How Bitcoin Works

how bitcoin works

 

Each Bitcoin user has one or more Bitcoin “address,” which is a digital account used to hold, send, or receive bitcoin.

A Bitcoin address is nothing more than a set of public & private cryptographic keys.

The public key is similar to a bank account number, and is what anyone would use to send bitcoin to your account.

The private key acts like a password or PIN, and is used to prove ownership of an address (thus, you shouldn’t share your private key with anyone).

Example Bitcoin Address

Public key: 1MsHWS1BnwMc3tLE8G35UXsS58fKiplB7a

Private key: 5HpHagT65TZzG1PH3CSu63k8DbpvD8s5ip4gEB3kEsreAbuatmU

Often, a number of Bitcoin addresses will be managed by one Bitcoin “wallet,” an account created with a Bitcoin wallet service (whether web-hosted or software).

The Block Chain

The core element of Bitcoin that makes it unique, compared to previous attempts at digital currency, is the block chain.

The block chain is essentially a public ledger system. Each time a Bitcoin transaction occurs between two or more addresses, it is registered on the block chain for all the world to see.

This is what prohibits double-spending, because once address A has sent bitcoin to address B, it can’t then send the same bitcoin to another address. If the owner tried to do so, the block chain would reject the second transaction.

As well, if the block chain didn’t have record of address A owning bitcoin in the first place, the attempt to send previously nonexistent bitcoin would be rejected. This is what prevents counterfeiting and artificial inflation.

Bitcoin Mining

The block chain is supported by “mining,” the process of using computing power in order to verify transactions and solve complex equations.

Once a Bitcoin miner (someone who “mines” Bitcoin) has verified a group of transaction as genuine, and solved a mathematical challenge, the transactions are added to the block chain as a “block.”

Miners are compensated for their efforts by transaction fees, and a reward generated after each successfully completed block (which is the only way new bitcoin may enter the economy).

Currently, the block reward is 25 bitcoin (or “25 BTC”), but that reward will decrease over time. Eventually, as the mining reward continues to shrink, the transaction fees will become the primary financial incentive to mine.

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