How Bitcoin Works ? The Complete Guide to Everything

How exactly to categorize Bitcoin is a matter of controversy. Is it a currency type, a store of value, a payment network or an asset class?

Fortunately, it’s easier to define what Bitcoin really is. It’s software. Don’t be fooled by archival images of shiny coins stamped with modified Thai baht symbols. Bitcoin is a purely digital phenomenon, a set of protocols and processes.

It is also the most successful of hundreds of attempts to create virtual money through the use of cryptography, the science of making and breaking codes. Bitcoin has inspired hundreds of imitators, but it remains the largest cryptocurrency by market capitalization, a distinction it has maintained throughout its more than a decade-long history.

Bitcoin is a network that runs on a protocol known as blockchain. A 2008 document by a person or people calling themselves Satoshi Nakamoto first described both blockchain and Bitcoin and for a time the two terms were almost synonymous.

Blockchain has become a separate concept, and thousands of blockchains have been created using similar cryptographic techniques. This story can make the nomenclature confusing. Blockchain sometimes refers to the original Bitcoin blockchain. At other times it refers to blockchain technology in general, or any other specific blockchain, such as the one that powers Ethereum.

The fundamentals of blockchain technology are mercifully simple. Any given blockchain consists of a single discrete blockchain of information, organized chronologically. In principle, this information can be any string of 1s and 0s, which means it could include emails, contracts, title deeds, marriage certificates or bond exchanges. In theory, any type of contract between two parties can be established on a blockchain as long as both parties agree on the contract. This eliminates any need for a third party to be involved in any contract. This opens up a world of possibilities that include peer-to-peer financial products, such as decentralized loans or savings and current accounts, where banks or any intermediary are irrelevant.

While the current goal of Bitcoin is a store of value and a payment system, there is nothing to say that Bitcoin cannot be used that way in the future, although a consensus should be reached to add these systems to Bitcoin. The main goal of the Ethereum project is to have a platform where these “smart contracts” can occur, thus creating a whole realm of decentralized financial products without intermediaries and the fees and possible data breaches that accompany them.

This versatility has caught the attention of governments and private corporations; in fact, some analysts believe that blockchain technology will ultimately be the most shocking aspect of the cryptocurrency craze.

In the case of Bitcoin, however, the information on the blockchain is mostly transactions.

Bitcoin is really just a list. Person A sent X bitcoin to Person B, who sent y bitcoin to Person C, etc. by counting these transactions, everyone knows where the individual users are. It is important to note that these transactions do not necessarily have to be done from human to human.

Anything can access and use the Bitcoin network and your ethnicity, gender, religion, species or political leanings are completely irrelevant. This creates great possibilities for the Internet of things. In the future, we could see systems where autonomous taxis or uber vehicles have their own blockchain wallets. The car would be sent passenger cryptocurrency and would not move until funds are received. The vehicle could assess when it needs fuel and would use its wallet to facilitate a refill.

Another name for a blockchain is a “distributed ledger”, which emphasizes the key difference between this technology and a well-saved Word document. The Bitcoin blockchain is distributed, which means it is public. Anyone can download it in its entirety or go to any number of sites that analyze it. This means that the record is publicly available, but it also means that complicated measures exist to update the blockchain ledger. There is no central authority to monitor all bitcoin transactions, so participants themselves do this by creating and verifying” blocks ” of transaction data. See the “mining” section below for more information.

The long strings of numbers and letters are directions, and if you were in compliance Is a mistaken idea that the network of Bitcoin is completely anonymous, but taking certain precautions can make it very difficult to link with the transaction.

How to buy Bitcoin
Despite being absolutely public, or rather because of that fact, Bitcoin is extremely difficult to manipulate. A bitcoin has no physical presence, so you can’t protect it by locking it in a safe or burying it in the forest.

In theory, all a thief would have to do to take it away would be to add a line to the ledger that translates to “you paid me everything you have.”

A related concern is double spending. If a bad actor could spend some bitcoin, then spend it again, confidence in the value of the coin would quickly evaporate. To achieve double spending, the bad actor would need to make up 51% of Bitcoin’s mining power. The larger the Bitcoin network grows, the less realistic it becomes, since the necessary computing power would be astronomical and extremely expensive.

To further prevent it from happening, you need confidence. In this case, the solution accustomed to traditional currency would be to conduct transactions through a central and neutral arbitrator, such as a bank. Bitcoin has made it unnecessary, however. (Probably not a coincidence Satoshi’s original description was published in October 2008, when confidence in banks was at a multigenerational low. This is a recurring theme in the current coronavirus climate and growing public debt.) Instead of having a reliable authority to maintain the ledger and preside over the network, the bitcoin network is decentralized. Everyone watches everyone else.

No one needs to know or trust anyone in particular for the system to work properly. Assuming everything works as intended, cryptographic protocols ensure that each block of transactions is screwed to the last in a long, transparent and immutable chain.

The process that keeps this book public without trust is known as mining. Surrounding the network of Bitcoin users who exchange cryptocurrency among them is a network of miners, who record these transactions on the blockchain.

Recording a series of transactions is trivial for a modern computer, but mining is difficult because Bitcoin software makes the process artificially slow. Without the added difficulty, people could forge transactions to enrich themselves or bankrupt others. They could record a fraudulent transaction on the blockchain and accumulate so many trivial transactions that untangling fraud would be impossible.

In the same way, it would be easy to insert fraudulent transactions into past blocks. The network would become an extensive mess and spam of competing bookkeepers, and bitcoin would have no value.

The combination of” proof of work ” with other cryptographic techniques was Satoshi’s breakthrough. Bitcoin software adjusts the difficulty faced by miners to limit the network to a new block of transactions of 1 megabyte every 10 minutes. In this way, the volume of transactions is digestible. The network has time to examine the new block and the ledger that precedes it, and everyone can come to a consensus on the status quo. Miners do not work to verify transactions by adding blocks to the distributed ledger simply out of a desire to see the Bitcoin network run smoothly; they are compensated for their work. We’ll take a closer look at mining compensation below.

As mentioned above, miners are rewarded with Bitcoin for verifying blocks of transactions. This reward is halved every 210,000 blocks mined, or approximately every four years. This event is called the halving or the ” withdrawal.”The system is embedded as a deflationary one, where the speed at which new Bitcoin is released into circulation.

This process is designed for rewards for Bitcoin mining to continue until about 2140. Once all Bitcoin is mined from the code and all halves are finished, miners will still be incentivized by the fees they will charge network users. The hope is that healthy competition will keep rates low.

This system increases the stock-flow ratio of Bitcoin and reduces its inflation until it is finally zero. After the third halving that took place on May 11, 2020, the reward for each block mined is now 6.25 Bitcoins.

Here is a slightly more technical description of how mining works. The network of miners, who are scattered all over the world and are not linked to each other by personal or professional links, receives the latest batch of transaction data. They execute the data through a cryptographic algorithm that generates a “hash”, a string of numbers and letters that checks the validity of the information but does not reveal the information itself. (Actually, this ideal vision of decentralized mining is no longer accurate, with mining farms on an industrial scale and powerful mining pools forming an oligopoly. More on this below.)

However, you can take a bunch of data pretending to be block # 480504 and make sure they haven’t been tampered with. If a number were out of place, no matter how insignificant, the data would generate a totally different hash. As an example, if you were to run the Declaration of independence via a hash calculator

Hash technology allows the Bitcoin network to instantly verify the validity of a block. It would be incredibly slow to go through the entire ledger to make sure the person pulling the most recent batch of transactions hasn’t tried anything funny. Instead, the hash of the old block appears inside the new block. If the most minute detail had been altered in the previous block, that hash would change. Even if the alteration were out of 20,000 blocks in the chain, hashing that block would trigger a cascade of new hashes and divert the network.

However, generating a hash doesn’t really work. The process is so fast and easy that bad actors could still spam the network and perhaps, given enough computing power, pass fraudulent transactions a few blocks down the chain. So, the Bitcoin protocol requires proof of work.

It does this by throwing miners a curveball: your hash must be below a certain target. That’s why the hash of block # 480504 starts with a long string of zeros. It’s small. Since each string of data will generate one and only one hash, finding a sufficiently small one involves adding nonces (“numbers used once”) to the end of the data. Then a miner will run [thedata]. If the hash is too large, she will try again. [thedata]1. Still too big. [thedata]2. Finally, [thedata] 93452 gives you a hash that starts with the required number of zeros.

The mined block will be transmitted to the network to receive confirmations, which take another hour or so, although occasionally much longer to process. (Again, this description is simplified. Blocks are not Hashed in their entirety, but are split into more efficient structures called Merkle trees.)

Depending on the type of traffic the network receives, the Bitcoin protocol will require a longer or shorter string of zeros, adjusting the difficulty to reach a rate of a new block every 10 minutes. As of October 2019, the current difficulty is around 6.379 billion, up from 1 in 2009. As this suggests, it has become significantly more difficult to mine Bitcoin since the cryptocurrency was launched a decade ago.

Mining is intensive and requires large and expensive rigs and lots of electricity to power them. And it’s competitive. It is not known which nonce will work, so the goal is to plow them as quickly as possible.

At first, the miners recognized that they could improve their chances of success by combining into mining groups, sharing computer power, and distributing the rewards among themselves. Even when several miners split these rewards, there is still ample incentive to pursue them. Each time a new block is mined, the successful miner receives a bunch of newly created bitcoin. At first, it was 50, but then halved to 25, and now it’s 12.5 (around octubre 119,000 in October 2019).

The reward will continue to halve every 210,000 blocks, or approximately every four years, until it reaches zero. At that point, all 21 million bitcoins will have been mined, and miners will rely solely on fees to maintain the network. When Bitcoin was launched, it was planned that the total supply of the cryptocurrency would be 21 million tokens.

The fact that the miners have organized themselves into pools worries some. If a pool exceeds 50% of the network’s mining power, its members could spend coins, reverse transactions, and Re-spend them. They could also block the transactions of others. Simply put, this group of miners would have the power to overwhelm the distributed nature of the system, verifying fraudulent transactions under the majority power it would have.

That could spell the end of Bitcoin, but even a so-called 51% attack would probably not allow bad actors to reverse old transactions, because the proof-of-work requirement makes that process so laborious. To go back and disrupt the blockchain, a group would need to control such a large majority of the network that it probably doesn’t make sense. When you control the whole currency, who is it there to trade with?

A 51% attack is a financially suicidal proposal from the miners ‘ perspective. When, a mining group, reached 51% of the network’s computing power in 2014, voluntarily promised not to exceed 39.99% of the Bitcoin hash rate to maintain confidence in the value of the cryptocurrency. However, other actors, such as governments, might find the idea of such an attack interesting. But, again, the sheer size of Bitcoin’s network would make this overwhelmingly expensive, even for a world power.

Another source of concern related to miners is the practical tendency to concentrate in parts of the world where electricity is cheap, such as China, or, after a Chinese crackdown in early 2018, Quebec.

Bitcoin transactions
For most people involved in the Bitcoin network, the ins and outs of blockchain, hash rates, and mining are not particularly relevant. Outside the mining community, Bitcoin owners usually buy their supply of cryptocurrencies through a Bitcoin exchange. These are online platforms that facilitate Bitcoin transactions and often other digital currencies.

Bitcoin exchanges like Coinbase bring together market participants from around the world to buy and sell cryptocurrencies. These exchanges have become increasingly popular (as Bitcoin’s popularity has grown in recent years) and are fraught with regulatory, legal and security challenges. With governments around the world viewing cryptocurrencies in various ways-as a currency, as an asset class, or any other classification-the regulations governing the buying and selling of bitcoins are complex and constantly changing. Perhaps even more important to the participants of the Bitcoin exchange than the threat of changing regulatory oversight, however, is that of theft and other criminal activities. While the Bitcoin network itself has been largely secure throughout its history, individual exchanges are not necessarily the same. Many robberies have targeted high-profile cryptocurrency exchanges, often resulting in the loss of millions of dollars in tokens. The most famous exchange theft is probably Mt. Gox, which dominated the Bitcoin transaction space until 2014. Earlier that year, the platform announced the likely theft of about 850,000 BTC worth about cerca 450 million at the time. Mt. Gox filed for bankruptcy and closed its doors; to this day, most of that stolen reward (which would now be worth a total of about aproximadamente 8 billion) has not been recovered.

Keys and wallets
For these reasons, it is understandable that bitcoin traders and owners want to take possible security measures to protect their holdings. To do this, they use keys and wallets.

Bitcoin ownership essentially boils down to two numbers, a public key and a private key. A rough analogy is a username (public key) and a password (private key). A hash of the public key called address is the one displayed on the blockchain. Using the hash provides an additional layer of security.

To receive bitcoin, it is enough for the sender to know its address. The public key is derived from the private key, which you need to send bitcoin to another address. The system makes it easy to receive money, but requires identity verification to send it.

To access bitcoin, use a wallet, which is a set of keys. These can take different forms, from third-party web applications offering insurance and debit cards, to QR codes printed on sheets of paper. The most important distinction is between ” hot ” wallets, which are connected to the Internet and are therefore vulnerable to hacking, and “cold” wallets, which are not connected to the Internet. At Mt. Gox previous case, it is believed that most of the stolen BTC were taken from a hot wallet. Still, many users entrust their private keys to cryptocurrency exchanges, which is essentially a bet that those exchanges will have a stronger defense against the possibility of theft than the computer itself.

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