How Bitcoin Really Works

Image Credit: Gemini.com

My intention in this post is to explain the main ideas behind Bitcoin Protocol in a clear and understandable way. This article will give an overview of the technical structure of Bitcoin networks, including blockchain nodes, miners and proof-of-work mining.

I will start from the first principles, build on a broad theoretical understanding of how the protocol works, and then focus on the essentials by examining the raw data behind Bitcoin transactions.

Bitcoin ( BTC ) is a cryptocurrency created by an unknown person or group in 2008 under the name of Satoshi Nakamoto. It is a decentralized digital currency that has no central bank or single administrator and can be transmitted without intermediary from user to user and peer to peer in the Bitcoin network.

The recipient of the first Bitcoin network transaction was early adopter Hal Finney, who created the first reusable proof-of-work (RPOW) system in 2004. On January 3, 2009, the Bitcoin network was founded by Nakamoto(?), who dismantled the beginning of each block of the network, the so-called Genesis block.

Bitcoin has experienced several forks of all kinds including Bitcoin Cash hard forks, which occurred after Block 661647, the last common block between Bitcoin and Bitcoin Cash. The Bitcoin cash fork stemmed from a disagreement within the Bitcoin community over the block size.

Bitcoin miners operate complex computer systems that solve mind-bending puzzles in an effort to verify a group of transactions, known as blocks. When a block’s success is added to the Bitcoin record, the miner is rewarded with a small amount of Bitcoins.

Bitcoin Cash introduced a block size of eight megabytes to increase transaction throughput, while Bitcoin keeps the block size at 1 megabyte to encourage greater node participation and to ensure decentralization.

Other participants in the Bitcoin market can buy and sell tokens and cryptocurrencies on the exchange. Because the Bitcoin register is fraudulent and untrustworthy, Bitcoin exchanges are working hard to defend themselves against potential theft, despite high-profile thefts.

Miners are responsible for ensuring that every Bitcoin transaction by a user is recorded as legitimate. Simply put, miners make groups of new Bitcoin transactions that are made within a set timeframe or block.

If a transaction has multiple inputs, it prints the bitcoin according to the output of the previous transaction. If it spends less Bitcoins than it takes in, the difference is treated as a transaction fee and collected as Bitcoin by the miners handling the transaction (more on that later).

Each node that succeeds in extracting a block and adding it to the end of the block chain receives one more transaction, making 2.5 brand new Bitcoins out of thin air. Each participant adds a transaction fee, a small voluntary tax that miners levy when they bury a transaction in a blockchain.

Your wallet adds transactions to the public register, which is notified by a single node on the Bitcoin network. This node forwards the transactions to other nodes, which forward them to each other, similar to how BitTorrent works.

The network communicates with the nodes on which the Bitcoin software running the Bitcoin blockchain operates. In order to achieve an independent review of the ownership chain, each network node stores its own copy of the blockchain. When network nodes validate a transaction or add a transaction, their copies are transferred to the Bitcoin blockchain and added to other nodes.

The Bitcoin network address is what people use to send each other bitcoins derived from a public key (Public Key D). The exact details of its format are complicated and change over time, but one can imagine it as a hash, a short random bit chain that serves as the cryptographic fingerprint of the public key.

Bitcoin addresses are encrypted in a custom format called base58check, which minimizes the risk of screw-ups.

Another important feature that I will not explain here is that instead of public keys, the output of the verification script is written in a simple Bitcoin-specific scripting language.

Bitcoin cryptography is based on the SHA-256 algorithm developed by the US National Security Agency.

Cracking it is practically impossible and only possible if the private key is tested on 2,256 atoms in the universe, estimated to be somewhere between 1,078 and 1,082. In fact, according to Bryan Lotti of Crypto Aquarium, a fraudster who guessed the key code to your Bitcoin wallet has the same chance of winning the Powerball lottery nine times in a row.

Bitcoin mining adds new transactions to the Bitcoin blockchain. Bitcoin exchanges are online platforms that facilitate transactions in Bitcoin and other digital currencies. They bring together market participants from around the world to buy and sell cryptocurrencies.

Owning Bitcoin comes down to two numbers: the public key and the private key. The public key consists of long numbers and letters and in some ways resembles your username and password.

It is not John Smith’s public key, but Bitcoin, the current block in the blockchain, so the computer running the blockchain does not allow Bitcoin to be used.

In fact, many Bitcoin wallets have a feature that allows you to import private keys. Anyone who knows your private key can convert it into a Bitcoin address. Your wallet can convert the private key into a Bitcoin address with a known function.

When you send Bitcoin to someone, your wallet generates a transaction output with the address of the person to whom you send the coins. Every transaction registered on the Bitcoin network has an address as a transaction entry for the person to whom you sent the coins. When someone sends Bitcoin to you, the address they send is registered as a registered transaction input in the Bitcoin blockchain (encrypted and inaccessible to others), and your address is the registered transaction output of the Bitcoin network.

The person to whom you send the coin sends Bitcoin to another address, which in turn becomes a transaction input, and the Bitcoin address is the transaction output.

You can simply think of Bitcoin as a computer file stored in a digital vault on a laptop, or mobile phone. As people become more familiar and comfortable with accepting digital transfers of traditional bank-issued currency, Bitcoin and related altcoins will gain even more widespread adoption.