How Bitcoin works

By November 3, 2014Bitcoin Business
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A lot of what makes Bitcoin new and interesting is that, for the first time, it lets two people securely exchange value online without a bank, government, company, or any other central authority between them. Here's a very high level example of how it works. Let's say that I want to send you one Bitcoin. This wallet includes my own Bitcoin address. Which is a compressed version of something known in cryptography as a public key. It also contains data needed to sign transactions, known as my private key.

The private key data must be kept hidden because anyone who gets my private key can access and spend my Bitcoins. So, I tap Send Coins, type in your address, and the amount to pay and then tap Send. The wallet uses my private key to sign the transaction, then it publishes a signed copy of it to the entire Internet. The balance in my wallet immediately goes down by one Bitcoin and the balance in yours goes up by the same amount. Out on the Bitcoin network our transaction gets bundled into a block with other transactions.

This block is tied shut with a cryptographic puzzle, which specialized computers called Miners compete to solve. Whichever computer solves the block puzzle first is entitled to claim any transaction fees that were included in that block, along with a block reward of some Bitcoins. This is actually how new Bitcoins are introduced to the world. The Miner publishes the soft block and it becomes part of the public ledger known as the block chain. This block solving process takes about ten minutes but we're not done yet, your wallet shows that you've been paid 1 Bitcoin but its not spendable yet.

You see, several Miners might have solved a block at essentially the same time and they're all competing to have their block be the next official one on the block chain. The passage of time solves all these conflicts. Without getting into the details, every additional block that gets solved confirms the ones that come before it. So, it's best to wait for confirmation of a few more blocks, after the one containing your transaction, before you treat it as irreversible and you treat the Bitcoins as spendable. This all happens in about an hour. Now, at first, you might think that, that's a lot slower than credit card transactions, which only seem to take a few seconds.

But in reality, those credit card settlements can take days and they can be disputed for weeks or months. They only seem to be fast because the credit card company is guaranteeing the transaction in exchange for some pretty high fees. The same is true for checks, which really take a few days to be cleared by the bank. By comparison, 60 minutes for Bitcoin isn't so long. Earlier, I said that Bitcoin works without a central authority between the sender and the recipient. What's replaced it, is this worldwide network of Miners where nobody is powerful enough to disrupt the entire network.

Now it's not a foolproof system and I'll talk about its potential problems in another video, but so far it's proven remarkably resilient. I skimmed over a lot of details on how Bitcoin works. Really explaining it fully requires sophisticated references to computer networking, to automated conflict settlement, cryptography and a host of other specialties. Fortunately, the source material is all easy to find if you want to find that stuff out. First and foremost is the original Bitcoin paper, available at bitcoin.org/bitcoin.pdf.

Then there's the Bitcoin Wiki at bitcoin.it. Finally, there's lots to explore on the Bitcoin Foundation's official site at bitcoin.org or bitcoin.com.bd

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