What is bitcoin and how it works?

The Bitcoin system was created in 2008 by a fabled Satoshi Nakamoto, an individual or a group of people whose true identity is still unknown. The Satoshi’s White Paper published that year explained in details the principal ideas of Bitcoin and the revolutionary technology that stood behind the digital coins. As peer-to-peer electronic cash, Bitcoin solved a notorious double-spending problem and offered a fresh approach to ‘trusted third parties’. As opposed to conventional currencies minted and issued by banks, Bitcoin is not governed by any institution or regulatory body. ‘Bitcoin’, a currency unit, circulates only within a computer network and is generated as a result of complex mathematical procedures that is traditionally called ‘mining’.

Bitcoin in simple terms

A bitcoin does not work as dollars, euros or other fiat currency – it is not traded in a physical form. In fact, a bitcoin is a chain of electronic signatures that exist only online. Every bitcoin owner transfers bitcoins by digitally signing the previous transaction, and this information is added to the end of the chain. In simple English, a bitcoin consists of the list of all previous owners and transactions. The key advantage of this scheme is that it cannot be falsified since all the transactions between peers are put into blocks and announced publicly to the entire network.

The blocks are organized into a blockchain or a huge public ledger that includes records of all transactions ever made by bitcoin owners, and this underpins the main drawback of Bitcoin; the ledger becomes more sizeable over time and it requires more computational power to process all previous bitcoin transactions. At the time of writing, the total blockchain size was 155 Gb and it keeps growing by about 5 Gb monthly.

Bitcoins are transferred directly between participants without a third party involved. In case of physical currency, there is a regulatory authority or a central bank that is held responsible for maintaining a legitimate nature of all transactions and taking measures against counterfeiting. Bitcoins work different: there’s no central entity to manage digital transactions and their verification is conducted by all participants in the bitcoin network who run a special software. To avoid double-spending, that is paying the same bitcoin more than once, all validated transactions are timestamped in order to prove the time of each bitcoin move in chronological order.

A bitcoin is a currency unit that has a ticker symbol of BTC or XBT. Smaller units are named an mBTC (a one-thousandth of a bitcoin or 0.001 BTC) and a satoshi (a one-hundred millionth part of a BTC).

What is bitcoin mining?

Paper currencies are regularly minted and brought to circulation and the number of dollar or euro bills steps up regularly. The Bitcoin system was mathematically established in a way to limit the total number of bitcoins that can ever be created to approximately 21,000,000. Recall that cryptocurrency is not minted – new bitcoins are ‘mined’.

Miners are individuals or big bitcoin farms that provide computing power of their devices to verify that new transactions within the bitcoin ecosystem are valid. Miners arrange new unspent transactions into blocks and try to solve a complex and time-consuming mathematical task of finding a number, known as a nonce, that lies in the range between 0 and roughly 4.2 billion. That number must produce a specific result when passed through the hash and combined with the block content. It takes about 10 minutes to confirm a block and one of the miners who contributed to the process receives a certain amount of bitcoins as a prize. Mining involves the use of computation power, which entails expenses on electricity consumed by the computing hardware, so the bitcoins awarded for solving the math task is a kind of incentive to miners. According to estimates, around 80% of all bitcoins have been produced so far, and the number of bitcoins granted to miners as a reward will be going down.

Irreversible transactions

It is not impossible to cancel a bitcoin transaction after being sent since no one has control over the system. So a sender needs to double-check every detail (a recipient address and amount) before clicking send. Failure to do this can result in the funds being channeled to a wrong recipient without any chance to retrieve them.

Security

Every bitcoin owner has an automatically generated private key which is tied to a specific digital wallet and is used to send cryptocurrency. A private key is a string of 64 characters (numbers 0–9 and letters A–F) related to a bitcoin address. If cryptocurrency needs to be received, the recipient informs his bitcoin address, also known as a public key, to the sender. If bitcoins need to be sent, the sender uses his private key to digitally sign the transaction and transfer an amount of bitcoins to the recipient’s address. The public-private key pair is absolutely resistant to brute force, and the digital coins can be transferred only by the person who knows his unique private key. So it is of importance to keep the keys in a safe location: on a hard drive, USB flash drive or on paper.

Anonymous transactions

Chapter 10 in Satoshi’s White Paper is about privacy. It reads that the conventional banking model maintains a proper level of privacy by not disclosing the names of the parties involved in transactions. But as identities are always linked to transactions, some information can leak out due to bank security breach or hacking. In Bitcoin, the network participants can see that someone moves digital coins to someone else but the identities of both are unknown. However, the Bitcoin’s anonymity is not full because there are some methods allowing to link a bitcoin address to its owner by tracing all related transactions. That is why, Bitcoin is considered to be a pseudonymous system, not the anonymous one.

To stay on the safe side and avoid your privacy being compromised, it is worth to follow these simple advice: