Guide: How Does Bitcoin Work?

Over the years, we have heard a lot about cryptocurrencies. Cryptocurrency is digital money – there’s no physical bill or coin. And today, we see the world divide into crypto-positive and crypto-negative people. For some, cryptocurrency is just hokum, and for others, it is the future of online transactions and business ventures. Bitcoin is the first and oldest cryptocurrency that emerged. Also, it is the most highly valued digital currency as well. At the time of writing this article, 1 BTC was trading at US$58,139. Do you ever wonder how something that was valued at a mere $1 back in 2011 has grown to be humongous?

Bitcoin transactions have seen a huge surge recently. Last month, billionaire and Tesla Inc. CEO Elon Musk invested $1.5 billion in Bitcoin. He said that the inability to receive a return on Tesla’s cash was the primary reason behind Bitcoin’s purchase. With more and more influential people promoting and believing in Bitcoin among other cryptocurrencies, it has put potential investors, non-believers, and newbies in a curious state. Today, people are drawn to Bitcoin. They want to know about Bitcoin mining, Bitcoin wallet, how does Bitcoin works, and who really is Satoshi Nakamoto.

In this post, we are going to discuss everything you need to know about the world’s most popular digital currency and how it works. Without further ado, let’s jump right into it.

An Overview of Bitcoin Blockchain

Years after skepticism, Bitcoin is gaining mainstream popularity at last. Created in 2009 by an unknown individual using the alias Satoshi Nakamoto, Bitcoin lets you transact and exchange money in a different way than you normally do. Transactions are anonymous and are made with no intermediaries or brokers. This is why it is called decentralized digital currency. Decentralized means it is not controlled by a government body or a bank.

At this very moment, you can use Bitcoin everywhere, from PayPal to Overstock.com and more. The list is expanding rapidly.

Now, Bitcoin and blockchain go hand in hand. Blockchain is the technology that enables the existence of digital currencies, among other things. Blockchain technology was specifically invented for Bitcoin. It is a decentralized ledger that is highly secure. All the transactions occur peer to peer, and the participants can confirm transactions without the involvement of a central clearing authority. The primary use cases of blockchain technology include fund transfers, voting, settling trades, and more.

How does blockchain work?

  1. Someone requests transactions
  2. The requested transaction is broadcast to a peer-to-peer network that comprises computers, known as nodes
  3. The network of computers or nodes validates the transaction and the status of the user using a robust algorithm
  4. A verified transaction can involve Bitcoin and other information
  5. Once the transaction is verified, it is combined with other transactions for creating a new block of data for the digital ledger
  6. This new block is then added to the existing blockchain, ensuring that it is unalterable and permanent
  7. Finally, the transaction is complete

Benefits of blockchain and unknowns

Benefits Unknowns
Cost reduction Competing platforms
Permanent ledger Implementation challenges
Accurate tracking Regulatory implication
Increased transparency Complex technology

What Makes Bitcoin Unique?

If you are new to the Bitcoin space or cryptocurrency overall, the last couple of years have been pretty happening. There have been some heart-stopping drops and steep climbs, making a roller coaster ride filled with emotion that is difficult to control.

Some of the pro-Bitcoin enthusiasts emphasize the difference between Bitcoin and other potential sources of private money. They point out that Bitcoin is digital, so it doesn’t have storage or physical production issues. Most importantly, it is impossible to meltdown a Bitcoin and pass it off as 2 Bitcoins, therefore ruling out the need for governments playing a role in verifying and securing it.

Nevertheless, enthusiasts also think Bitcoin is unique because it can only be created using a special algorithm that essentially limits the total number of Bitcoins to just 21 million. And thanks to blockchain technology, it guarantees that the payments are irreversible and anonymous.

What Gives Bitcoin Value?

Being the world’s first decentralized digital currency, Bitcoin’s value primarily comes from it being an asset that no government body, authority, organization, or a single person has control over. Simply put, anyone can buy Bitcoin or receive it in a Bitcoin wallet, and nobody can tell them what they should do with it and what they cannot. So, what gives Bitcoin value is that:

  • It is free from the control of any authority. Therefore, it cannot be manipulated, devalued, or printed at will.
  • It is borderless, making it incredibly easy to exchange across any location.
  • It is apolitical. That is, it doesn’t favor a particular group of people or system.
  • Bitcoin has a limited supply of 21 million coins that will never be changed.

Overall, it isn’t easy to understand why Bitcoin is valuable to people, particularly to those living in developed nations. For them, fiat is most likely very sound. But in order to understand the true value of Bitcoin, people need to realize why fiat currency is unsound.

The problem with the fiat money system is that its value has decreased since the day it was taken off of the gold standard.

How Many Bitcoin (BTC) Coins Are There in Circulation?

As said, the Bitcoin network is worth 21 million BTCs. That is, there are only 21 million Bitcoins in existence. Pro enthusiasts like to compare Bitcoin with gold in many ways. For starters, like gold, Bitcoin cannot be created arbitrarily. You need to work to mine or extract it.

Though gold is mined from the earth, BTC is mined via computational means. But, it has a limited and finite supply. Once all the 21 million Bitcoins are mined, the mining will come to an end. Every new Bitcoin is introduced to the Bitcoin supply as a new block. And in every 4 years, the amount of Bitcoin released in these blocks is halved. It is called Bitcoin halving.

As of February 2021, approximately 18.638 million BTCs have been mined. This means that the remaining 2.363 million Bitcoins are yet to be introduced into circulation.

What is Bitcoin Halving?

As discussed in the above section, Bitcoin halving is the process of reducing 50% of the rewards of mining Bitcoins after each set of 21 million blocks is mined. As more blocks are mined, it reduces the rewards of mining Bitcoin, ensuring that the amount of Bitcoin in circulation doesn’t increase drastically. This is what influences the price of Bitcoin in the majority of cases.

For every 21 million blocks that are mined, the reward for mining a block is halved. In Bitcoin’s early days, for the first 21 million blocks, the reward was 50 BTC per block. Over the years, more and more blocks were mined and more BTCs went into circulation.

By 2012, the first set of 21 million blocks were mined. And the reward was halved to 12.5 BTC. Last year in May, the latest halving occurred. The third set of halving took place with the reward cut down to 6.25 BTC per block.

So, Bitcoin mining occurs in 4-year intervals. The next halving is expected to take place in 2024.

How Is The Bitcoin Network Secured?

Bitcoin is cryptographic, distributed, irreversible, and public. So, attacking and taking control of the Bitcoin network is nearly an impossible prospect. Also, hijacking the blockchain or brute-forcing the private keys by controlling 50% of the Bitcoin network’s computational power is impossible.

Bitcoin is also called the ‘original cryptocurrency.’ It uses a public and private key to make sure the integrity and authenticity of transactions are maintained. Also, Bitcoin’s digital signatures are signed via ECDSA (Elliptical Curve Digital Signature Algorithm). It is a cryptographic algorithm that ensures funds can only be spent by their rightful owners.

The following are the few concepts related to the Elliptical Curve Digital Signature Algorithm:

  • Private Key: It is a secret number that the person who has generated it has access to. A private key is a randomly generated number that gives the Bitcoin owner the ability to spend the funds. In Bitcoin, it is a single 256-bit unsigned integer.
  • Public Key: It is a number that doesn’t need to be kept a secret. A public key is used to identify if a signature is genuine or not.
  • Signature: A signature is a numerical value that proves a signing operation has taken place.

Bitcoin Mining Explained

In simple terms, bitcoin mining is the process of digitally adding transaction details to the blockchain. It is best described as the process of discovering new Bitcoin. As you already know, a blockchain is a publicly distributed ledger that holds the record and history of every Bitcoin transaction. Each block contains information about a group of Bitcoin transactions.

So, Bitcoin mining is a record-keeping process that is implemented via immense computational power. The Bitcoin miners across the globe contribute to a decentralized P2P network to make sure the payment network is secure and trustworthy.

Miners use high computing power to solve complex mathematical problems. When they find a solution to a particular problem, a new block of confirmed transitions is added to the already existing blockchain.

The miner who contributed to the network by solving the problem is given an incentive in the form of a block of the blockchain.

Basics of Bitcoin mining:

There are three ways using which you can acquire Bitcoin-

  1. Mine new Bitcoin
  2. Receive them in exchange for products and services
  3. Purchase them on an exchange

How a Bitcoin Transaction Works?

In the Bitcoin whitepaper, Satoshi Nakamoto, the creator of Bitcoin, stated that BTC exists as records of Bitcoin transactions.

A Bitcoin transaction comprises of three parts:

  1. Input: An input is a record of the Bitcoin address from which you received the Bitcoin that you want to send to someone else
  2. Amount: An amount is the amount of Bitcoin that you want to send to someone else
  3. Output: The output is the receiver’s public key. It is also known as the ‘Bitcoin Address.’

In order to send Bitcoin to someone, you will need to have access to the private and public keys associated with the amount of Bitcoin you want to send.

A sample Bitcoin transaction:

Suppose you have 2 BTC in your Bitcoin wallet. You received them from 4 different sources – 0.5 BTC each. While the wallet will show your holdings as 2 BTC, your Bitcoin wallet doesn’t really add up four 0.5 BTC transactions to make it 2 BTC. The reality is that your wallet will keep track of the four 0.5 BTC transactions separately.

Now, when you go out to buy something with Bitcoin, your BTC wallet will use the transaction records of each amount that you wish to spend. Suppose the bill generated is 0.25 BTC. Please note that you cannot split a transaction into smaller amounts, and you can only spend the entire output of the transaction.

Thus, when you type 0.25 BTC to send to the merchant, what will happen is that one of the 0.5 BTC transactions you received will be sent wholly. The difference, which is 0.25 BTC, is then returned via a new transaction.

Simply put, you will send the available transaction in its entirety to the merchant. The merchant will keep the billed amount and send you a new transaction as the ‘change.’

Though it sounds confusing, the best thing is that Bitcoin owners don’t necessarily have to know about this in order to send and receive Bitcoin.

How much are Bitcoin transaction fees?

A Bitcoin transaction fee is the fee charged in USD when a BTC transaction is processed by the BTC miner. The fee can fluctuate based on the periods of congestion on the Bitcoin network.

Please note that a single block of Bitcoin blockchain cannot contain more than 1 MB of information. Therefore, the transaction fees will depend on the transaction size.

Nevertheless, the majority of Bitcoin wallets use dynamic fees, meaning they change all the time based on the transaction size and current network conditions.

Bitcoin owners are given the option to choose between regular fee and priority fee. The regular fee can be lower and is meant for Bitcoin owners who can afford to be patient. The priority fee, on the other hand, is calculated to include your transaction in a block within an hour. So, it can be expensive.

Overall, the average fee for a Bitcoin transaction is $23. However, it can fluctuate between $23 and $31—the fee increases when the blockchain gets congested.

How Are Bitcoins Spent?

In the beginning, there weren’t many options for Bitcoin owners to effectively use BTC. However, today, you can spend your BTC on almost anything in a variety of places and businesses, both online and offline.

From tipping and charity to buying common household items, you can spend Bitcoins in any way you want. The following is a comprehensive list of items or things that you can buy with Bitcoin:

  • Food items like pizza, fried chicken, cheese, and more
  • Drink and beverages like coffee, wine, soda, energy drinks, and more
  • Shoes and clothing like tees and tops, costumes, footwear, and more
  • Luxury cars like Rolls Royce, Bentley, Mercedes, Bugatti, and more
  • Bikes, motorcycles, aircraft, and more
  • Electronics like laptops, smartphones, tablets, and more
  • Household items like furniture, grocery, even a house, and more

Is Bitcoin infinite?

Bitcoin is definitely not infinite but scarce. In other words, it is infinitely divisible in theory, meaning there still can be an infinite number of units, but not infinite value. Bitcoin has a market cap of over $400 billion. And as long as you hold Bitcoins, you will have your share of that market cap.

Is it Safe?

Please try to understand that as with trading and buying fiat and commodities, purchasing Bitcoin isn’t free of risk. You may buy and sell Bitcoin based on how the cryptocurrency is performing. But, you cannot say that it is totally safe. Its volatile price makes it riskier than other types of investments. Nevertheless, its volatility is what makes it profitable as well.

All you have to do is keep your Bitcoin stored safely in a dedicated app or a device that isn’t connected to the internet.

Conclusion

So, that’s it. This is everything you need to know about Bitcoin – the world’s more profitable cryptocurrency. Whether you are an investor or an enthusiast seeking entry into the crypto world, it is better that you understand the market first to make an informed decision. The Bitcoin market is highly volatile, and thus, you should know your next moves before something bad happens. Overall, it is said to be the future of transactions and all businesses. So, let’s wait and see how it turns out to be.

FAQ

Unfortunately, yes, as long as you store your Bitcoin on the internet. Hackers use this popular method called phishing to log into your system and access confidential data. You are advised to use quality and trustworthy wallets for Bitcoin. Also, you can use physical cold wallets to store your Bitcoin.

Bitcoin ensures transaction security by means of blocks. It uses a hash-based Proof of Work (PoW) mechanism to keep the blocks secure. The fact that Bitcoin has never been hacked since its inception should give you confidence in its system.

Sometimes the Bitcoin network traffic is so high that it can compromise the transaction, making users wait longer than usual before it is confirmed. The increasing demand for transactions per block has exceeded the usual capacity for a block to process transactions. Ultimately, the transactions are put in queues for confirmation by the Bitcoin miners.

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