leading global exchanges that meet criteria specified by the BPI.

Cryptocurrency

Another name for digital currency or a form of digital currency produced and secured by cryptography. 

Cryptography

Cryptography is a branch of mathematics. It involves the practice and study of techniques used for encryption.

Digital Commodity

A digital commodity is a scarce, electronically transferrable, and intangible, with a market value. 

Distributed Ledger

Distributed ledgers are a type of database that is spread across multiple sites, countries or institutions. Records are stored one after the other in a continuous ledger. 

Double Spending

Double-spending is the result of successfully spending some money more than once. Bitcoin is the first to implement a solution in early 2009 which protects against double spending by verifying each transaction added to the blockchain to ensure that the inputs for the transaction had not previously already been spent. 

Fork

The creation of an ongoing alternative version of the blockchain, by creating two blocks simultaneously on different parts of the network. This creates two parallel blockchains, where one of the two is the winning blockchain. The winning blockchain gets determined by its users, by the majority choosing on which blockchain their clients should be listening.

Genesis block

The very first block in the blockchain also called Block 0. 

Hash rate

The number of hashes performed per second to secure a proof of work blockchain. 

Halving

A reduction in the block reward given to cryptocurrency miners once a certain number of blocks have been mined. The Bitcoin block mining reward halves every 210,000 blocks

Mining

It is the process by which transactions are verified and added to a blockchain. This process of solving cryptographic problems using computing hardware, which is also how new bitcoins are generated.

Miner

Miner is a person who owns the computer equipment and software which mines for bitcoins.

Private Key

A private key is a string of data that shows you have access to bitcoins in a specific wallet. Private keys can be thought of as a password. 

P2P

Peer-to-peer (P2P) refers to the decentralized interactions that happen between at least two parties in a highly interconnected network.

QR Code

QR Code is a two-dimensional graphical block containing a monochromatic pattern representing a sequence of data. It is similar to a barcode. 

Satoshi

It is the smallest unit of Bitcoin, which equal to 0.00000001 BTC.

Transaction Block

A collection of transactions on the bitcoin network gathered into a block that can then be hashed and added to the blockchain. 

Wallet

Just like a bill-and-coin wallet, it is a place to keep your digital currency.