How does Bitcoin work?

As a new user, you can get started with Bitcoin without understanding the technical details. Once you have installed a Bitcoin wallet on your computer or mobile phone, it will generate your first Bitcoin address and you can create more whenever you need one. You can disclose your addresses to your friends so that they can pay you or vice versa. In fact, this is pretty similar to how email works.

If you however want to know more about the inner workings of bitcoin, the technical stuff… read on.

Balances – block chain

Contrary to the current money regulating system, bitcoins are sent through the network of public computers. All computers in the network must agree on all transactions being made in the entire bitcoin network.

The block chain is a shared public ledger on which the entire Bitcoin network relies. All confirmed transactions are included in the block chain. This way, Bitcoin wallets can calculate their spendable balance and new transactions can be verified to be spending bitcoins that are actually owned by the spender. The integrity and the chronological order of the block chain are enforced with cryptography.

Transactions – private keys

Bitcoins can be sent from a computer or smartphone without a trusted 3rd party. The processing and securing of transactions is done by servers called miners. Miners are private computers processing the transactions.

A transaction is a transfer of value between Bitcoin wallets that gets included in the block chain. Bitcoin wallets keep a secret piece of data called a private key or seed, which is used to sign transactions, providing a mathematical proof that they have come from the owner of the wallet. The signature also prevents the transaction from being altered by anybody once it has been issued. All transactions are broadcast between users and usually begin to be confirmed by the network in the following 10 minutes, through a process called mining.

Processing – mining

The miners communicate over the internet, confirming transactions by adding them to a ledger, also called a block. All miners must agree on a given transactions for it to be considered valid in the network. Each new confirmed ledger update, or found block, generates 12 new bitcoins.

This process is where all the bitcoins come from. Imagine being able to find gold nuggets with your computer. The number of new bitcoins created in each confirmed block is halved every 4 years until the year 2140 when all the bitcoins will have been found. The total number of bitcoins that can be found is 21 milion.

Mining is a distributed consensus system that is used to confirm waiting transactions by including them in the block chain. It enforces a chronological order in the block chain, protects the neutrality of the network, and allows different computers to agree on the state of the system. To be confirmed, transactions must be packed in a block that fits very strict cryptographic rules that will be verified by the network. These rules prevent previous blocks from being modified because doing so would invalidate all following blocks. Mining also creates the equivalent of a competitive lottery that prevents any individual from easily adding new blocks consecutively in the block chain. This way, no individuals can control what is included in the block chain or replace parts of the block chain to roll back their own spends.

With this structure the bitcoin system provides 2 key features:

  • Ensuring that every bitcoin is accounted for. This prevents double spending
  • There is no more need for a third trusted party like a bank.


Security and annonimity

Because all the blocks are chained in the code and published on the internet, every transaction in the entire bitcoin system can be verified by anyone. A worldwide public ledger containing every transaction. Only the account numbers, called wallet addresses are stored. The technique used in the bitcoin system, as described by Satoshi has been verified by highly regarded software and security engineers all over the world. Creating a bitcoin wallet can be done by installing a wallet on your computer or smartphone. This does not require any personal data or further registration.

Going down the rabbit hole

This is only a short and concise summary of the system. If you want to get into the details, you can read the original paper that describes the system’s design.

Where do I store Bitcoin?

The next chapter will explain what a wallet is and where you can get one.