How does Bitcoin Work?

An Overview of the Bitcoin Network

Written by the Lightning Pay Team

Updated Nov 28, 2024

 

Bitcoin is a decentralized digital currency that enables peer-to-peer transactions without the need for intermediaries like banks. It operates on a global network of computers, ensuring secure and transparent transactions. 

Every participant of Bitcoin has a copy of all the transactions, they only accept and transmit transactions that are valid (the owner had the coins in the first place, and didn't send them twice). This ensures security, transparency, and immutability of the transactions.

Here’s an overview of how it works:

The Bitcoin Blockchain

At the heart of Bitcoin is the blockchain—a public ledger recording all transactions. Each block contains a list of transactions, a timestamp, and a reference to the previous block, forming a chronological chain. This design ensures that once information is added, it becomes immutable, safeguarding the integrity of the transaction history.

Decentralization

Bitcoin's network is decentralized, maintained by numerous nodes (computers) worldwide. Each node holds a copy of the blockchain, making the system resilient against failures or attacks on any single point. This decentralization eliminates the need for a central authority, granting users full control over their funds.

Bitcoin Transactions

To initiate a transaction, a user creates a digital message specifying the recipient's address and the amount to send, then signs it using their private key. This signature verifies the transaction's authenticity without revealing the private key. The transaction is then broadcast to the network, where nodes validate it against the blockchain's history to prevent double-spending.

Mining and Proof of Work

Miners play a crucial role by grouping pending transactions into blocks and competing to solve complex mathematical puzzles—a process known as proof of work. The first miner to the puzzle first gets rewarded with newly minted Bitcoin (block reward) and transaction fees from all the transactions they included into their block. Once a block is "mined", it is broadcast to the network and added to every node’s copy of the blockchain, and the transaction is confirmed.

Bitcoin Addresses and Keys

A Bitcoin wallet is a digital tool that performs various functions. Sometimes these jobs are done in one place, and sometimes these roles are split between different tools.

  • Stores private and public keys.
    • Public Key: Used to generate a Bitcoin address to receive Bitcoin.
    • Private Key: Used to sign transactions to spend Bitcoins.
  • Generates new addresses from the public key
  • Constructs transactions and broadcasts them to the network

Only the owner of the private key can spend Bitcoin associated with a specific address. It's crucial this private key remains a secret, only accessible by the owner of the bitcoin it controls.

Limited Supply

Bitcoin's protocol caps the total supply at 21 million coins. This finite supply is enforced by the network's consensus rules, making it impossible to create more bitcoins beyond this limit.

Security and Trust

Bitcoin's security stems from its decentralized structure, cryptographic principles, and economic incentives for miners. The transparent nature of the blockchain and the open-source nature of the Bitcoin code allows anyone to verify transactions, fostering trust without relying on centralised entities.

Key Features of Bitcoin

  • Decentralized: No central authority controls Bitcoin.
  • Global and Permissionless: Anyone with internet access can use it.
  • Immutable: Transactions cannot be reversed or altered once confirmed.
  • Pseudonymous: Users transact using Bitcoin addresses, not personal identities.

Understanding these components provides insight into how Bitcoin functions as a revolutionary digital currency, offering an alternative to traditional financial systems. 

As always, if you have any questions about these concepts, you can keep learning at Lightning Pay, or feel free to contact us.